New research from the IEA released

New research shows that government attempts to tackle poverty are fundamentally flawed. The current focus on redistribution comes at a high fiscal cost and is trapping people in long-term dependency. These policies are driven by meaningless child poverty targets and are a major barrier to the government cutting the welfare bill.

The UK now spends £193 billion (13% of GDP) per year on welfare. Notably, 6.3m households are now in receipt of tax credits, costing the taxpayer £24bn annually (1.6% of GDP), while 4.6m households are in receipt of housing benefit, which costs the taxpayer £20bn annually (1.3% of GDP).

Nevertheless, despite pouring ever increasing amounts of money into the welfare budget, actual poverty is still not being addressed. The relative and absolute measures currently used to measure poverty are deeply flawed as they focus on income rather than issues such as the price of housing (more details on current poverty measures are included in the notes to editors).

A New Understanding of Poverty, an IEA report released today shows why current poverty measures and the redistributive policies built around them should be scrapped. They should be replaced by a radical new measure looking at poverty in terms of what people can afford to buy, rather than their level of income relative to others.

Poverty fighting strategies should then be implemented that are focused on reducing the price of those goods and services, removing obstacles to work and fostering economic growth, not around redistributing income.

Introduction of new poverty measure needed

Based on flawed poverty targets, governments have focused on the redistribution of income towards those at the lower end of the income distribution, but this approach leads to long-term dependency and ever-increasing fiscal demands. It also ignores the plight of many who struggle to afford life’s necessities, as it does nothing to help bring down the price of goods and services.

It is largely meaningless to look at someone’s income. Far more important is the price of the products and services they need to be able to buy to enjoy a decent standard of living and this will change over time.

Poverty should be measured by agreeing a basket of goods and services that are necessary to enjoy a decent standard of living, for example items such as housing, heating, adequate food etc. This basket should then be priced at a regional level and people whose expenditure (not income, which is an unreliable measure of living standards) is below this level classified as poor.

Poverty should be measured in a way that takes into account regional differences and the costs of goods and services becoming cheaper or more expensive over time. Making sure someone can afford basic goods is more meaningful than knowing how much money they have to spend compared with someone else or their nominal level of income.

A pro-poor strategy

  • Reduce the price of essential goods and services through competition, entrepreneurship and creating more open markets through:

    • abolishing agricultural protectionism within the EU;

    • liberalising the land-use planning system and

    • deregulating the utilities industry.

  • Remove poverty traps, by:

    • Replacing the hugely complex benefit system by a simple Negative Income Tax (NIT). This is a system in which, instead of paying income tax, low-earners would receive a tax transfer (so their tax liability would be negative) if their income falls below the tax-free allowance. As their income increases, their entitlement to NIT would gradually shrink, until eventually they would start paying ‘positive income tax’. This would be far more logical and efficient than the present system, in which low-earners pay taxes first, and then receive state transfers (tax credits, or ‘Universal Credit’ in the future). It would also mean an end to the couple penalty in the benefit system.

    • Introducing full-time work requirements for all able-bodied people on welfare. These schemes would be more extensive than those proposed by the coalition and would be run by local authorities.

Author of the report, Kristian Niemietz, Poverty Research Fellow at the Institute of Economic Affairs, said:

“For decades now successive governments have been ineffective at tackling poverty in the UK. There has been no substantial reduction in the number of people trapped in dependency and many of those on low incomes have continued to struggle as the price of many essential goods such as housing has risen.

“Obsessing about child poverty targets based on meaningless relative measures has done little to help Britain’s poor. A fundamental shift in the way poverty is measured and tackled is required. This should look at what people can actually afford to buy and focus on reducing the price of housing, utilities and food through cutting regulation and opening markets up.”

Notes to Editors

To arrange an interview with Mark Littlewood, IEA Director General, please contact Stephanie Lis, Communications Manager, 077 5171 7781, 020 7799 8900, [email protected].

Current estimates of poverty meaningless 

Poverty in the UK is currently being measured in four ways, all of which are deeply flawed:

  1. Relative poverty

  • Under this measure, households are classified as poor if their income falls below 60% of the national median income, correcting for differences in household size. It is the primary measure of poverty in the UK. It is also the one most frequently quoted, and most favoured by charities such as Oxfam and the Child Poverty Action Group. Since relative poverty is nothing else but a measure of income inequality, the reliance on this indicator has encouraged successive governments to pursue income redistribution as the primary way of trying to tackle poverty.

  • The measure focuses entirely on people’s income, this means many people who are not poor are included in the measures and many who are, are missed. For example someone living in a very expensive area of the country such as London in a low paying job might not be categorised as poor, even though the price of housing in this area might be so high that they struggle to afford basic necessities. By contrast, someone living in Wales might be seen as poor even if they can afford all essential goods and services because their living costs are relatively low.

  • The relative poverty measure also means that if the cost of housing halved overnight, there would be no drop in the number of people defined as poor. This is because current measures take no account of the changing price of goods and services which are particularly important for poor families over time. Neither do these measures take savings, assets and benefits in kind (like social housing) into account.

2. and 3. Absolute poverty and persistent relative poverty

These measures are variations of the above and are flawed for exactly the same reasons. The absolute poverty index uses a poverty line which is fixed in real terms, the persistent relative poverty measure looks at a time span of four years rather than one year.

4.    Material deprivation

This measure counts the share of households who claim to be unable to afford essential goods. It is a better measure than the ones above, but it has a severe flaw nevertheless: it counts people as poor if they choose to spend their money in different ways than poverty researchers think they should; say if they cannot afford household content insurance because they have already spent the money on tobacco.

A New Understanding of Poverty

The full report A New Understanding of Poverty by Kristian Niemietz can be downloaded here.

Kristian Niemietz joined the IEA in 2008 as Poverty Research Fellow. He studied Economics at the Humboldt Universität zu Berlin and the Universidad de Salamanca. In 2007, he graduated as Diplom-Volkswirt (MSc in Economics), with a dissertation on the privatised pension system in Chile. During his studies, he interned at the Central Bank of Bolivia (2004), the National Statistics Office of Paraguay (2005), and at the IEA (2006). After graduating, he went on to work for the Berlin-based Institute for Free Enterprise (IUF). Kristian is currently a PhD student in Public Policy at King’s College London, where he also teaches economics. He is a regular contributor to various journals in the UK, Germany and Switzerland.

The mission of the Institute of Economic Affairs is to improve understanding of the fundamental institutions of a free society by analysing and expounding the role of markets in solving economic and social problems. The IEA is a registered educational charity and independent of all political parties.