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The Welfare Benefits Up-rating Bill, which gets its Second Reading in the House of Commons tomorrow, proposes to cap the annual increases in most working-age benefits at 1% in cash terms in 2014–15 and 2015–16, in addition to the 1% cap on increases already confirmed for 2013–14.
By default, working-age benefits and tax credits are up-rated each April in line with the Consumer Prices Index (CPI) in the preceding September. CPI inflation was 2.2% in September 2012 and is forecast to be 2.6% and 2.2% in the Septembers of 2013 and 2014 respectively. The government plans instead to uprate the majority of these benefits by 1% for the next three years (though only the proposed April 2014 and April 2015 cash increases are included in the bill). Given current forecasts of inflation, this implies a cumulative 4% real cut in the benefits affected. The actual real-terms cut, though, will depend on future levels of inflation. If inflation is much lower than forecast then the real cuts will be small. If it is higher than forecast then the real cuts will be bigger than is currently expected. Similarly the effect of the measures on benefit levels relative to earnings levels will depend upon future rates of earnings growth. There is an arbitrariness to this eventual outcome. That is the result of specifying future benefit changes in nominal terms rather than, for example, relative to actual price or earnings changes.
When announcing the policy, the Chancellor drew attention to the fact that out-of-work benefit rates have grown substantially faster than earnings since 2007, as shown in Figure 1. This essentially reflects the fact that earnings have not kept pace with inflation, whereas rates of out-of-work benefits (Income Support, Jobseeker’s Allowance and Employment and Support Allowance) have risen broadly in line with prices (though there have been discretionary cuts to the rates of other benefits and tax credits).
Figure 1. Earnings and out-of-work benefits (Jan 2007 = 100)
Sources: Past earnings from ONS series DTWM, ROYK, MGRZ, MGRQ, past benefits from DWP (JSA personal allowance for a single person over 25), forecasts of inflation and earnings growth from OBR
If earnings fall relative to benefit levels, then being in work becomes less financially attractive, all else equal. At present, out-of-work benefits for a home-owning couple without children stand at 27.7% of what the family’s net income would be if one of the couple earned £560 per week. If instead earnings had grown as fast as benefit rates since 2007, that fraction would have been 25.3%. However, higher wages would not have significantly affected the incentive to work for all groups. For a lone parent with two children and rent of £100 a week working 16 hours a week at the minimum wage, out-of-work income is 80% of in-work income in both scenarios, because almost all of the additional earnings are lost in withdrawn benefits.
There is, of course, nothing special about relativities in 2007. Historically, earnings have tended to rise in real terms and hence outstrip price-indexed benefit rates (although, particularly for families with children, above-indexation increases have seen some entitlements grow considerably faster than prices). Relative to that “normal” scenario, the recent fall in earnings compared to out-of-work benefits looks even more striking. On the other hand this is a reminder that when real earnings growth returns, current policy implies that benefit rates will fall relative to earnings.
Figure 2 shows the distributional effect of the benefit reductions contained in the Welfare Benefits Up-rating Bill in the context of all the Autumn Statement tax and benefit announcements and the consolidation package as a whole. This shows that the majority of the impact of the Autumn Statement announcements will come through the changes to up-rating policy set out in the Bill, but that this is only a small fraction of the net ‘takeaway’ from households resulting from the overall fiscal consolidation.
As far as the effects of benefit up-rating measures are concerned, reductions in entitlement are unsurprisingly concentrated in the bottom half of the income distribution. The lowest-income decile group see the largest fall in entitlements as a percentage of income (1.5%) as a result of measures in the Bill, and the second decile see the largest decrease in cash terms, losing about £150 per year on average.
Because the proposed uprating changes apply to almost all benefits and tax credits, both in-work and out-of-work households are affected. Of 2.8 million workless households of working age, 2.5 million will see their entitlements reduced, by an average of about £215 per year in 2015 –16. Of 14.1 million working-age households with someone in work, 7.0 million will see their entitlements reduced, by an average of about £165 per year. Note that this figure includes 3.0 million families who lose only from the cuts to Child Benefit, at an average of about £75 per year (monetary amounts are in current prices).
As the chart shows, other elements of the consolidation package have been much more significant, especially for those with the very highest incomes. It is important to see the effects of this Bill alongside the other tax and benefit changes, as well as falling real earnings which have hit those in the middle and upper parts of the overall distribution the hardest.
Figure 2: Distributional impact of tax and benefit reforms
January 2010 - April 2015 inclusive, as if Universal Credit fully in place
Note: Income decile groups are derived by dividing all households into 10 equal-sized groups according to income adjusted for household size using the McClements equivalence scale. Source: Authors’ calculations using 2010–11 Family Resources Survey and TAXBEN, the IFS’ tax and benefit micro-simulation model.
When cutting public spending dramatically to help reduce an unsustainable budget deficit it is almost inevitable that spending on benefits and tax credits – which account for 30% of the government’s total budget – will be targeted. This policy achieves savings through an across-the-board reduction in the real value of benefits for people of working age at a time when real earnings have been falling.
But we don’t know two things. First, the actual effects of the bill on real benefit rates are unknown, because they depend on future price levels. This exposes the poorest in society to inflation risk. Second, we don’t know the government’s view on how benefit rates should be indexed in the longer run. We ought to.
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Cutting the deficit: three years down, five to go?
The UK is in the fourth year of a planned eight-year fiscal tightening. Following further announcements made in Budget 2013, this fiscal consolidation is now forecast to total £143 billion by 2017–18. The UK is intending the fourth largest fiscal consolidation among the 29 advanced economies for which comparable data are available. By the end of this financial year, half of the total consolidation is expected to have been implemented. However, within this tax increases and cuts to investment spending have been relatively front-loaded, while cuts to welfare spending and other non-investment spending have been relatively back-loaded.
The March Budget forecast that borrowing would fall by £0.1 billion from £121.0 billion in 2011–12 to £120.9 billion in 2012–13. On Tuesday, the Office for National Statistics is due to release its first estimate of public sector net borrowing in March 2013 and, therefore, for the whole of 2012–13. Borrowing could easily end up being higher or lower than it was in the previous year, either due to backwards revisions, the uncertainty inherent in forecasting borrowing even a month in advance, or both. However, whether borrowing is slightly up or down in cash terms is economically irrelevant. Either way, the bigger picture is that having fallen by roughly a quarter between 2009–10 and 2011–12, borrowing is forecast to be broadly constant through to 2013–14.
Women working in their sixties: why have employment rates been rising?
Employment rates through the recession have been remarkably robust, with today’s ONS figures showing employment remaining close to 30 million. The young have experienced historically low employment rates and high unemployment rates but the employment rate of women aged 60 to 64 has increased as fast since 2010 as it did during the 2000s. An important explanation is the gradual increase in the state pension age for women since 2010, which has led to more older women being in paid work. Without this policy change, the employment rate for 60 to 64 year women would have been broadly flat since 2010.