Universal Credit: what went wrong? (Part 3: lessons from Germany)
Its system consists of two parts: one is the infamous Hartz IV, similar to UK unemployment benefits – based on basic need. However, there also exists another payment with much more of a state-insurance character: it can only be received by those who have worked at least 12 months in the last two years, and the amount paid and the length of entitlement depend on the previous wage earned and time spent in employment by the recipient. Thus, the average replacement rate, signifying the percent of previous earnings received in benefits payments, is much higher in Germany than in the UK for short periods of employment, but becomes virtually the same for long periods of unemployment, as the recipient falls from the insurance-type payment to Hartz IV payments. This two-tier system can incentivise efforts in employment, as it pays off even when a temporary phase of unemployment hits. Furthermore, it prevents an immediate forced adjustment to lower living standards for those who have only just entered unemployment. On its implementation in 2005, Hartz IV was a prestige project by Germany’s centre-left and itself as radical a change as UC is today. However, although it is widely credited with causing the impressive decrease in unemployment seen since, it is also increasingly criticised for being too harsh on recipients. Its inventors’ attempt to remedy this has stimulated various reform proposals.
To the UC-savvy observer, one reform suggestion, found across the political spectrum, stands out: the demand to streamline the German welfare system by combining several payments including unemployment benefits, child support and housing support into one payment and one administrative system – in short, to “universal credit” it. The advantages and problems do not need to be repeated here, but it seems that German policymakers would be well-advised to consider the lessons that can be learned from the British UC implementation.
In the other direction, one German idea in particular is worth considering: that of the “liberal” party, FDP, for a reform of the taper rate. This rate signifies how much of a pound (or euro) earned by a benefit recipient will be taken away, after a certain disregarded amount called the work allowance, through a reduction in their benefit payment. This rate cannot be too low for obvious reasons, but at the same time, when too high, it disincentivises employment. The UK has a flat taper rate. It was adapted several times under UC and currently stands at 63p per pound earned. By contrast, the German Hartz IV system involves a rising taper rate, meaning that the more you earn, the higher the rate becomes. This has had the unintended consequence of disincentivising recipients from increasing their work hours, thereby damaging their prospects of re-entering full employment. The FDP now suggests not to make the taper rate flat but rather to reverse it: let the taper rate decrease as a recipient’s income increases. One example is a taper rate of 80% for incomes under €300, 70% up to €700 and 60% for incomes above, although considering a current rate of 63%, it may be advisable to set each of those rates comparatively lower. This incentivises participants to increase their working hours by making an increase in their income doubly financially advantageous.
Should the ongoing dissatisfaction with UC lead to further reform, British policymakers should take this chance to increase employment incentives further. Government data show that the costs of the decrease in the British taper rate which was already implemented are far outweighed by the savings of decreasing the work allowance, where the first sets much stronger incentives for increased work. It can be expected that implementing a decreasing taper rate as proposed by the FDP may even lead to savings in the short run. It may lead to increased costs once a large share of recipients starts earning in the category with the lowest taper rate. However, this would entail positive effects for recipients’ prospects of entering full employment as well as the economy as a whole.
Carolin Bollig is a research intern at the IEA.