The DWP on welfare reform: good on the generalities, weak on the details

“The welfare state is now a vast, sprawling bureaucracy that can act to entrench, rather than solve, the problems of poverty and social exclusion.”

The above quote does not come from a think tank publication, but from a policy paper by the Department for Work and Pensions. Compared to the pamphlets the DWP released under its previous incumbent, this one is a delight. It describes the failings of the present welfare system – mind-boggling complexity, multiple benefit types working against each other, steep withdrawal rates – with a boldness one would never expect to come from within the political machinery. It also outlines an alternative strategy: merge most non-contributory benefits and tax credits into a single ‘Universal Credit’ (UC) with a uniform taper rate.

But as good as the paper is on the generalities, it stops at the sound bite level when it comes to the more unpleasant trade-offs in welfare design. The paper’s basic dilemma is apparent in this quote:

“Reforms could:

  • improve work incentives by reforming the way in which benefits are tapered as incomes rise and allow people to keep more of their earnings;

  • be fair and targeted to those most in need through tapers which focus payments on those on the lowest incomes, while maintaining levels of support for those out of work”.

Both of these points make sense in their own right. But in combination, they blatantly contradict each other. For any given level of income replacement, lowering taper rates improves work incentives, but it also makes benefits less targeted by spreading entitlement to people further up the income distribution. Raising the taper rate achieves the opposite.

Let’s put some numbers on this. Suppose a workless single household receives £280 per month in Income Support, and, just to obtain a round number, £420 in Housing Benefit. (£420 is less than what can be claimed in middle-sized cities like Bath, Birmingham, Canterbury or York.) Let’s ignore Council Tax Benefit and any possible add-ons. The DWP-paper emphasises that there is no intention to cut out-of-work support, so this household would be entitled to £700 in UC.

The rest depends on the UC taper rate. If set at 75%, our household would have to earn £933 per month to come off benefits. This corresponds to an equivalised income of £1530 (=£933/0.61), which would place the household somewhere close to the 40th percentile of the income distribution. UC would then be fairly targeted, but an implicit marginal tax rate of 75% is still a heavy penalty on work.

Lowering the taper to 55% would improve incentives, but it would turn UC into a ‘middle-class benefit’. Our example household would now have to climb up to about the 60th percentile of the distribution to come off UC. Working from the reverse end, it would be possible to calibrate UC in such a way that it trails off as the household reaches the 25th percentile of the distribution. But this would require a taper of 95%, a rate at which only devout Calvinists would care to advance in the labour market.

UC would be a huge improvement over the present system because of its greater clarity and predictability. But it would not solve the basic dilemma that within the present system, we can only choose between stifling work incentives, and pouring out huge sums of money to well-to-do people who do not need it. When it comes to welfare reform, simplification can only be a start.

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).