Tax and Fiscal Policy

Chancellor continues his ‘Edward Scissorhands’ approach to cuts

There can be no doubt that spending on working-age benefits is out of control. Over the past decade alone, spending on Housing Benefit has increased from about £16 billion to £25 billion (in current prices), whilst spending on tax credits has increased from £17 billion to £28 billion. This is an upward trend which goes back to well before the Great Recession.

Right from the start, Chancellor George Osborne’s response to runaway welfare spending has been to leave the structure of income transfer programmes largely unchanged, and to realise savings by randomly chopping off bits and pieces here and there. This was already apparent in the 2010 Budget and the Comprehensive Spending Review, where the majority of cuts came from fiddling with the uprating formulas: child benefit and some tax credit elements were temporarily frozen, while benefits that had previously been uprated in line with the Retail Prices Index were pegged to the (generally lower) Consumer Price Index instead.

Back then, one could have justified these steps as first-aid measures; not visionary, but perhaps necessary to gain some breathing space for devising a more systematic plan. But no such systematic plan ever came. Four years on, Osborne’s announcements at the Conservative Party Conference are a continuation of his standard ‘Edward Scissorhands’ approach of random cuts. Working-age benefits will now be frozen for two years, a measure which follows an earlier 1 per cent uprating cap from 2012. This is a way of cutting ‘by stealth’, i.e. letting inflation do the job that Osborne and his colleagues should be doing.

A more strategic approach would have begun by analysing why welfare spending has risen so inexorably in the first place. Take housing benefit (HB). The reason why HB has risen to such astronomical levels is that in most parts of the UK, rents have risen to astronomical levels, and until recently, housing benefit rates have been pegged to rents. The explosion in rents, meanwhile, is simply a reflection of the general explosion of house prices, which is a consequence of the UK’s excessively restrictive planning system and the inability of the political class to stand up to NIMBY interests. According to the latest estimate, by the LSE’s Christian Hilber and Wouter Vermeulen, planning constraints are responsible for more than a third of the price of a house. This is almost certainly an underestimate, because the authors define ‘planning constraints’ in a very cautious way.

Thus, if the government had the courage to ease planning restrictions (e.g. roll back the green belt) and put the NIMBYs in their place, house prices and rents could tumble by at least a third. The cost of HB would then automatically fall as well. Compared to a simple freeze, this approach would have countless other advantages as well. It would also benefit those who earn just a little bit too much to qualify for housing benefit, but who still struggle with their housing costs. And making the private rental sector more widely accessible would take pressure off the social housing sector, such that its subsidies could be reduced commensurately.

Tax credits also require a much more systematic overhaul, not just an arbitrary freeze. Tax credits were initially meant to be a wage supplement, but they have increasingly become a wage substitute for people who work part-time, or not at all. The solution is to get work incentives right. Tax credit recipients who increase their working hours – say, from a two-day to a four-day workweek – are effectively facing a marginal tax rate of 73 per cent, due to the combination of tax credit withdrawal, income tax and national insurance contributions. Increasing their gross earnings by say £50 per week would only leave them £13.50 better off. This could be ameliorated by disentangling tax credit entitlement from income tax (and NI) liability, i.e. converting tax credits into a ‘negative income tax’. People would then be either tax-credit recipients or income-tax payers, but never both at the same time. Also, for part-time employees, receipt of tax credits could be coupled with a requirement to increase working hours over time, to something eventually approaching full-time employment. This would mean a time limit to part-time tax credits. Ideally, tax credit reform would be combined with the rolling out of a locally funded ‘workfare’ scheme, comparable to the system that drove down welfare dependency in Wisconsin.

Osborne’s unsystematic lawnmower cuts have not delivered a lot even on their own terms, because they have failed to address the reasons for the prior spending escalation. Instead, strengthening work incentives and ensuring that basic essentials like housing are easily affordable would greatly reduce the need for welfare spending. Welfare spending would then fall automatically and permanently. The most intelligent ‘cuts’ are those that begin by making spending less necessary.

This article was originally published by the Huffington Post UK.

Head of Political Economy

Dr Kristian Niemietz is the IEA's Head of Political Economy. Kristian studied Economics at the Humboldt Universität zu Berlin and the Universidad de Salamanca, graduating in 2007 as Diplom-Volkswirt (≈MSc in Economics). During his studies, he interned at the Central Bank of Bolivia (2004), the National Statistics Office of Paraguay (2005), and at the IEA (2006). He also studied Political Economy at King's College London, graduating in 2013 with a PhD. Kristian previously worked as a Research Fellow at the Berlin-based Institute for Free Enterprise (IUF), and taught Economics at King's College London. He is the author of the books "Socialism: The Failed Idea That Never Dies" (2019), "Universal Healthcare Without The NHS" (2016), "Redefining The Poverty Debate" (2012) and "A New Understanding of Poverty" (2011).

1 thought on “Chancellor continues his ‘Edward Scissorhands’ approach to cuts”

  1. Posted 01/10/2014 at 14:18 | Permalink

    HB is a State subsidy to landlords. Not only does this raise rents, but by increasing the margins for landlords, it allows them to out compete first time buyers in the housing market.

    Like all State subsidies HB should be scrapped. Do we really need to be giving landlords tens of billions in free cash?

    Of course HB is small fry to the biggest subsidy to landlords and landowners, capitalised land rent. £200bn per year worth of free lunch. Get rid of that huge distortion, the “housing crisis” sorts itself out, without adding to our oversupplied and inefficient property market. Or the need for Greenbelt restrictions to contain the urban sprawl capitalised rent causes.

    Free market capitalism works better than protected State privileges and subsidies. Odd how the IEA keep espousing the latter.

Comments are closed.