Observations

What can be done to simplify benefits and strengthen work incentives?

Date: 27 May 2010
Authors:
Publisher: IFS

Iain Duncan Smith, the Secretary of State for Work and Pensions, today gave a little more detail on the Government's plans for welfare reform, suggesting that the benefit system needed simplifying, incentives to work strengthening, and welfare-to-work programmes reforming . But what can actually be done?

The fact that the Government wants a simpler benefits system should not be a surprise: when was the last time you heard a Secretary of State calling for the benefit system to be made more complicated? The problem that confounds any government holding these worthy ambitions is that simplifying benefits is usually difficult, and often costly unless there are to be many people made worse off: the current benefit system is complicated because it targets money in very precise ways.

An easy route to a simpler system is to keep the existing set of benefits, but make them operate as a more seamless whole. For example, some benefit recipients have to give information to three authorities at present when circumstances change, and it would clearly be simpler for recipients if this information were given just once. These sorts of changes might involve governments having to spend more money themselves on administration, but could lead to savings if they reduced the money lost and administrative efforts wasted through the mistakes that can arise. There would be greater scope to make these sorts of changes, though, if the Department for Work and Pensions became the only authority administering benefits and tax credits: this would require taking responsibility for tax credits away from HMRC, and having local authorities pass the burden of administering housing and council tax benefit back to central government. The Conservative Party suggested such a change for tax credits when in opposition, but the coalition Government has so far remained silent on this issue. However, the benefit simplification suggested by the Centre for Social Justice would be much more dramatic, scrapping all existing benefits and tax credits, and replacing them with just two. Such a radical reform could substantially simplify the benefit system, but would pose considerable practical challenges.

Iain Duncan Smith also pointed to the weak work incentives that face some low-earning adults, a subject about which the IFS has done considerable research. The weakest work incentives - often characterised by the very high marginal withdrawal rates faced by some working adults - arise when benefits and tax credits are both withdrawn at the same time as individuals are paying income tax and national insurance on their earnings.

There are two broad approaches to addressing this problem, both with their disadvantages.

First, the problem can be reduced by means-testing benefits or tax credits less aggressively, but this leads to higher welfare spending, and will usually bring more families into the reach of means-testing. In general, this was the approach taken by the previous government, and, interestingly enough, also by a report published last year by the Centre for Social Justice. Given the priority accorded to reducing the size of the fiscal deficit, it is hard to believe, though, that the current Government feels this is the right time to increase spending on welfare benefits.

Alternatively, one can address this problem without spending more by limiting the reach of means-testing benefits, or by increasing taxes to pay for more generous benefits for low earners: this was the approach I took when contributing to the Mirrlees review of the tax system, where I proposed a reform to strengthen incentives to take low-earning jobs, and suggested this be paid for by cutting benefits for those who do not work, scrapping child benefit, and increasing most people's income tax bills; such a reform can strengthen incentives to work for some, and be made revenue neutral, but makes many people worse off.

Finally, the Secretary of State repeated the Government's intention to combine welfare-to-work programmes into a single Work Programme, with greater use of the private and voluntary sector, and more payment by results. In opposition, the Conservative Party made a similar proposal which they thought would cost £600m more over three years than the previous government's plans, but there is no indication yet what the Government's actual proposals might cost.