Patrick Nolan

What do you need to know ahead of the Spending Review – Welfare

What do you need to know ahead of the Spending Review – Welfare
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This is the fourth of our posts with Reform looking ahead to the Spending Review. The first three posts were on health, education, and the first hundred days.

What is the budget?

The welfare budget must be at the heart of the debate on how to restore the public finances. The Government spends more on welfare than anything else. In 2009 the bill for social protection was around £199 billion. This has almost doubled in real terms over the last 20 years from £104 billion in 1989. Social protection now represents 32.5 percent of all government expenditure or 14.2 per cent of GDP.

Some welfare spending varies with economic conditions, with increasing unemployment, for example, leading to greater expenditure on assistance to support people back into work. Yet since 2000 spending on welfare has increased even when the economy was growing. Rather than reforming welfare to support enterprise and mobility during this period of growth, entitlements were expanded to groups not in need. Failure to undertake reform while the economy was growing was a wasted opportunity and means that welfare spending now needs to be curbed in the face of deteriorating public finances and economic conditions.

Where does the money go?

The main areas of expenditure on welfare are on elderly people and families. Only 12 per cent of welfare expenditure is spent on the major out of work benefits, while 42 percent (around £80 billion) is spent on the elderly and 21 percent (around £41 billion) is spent on working families. In 2008, 60 percent of households were in receipt of at least one benefit. This figure rises to 93 percent for households with children. Expenditure on key welfare programmes for 2009-10 includes:

•    Basic State Pension – £53.7 billion

•    Housing Benefit – £19.5 billion

•    Child Tax Credit – £16.2 billion

•    SERPS and Second State Pension – £13.2 billion

•    Child Benefit – £11.8 billion

•    Disability Living Allowance – £11.4 billion

•    Pensions Credit (Savings and Guarantee) – £8.3 billion

•    Income Support – £8.2 billion

Is the money well used?

Although the UK government spends a relatively high amount on welfare this spending performs poorly. As Reform research has demonstrated the UK is spending at European levels for poor American results. Attempts to use an extensive system of benefits to improve social outcomes have proved ineffective. Poor quality spending, not a lack of spending, is the major social policy problem.

By international standards the outcomes for children are poor in the UK. The UK is worse than average for overall child well-being, with high rates of risky behaviours, high levels of underage drinking, high teenage pregnancy rates and more than 10 per cent of 15 to 19-year-olds not being in school, training or work and education. Indeed, as the OECD has noted, the rates of drunkenness are the highest in the OECD, with one in three 13 to 15 year olds having been drunk at least twice, and the teen pregnancy rate being fourth highest in the OECD.

Improving outcomes while reducing costs will require reform in three areas: assistance for working-aged households, middle class welfare and the cost of pensions.

Assistance for working-aged households

On welfare for working-aged people the Government has set out an agenda of reform to reduce poverty through emphasising “Big Society” not big government, while Frank Field has begun a review of poverty and opportunity. Making progress on this agenda requires focussing on reducing the mobility blocks contained in the benefit system and improving educational outcomes for the poorest. This also requires seizing local initiative and innovation and moving the welfare system from the economics of redistribution to the economics of growth and mobility.

Rt Hon Iain Duncan Smith MP set out proposals for a comprehensive reform of the welfare system. The goal is to replace 51 benefits with a single and flexible allowance.  It has been claimed that this reform would allow people with jobs to retain more of their benefits and ensure that people who work will always be better off than people on benefits. While introducing proposals for simplification of welfare is common among new governments around the world little tends to come of these proposals. This is because of their problems of fiscal cost (with them requiring large upfront spending) and fairness (as some differences in people’s circumstances will no longer be taken into account when assessing assistance).

Middle class welfare

Reform has estimated that the cost of middle class welfare (benefits paid to wealthier families) at £31 billion. Reform defined middle class as a household in which every adult has £15,000 in income and every child £5,000 annually. For a couple with one child the threshold would be £35,000. The most poorly targeted areas of middle class welfare are the universal Child Benefit and pension gimmicks such as the Winter Fuel Allowance, free TV licences and bus passes. Twice as much is spent on Child Benefit as on Job Seekers Allowance, close to 90 per cent of spending on the winter fuel allowance goes to people who are not in fuel poverty, and free bus passes account for close to a third of all government spending on busses.

Improving the targeting of spending would make the welfare system stronger and more just. Experience shows that poorly targeted spending leads to less generous support for poor families. Even a small increase in the generosity of a universal programme comes at a very large financial cost, meaning resources have to be spread thinly and less is available for poor families.  Although spending on middle class welfare is expensive and represents poor value for money the Coalition has been, aside from the cases of a relatively few small programmes such as the Child Trust Fund, reluctant to require well-off families to take greater responsibility for themselves.

The cost of pensions

Over 40 per cent of the welfare budget is already spent providing support for pensioners at a cost of around £80 billion a year. In the Emergency Budget the Coalition committed to restoring the link between the core state pension and wages. Even before this commitment, the cost of assistance to pensioners was forecast to increase by £162 billion (in today’s dollars) by 2050. This commitment will mean the cost will be higher by £21 billion (in today’s money) by 2050.

It has been argued that bringing forward the already planned increase (from 2026 to 2016) in the retirement age will address these costs but this is not correct. Costs will be higher in the period up to 2016 and after 2024, when the pension age will be back on its current trajectory, any cost savings from bringing forward the retirement age will be minimal.  The Government remains in denial over the need to amend the pensions system. This denial will cost younger generations dearly.

Further reading

Bassett, D., T. Cawston, A. Haldenby, P. Nolan, L. Parsons, N. Seddon and K. Trewhitt (2010), Budget 2010: Taking the tough choices, Reform.

Cawston, T., A. Haldenby and P. Nolan (2009), The end of entitlement, Reform.

Duncan Smith, Rt Hon Iain (2010), 21st Century Welfare, Department for Work and Pensions.

House of Commons Environment, Food and Rural Affairs Select Committee (2009), Energy efficiency and fuel poverty: Third report of session 2008-09.

Nolan, P (2010), ‘The First Hundred Days,’ The First Hundred Days, Reform.

OECD (2009), ‘Country Highlights: United Kingdom,’ Doing Better for Children, OECD, Paris.

Oxera (2009), Securing best value and outcomes for taxpayer subsidy of bus services, Local Government Association.

PPI (2010), PPI Submission to the DWP’s State Pension Age Review, Pensions Policy Institute, Lo

Patrick Nolan is Chief Economist at Reform.