Tax and Fiscal Policy

The work-vs-welfare trade-off


Economic Theory
As the United Kingdom looks to reform its policies for dealing with the poor and unemployed, it should take notice of one basic fact: There is no evidence to suggest that poor people are lazy, but they are also not stupid. If you pay someone more not to work than they can earn by working, they will be less likely to work. For the poor as much as the wealthy, incentives matter.

A recent Cato study looked at what a single parent with two children could receive from four broad categories of welfare benefits: social assistance, housing assistance, family and child benefits, and tax credits. We found that in six countries – Austria, Denmark, Finland, Ireland, the Netherlands, and the United Kingdom – benefits exceeded £16,000 (€21,500). And, in Denmark, the most generous country, the potential benefit package exceeded €34,000 (£25,000) per year.

The benefit package was large enough in most countries that it could pose a significant deterrent to transitioning to work. In 9 countries, including the UK, welfare potentially pays more than that country’s minimum wage. In fact, benefits in the UK could top 150 percent of the minimum wage. Not just the minimum wage either. In the UK and five other countries, the benefits are worth more than 60 percent of the country’s net income at average wage. Economists often discuss the danger that high marginal tax rates can discourage economic activity. But, when you consider taxes, the phase-out of benefits, and the cost of going to work, some of the highest effective marginal tax rates in the world are for someone leaving welfare for a job: in 15 countries – the UK among them – a single parent moving from welfare to a job paying half of the average wage would face an effective marginal tax rate higher than 50 percent. Of course the UK can always take comfort that it isn’t Austria, Croatia or Denmark, where this rate approaches 100 percent.

Is it any wonder that people might choose to remain on the dole when high effective marginal tax rates would take away most or all of their additional earnings?

Work should be at the heart of any effort to reduce poverty. Getting that first job, even an entry level, minimum wage job, is perhaps the single most important step that a poor person can take toward getting out of poverty.  In the UK, very low work intensity households (working-age adults working less than one-fifth of total available months) were almost four times more likely to be at risk of poverty than all other households. In the entire European Union, for households with very low work intensity, the at-risk-of-poverty rate is 56 percent, compared to 12.4 percent for all other households.

Most European countries appear to be recognising the problems their tangled welfare programs and related poverty traps can exacerbate, and have begun to reform in an effort to make work more attractive. For example, several countries have followed the UK’s lead in consolidating multiple programs, which could make it easier to mitigate some of the adverse effects of their current systems. Others have strengthened work requirements or established time limits for benefits. Still others have expanded work-based tax credits or transitional assistance to increase the value of work.

The United Kingdom is in the midst of integrating six major welfare programs into one streamlined Universal Credit (UC), with the goal of reducing the work disincentives and improving efforts to help participants transition into a job. The reform has faced some technical problems in implementation, but early results from pilot programmes show that it has increased work effort among participants relative to the old system. While there remains room for improvement (and newly elected Labour leader Jeremy Corbyn remains strongly opposed to the recent reforms and has pledged to fight further changes), they are a welcome step in the right direction.

Those who seek to help the poor and those in need must decide the purpose of social welfare programs. If the goal is simply to make poverty a bit less uncomfortable, current programs may be satisfactory. But if the goal is to enable more people to escape poverty and reach their full potential as self-supporting members of society, those programs should always encourage work rather than continued dependence.  The UK has started down the road to reform. It should keep going.

Michael Tanner is a senior fellow and Charles Hughes is a research associate with the Cato Institute in Washington, DC. They are the authors of the Policy Analysis paper The Work versus Welfare Trade-Off, Europe.

2 thoughts on “The work-vs-welfare trade-off”

  1. Posted 07/10/2015 at 19:00 | Permalink

    I’m pretty sure most people are not content with spending their lives on £73 pw JSA. It is the conditionality and means testing of benefits that causes all the problems. It would be best if we scrapped our entire welfare system and instead introduced a Citizen’s Income.Not only would there be administrative cost saving, but we’d get a fully flexible workforce, with no bureaucratic intrusions into people’s lives.

  2. Posted 09/10/2015 at 07:09 | Permalink

    The UK Working Tax Credit system has been an implementation of the idea of a citizen’s income, or negative income tax. It has tapered the penal marginal tax/benefit withdrawal rates that this piece describes.

    The present Government has decided substantially to withdraw the scheme, and we must presume that they are prepared to pay the political price of the obvious consequences. Who can doubt that there will be reduced participation in the workforce and increasing segregation of those dependent on benefits, and their increasing impoverishment and immiseration? We are rebuilding the poverty trap.

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