Making Work Pay

November 11, 2010 9:05 PM


 

The jobs boom didn't help

All credit to Iain Duncan Smith for pressing on with his welfare reform package in the face of a bare fiscal cupboard.


He hasn't been able to achieve as much as we'd hoped and proposed back in the summer (see here), but he has managed to hold on to the crucial central feature of any meaningful reform of working age welfare - that work should always pay.


Under his planned Universal Credit the poor will no longer face effective marginal tax rates on their earnings in excess of 80% (ie they will no longer lose 80 or 90 pence or more of every extra pound they earn). Instead, the maximum anybody will lose is 76% (the combined effect of a 65% benefits withdrawal rate overlaid on 20% basic income tax rate, plus employees' National insurance).


Yes, that is still far too high - much higher than the 55% fixed maximum we incorporated in our own proposal. But the Universal Credit is much simpler than the current impenetrable morass, and that will eventually save administration costs and cut the losses from fraud and error. Most importantly, it at last it offers the poor some certainty - certainty that they will always be better off working than not working.


Here's how the Universal Credit will look for two key groups - single people, and couples with two children. The charts show how their net incomes increase according to how many hours they work, assuming they are earning the minimum wage. We can see how both groups are almost always better off under the new system compared to the existing arrangements, and that they are always better off working more hours:




Moreover, Duncan Smith has pledged something our proposal did not offer - that nobody will be any worse off under his plan than under the current system.


 Clearly that is a very reassuring promise, but it is also very expensive. Which is why we didn't propose it, and why, despite the additional £2bn IDS has set aside to smooth implementation, there is not enough money to fund lower effective tax rates.


As we have discussed many times, there are some extremely difficult choices here. Everyone wants to cut those high effective marginal tax rates in order to provide a compelling reward for working. But it is enormously expensive - our own calculations suggested that to cut the effective tax rate by 10 percentage points would cost £10 - 20 bn pa.


So in these tough fiscal times where are we to find the money? Our answer was to cut the official definition of the poverty line from 60% to 50% of median income, which we reckoned would save £20 - 30bn pa. And that would fund a substantial cut in marginal tax rates, making work much more attractive to the poor.


Duncan Smith has shied away from such a dramatic change. The White Paper reports that DWP have studied our proposal but they don't like the prospect of "substantial numbers of people in vulnerable situations losing entitlement".


And that is the nub of the problem. We find ourselves with a welfare system that has rewarded poor people for not working. 6 million of our working age poor are now dependent on welfare rather than their own earnings. And we all agree that we must rebalance the incentives so that work is always going to be the more attractive option.


But we simply don't have the cash to focus the entire shift on increasing the reward from work. The inconvenient truth is that in one way or another we will have to find some way of cutting the current level of welfare provision for the able bodied poor.


We certainly welcome the Duncan Smith reforms, which undoubtedly point us in the right direction. But we should be under no illusions - some even more difficult decisions still lie ahead.


 

The jobs boom didn't help

All credit to Iain Duncan Smith for pressing on with his welfare reform package in the face of a bare fiscal cupboard.


He hasn't been able to achieve as much as we'd hoped and proposed back in the summer (see here), but he has managed to hold on to the crucial central feature of any meaningful reform of working age welfare - that work should always pay.


Under his planned Universal Credit the poor will no longer face effective marginal tax rates on their earnings in excess of 80% (ie they will no longer lose 80 or 90 pence or more of every extra pound they earn). Instead, the maximum anybody will lose is 76% (the combined effect of a 65% benefits withdrawal rate overlaid on 20% basic income tax rate, plus employees' National insurance).


Yes, that is still far too high - much higher than the 55% fixed maximum we incorporated in our own proposal. But the Universal Credit is much simpler than the current impenetrable morass, and that will eventually save administration costs and cut the losses from fraud and error. Most importantly, it at last it offers the poor some certainty - certainty that they will always be better off working than not working.


Here's how the Universal Credit will look for two key groups - single people, and couples with two children. The charts show how their net incomes increase according to how many hours they work, assuming they are earning the minimum wage. We can see how both groups are almost always better off under the new system compared to the existing arrangements, and that they are always better off working more hours:




Moreover, Duncan Smith has pledged something our proposal did not offer - that nobody will be any worse off under his plan than under the current system.


 Clearly that is a very reassuring promise, but it is also very expensive. Which is why we didn't propose it, and why, despite the additional £2bn IDS has set aside to smooth implementation, there is not enough money to fund lower effective tax rates.


As we have discussed many times, there are some extremely difficult choices here. Everyone wants to cut those high effective marginal tax rates in order to provide a compelling reward for working. But it is enormously expensive - our own calculations suggested that to cut the effective tax rate by 10 percentage points would cost £10 - 20 bn pa.


So in these tough fiscal times where are we to find the money? Our answer was to cut the official definition of the poverty line from 60% to 50% of median income, which we reckoned would save £20 - 30bn pa. And that would fund a substantial cut in marginal tax rates, making work much more attractive to the poor.


Duncan Smith has shied away from such a dramatic change. The White Paper reports that DWP have studied our proposal but they don't like the prospect of "substantial numbers of people in vulnerable situations losing entitlement".


And that is the nub of the problem. We find ourselves with a welfare system that has rewarded poor people for not working. 6 million of our working age poor are now dependent on welfare rather than their own earnings. And we all agree that we must rebalance the incentives so that work is always going to be the more attractive option.


But we simply don't have the cash to focus the entire shift on increasing the reward from work. The inconvenient truth is that in one way or another we will have to find some way of cutting the current level of welfare provision for the able bodied poor.


We certainly welcome the Duncan Smith reforms, which undoubtedly point us in the right direction. But we should be under no illusions - some even more difficult decisions still lie ahead.

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