The cost of Housing Benefit (HB) has exploded over the last five years, rising from £13.5 billion in 2004/05 to £20 billion in 2009/10. This is a cause for deep concern, not just because HB is a major burden on taxpayers, but also because it produces severe disincentives for workless people to enter employment.

The benefit is withdrawn at a rate of 65p for every pound earned above a certain amount. For many claimants it is the main reason that it is not worth starting low-paid work. This withdrawal of HB is normally in addition to the withdrawal of benefits and labour market taxes that have to be borne at the margin.

The Housing Benefit trap is particularly pernicious in high rent areas such as London. The capital receives 26% of HB payments although accounting for 12% of the UK’s population. This may partly explain why parts of London have some of the highest rates of worklessness in the country despite the wide range of employment opportunities.

From time to time the newspapers print a story that illustrates the problem. Last month the Evening Standard looked at the case of a mother of six receiving HB to rent a £2 million house in St John’s Wood, at a cost of £6,400 a month. Once other benefits such as Child Tax Credits and Income Support are factored in, as well as Income Tax and National Insurance, it’s clear she would have to earn in excess of £150,000 a year to be better off in work.

Such perverse incentives, as well as the clear injustice of such cases, provide strong arguments for reform of the system both to reduce public spending and address high levels of welfare dependency.

A simple first step would be to phase in a requirement for HB claimants to pay a proportion of their rent out of their basic benefits (such as Income Support). This would act as a deterrent to those exploiting the system to live in luxury homes in exclusive areas and would encourage tenants to seek out low-cost accommodation.

A second measure would be to reform the “local connection” criteria which in effect provide claimants with an entitlement to live in a particular area, no matter how expensive. Councils should be far freer to house homeless families in low-cost areas. At the very least, they could be housed in cheaper areas within a short commute of the borough in question (for example, Westminster Council could house people in Barking and Dagenham).

The long-term solution to the Housing Benefit problem lies, however, in the liberalisation of planning and building regulations that prevent the supply of ultra-low-cost accommodation. A liberal approach to land use could finally bring an end to this costly, complex and counterproductive system, and go hand-in-hand with the abolition of housing benefit so that all welfare benefits were simply paid as untied cash.