The case for a real-terms benefit cut is weak – and it would be political madness

The reluctance of both the Chancellor and the Prime Minister to confirm that non-pensioner benefits (notably Universal Credit) will be uprated next year in line with inflation has fed speculation that the Government is considering a real-terms cut.

My advice would be to squash this idea as soon as possible – mainly because it is bad economics. But it would be bad politics too, undoing any good done by the U-turn on the 45p rate of income tax.

To recap, benefits are usually uprated each April in line with the CPI measure of inflation recorded in the previous September. This meant that benefits rose by just 3.1% in April this year (the inflation rate in September 2021), well below actual inflation of 9.0% in April itself.

The row about this at the time was partly defused by additional one-off payments to low-income households. But ministers also argued that benefit claimants could expect to catch up next year when payments were uprated in line with the September CPI (probably about 10%).

There seem to be three arguments in support of a smaller increase in benefits now.

In my view, the weakest argument is that it would somehow be ‘unfair’ for people on benefits to be protected against inflation when many others (who pay for benefits through their taxes) are seeing a real-terms cut in their wages.

This argument might be stronger if we were talking about pay increases for, say, senior staff in the public sector who already earn more than the average. But those who rely on benefits are, by definition, poorer than the average (and will remain so). They are also far less likely to have savings to tide them over a temporary shock, or to be helped by the tax cuts announced in the September mini-Budget.

It therefore makes no sense to target them for spending cuts. The benefits system is meant to protect the most vulnerable during difficult economic times, not to ensure that they share the pain.

A variation on this argument is that increasing benefits by more than the increase in average earnings might discourage some claimants from seeking work or increasing their hours. But a real-terms cut in benefits for everyone is a pretty blunt tool to boost labour supply.

Indeed, the large majority of people on Universal Credit (about three-quarters, or more than 4 million) are either already working, or are not expected to work (on health grounds, or because they are carers). The UK also has one of the least generous systems of unemployment benefit in the OECD, and the welfare budget has already been squeezed for many years.

A better argument is that benefit claimants are already being compensated for higher inflation in other ways, including the additional cost-of-living support and discounts on energy bills. Raising benefits by the full amount of inflation too could therefore be ‘double counting’.

This makes more sense (and is the argument that supporters of a smaller increase in benefits should be making). These transfer payments are not reflected in the official measure of inflation because (unlike the energy price cap) they do not reduce the unit cost of energy.

Uprating in line with average earnings rather than inflation would mean most claimants receive several hundreds pounds less than they would otherwise have done.  Nonetheless, it might be reasonable to factor in the additional support they are already receiving.

For example, a household receiving £10,000 a year in benefits might gain £1,000 if these benefits were uprated in line with inflation (10%) but only £550 if uprated in line with average earnings (assuming 5.5% for this), a loss of £450. If you add back in the £650 cost of living payments for those on means-tested benefits, they might still be ahead.

But is this the right way to look at this? They would still be £450 worse off than if benefits were uprated in line with inflation, or relative to where they might have been expected to be. What’s more, the additional cost of living payments (and the energy bill discounts) are a one-off, whereas the smaller increase in benefits would leave income permanently lower.

Averages also conceal a wide range. The table below provides some estimates (from the Joseph Rowntree Foundation) of the losses for different family types if benefits are only uprated by earnings. For a couple with two children, the loss could be over £700: 

Working-age households on means-tested benefits Average annual loss in 2023/24 
Single parent with one child £406 
Couple with two children £706 
Single adult with no children £186 
Couple with no children £316 

The argument that people on low incomes are already being compensated in other ways could open up a whole new can of worms.

If you argue that the additional cost-of-living support means that ‘real’ inflation for benefit claimants is lower than the average rate, others will point out that inflation is typically higher for poorer households, so they would still be facing a shortfall of several hundred pounds. If anything, there is a case for bringing forward the usual inflation uprating from April, or at least making additional payments to bridge the gap.

The third argument is that there is a precedent – the temporary unpicking of the triple-lock on the state pension, which was also only increased this year by the September 2021 inflation rate of 3.1% rather than the (then higher) increase in average earnings. (The ‘triple-lock’ increases pensions by the highest of CPI inflation, average earnings growth, or 2.5%.)

But this is not a strong precedent. It was much easier to argue that the average earnings measure was distorted by the pandemic and that uprating in line with inflation instead was fair. Here, we are talking about a real-terms cut in benefits.

This opens up yet another can of worms. If you argue that working-age benefits shouldn’t be increased by the full amount of inflation, why should that not also apply to pensions (especially as the basic state pension is not means-tested)?

Indeed, the triple-lock on the state pension is a far bigger threat to the sustainability of the public finances. It has a ‘ratchet effect’, because pensioners participate in any upside during booms but are protected on the downside during recessions. As a result, the share of national income spent on paying state pensions will inexorably increase over time.

Any reforms to the benefit system in the coming months should therefore be limited to changes that improve incentives at the margin. In contrast, a real-terms cut across the board would undermine confidence and demand.

A stronger economy, with more people in better paying jobs, is also a far better way to reduce the welfare bill in the longer term (although the triple-lock on the state pension will have to go, eventually).

Finally, I am worried that the old Treasury orthodoxy is reasserting itself here. A narrative is already developing that there needs to be big and immediate cuts in public spending, including benefits, in order to pay for ‘big cuts’ in taxes.

Instead, ‘Trussonomics’ is about growing the economy, through a mix of tax cuts and supply-side reforms. This means that the burden of debt is reduced over time and that higher tax revenues can fund better public services. If this means that borrowing has to take the strain in the near term, then so be it.

There is also a long tradition of free-market support for welfare benefits and other forms of social insurance. Indeed, Hayek himself (in The Road to Serfdom) made the case for protecting people from shocks which they could not reasonably be expected to insure against themselves.

In short, the Government should be willing to make unpopular decisions, but the economic case for failing to uprate benefits in line with inflation is flimsy. Politically, it seems like madness.

This is an extended version of a piece first published by CapX on 3rd October 2022

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