The Money-Go-Round Cutting the Cost of Welfare

The Money-Go-Round Cutting the Cost of Welfare 14 October 2010

Structure • The cost of welfare and three areas of concern • The money-go-round • Taper design • Delivering welfare • Conclusions

The cost of welfare • The government spends more on welfare than anything else. The bill for social protection has approximately doubled in real terms since 1990 to £218 billion (including departmental spending) today. Spending has been increasing even as caseloads have been falling • Although the welfare system is relatively expensive (the UK spends £90,000 per child from birth to 18, the OECD average is £80,000), it produces poor results (high rates of risky behaviours and NEETs) • Only 10 % of expenditure is on the main out of work benefits. 54 % is spent on the elderly and 27 % on children

The cost of welfare • Budget 2010 proposed £11.0 billion in savings from welfare measures. These included freezing the Child Benefit, indexing main benefits to prices not wages, medical tests for sickness benefits and reducing generosity of housing benefit • These savings are in the context of £31.9 billion of savings above previous government plans. £18.8 billion will come from other current spending (departmental budgets) and £2.2 billion from capital spending • But these savings are measured against spending plans. The following slide shows changes as measured against baselines (current spending levels)

The cost of welfare Spending Plans Measured Against Baselines, £ billions

The cost of welfare • As a share of Total Managed Expenditure spending on Social Protection is estimated to increase from 27.8% in 2010-11 to 31.7% in 2014-15 • Non ring-fenced Departmental Expenditure Limits are, in contrast, estimated to fall by 8.4% against baselines • Making greater savings in welfare would reduce the size of savings needed in departmental budgets • Saving an additional £10 billion by 2014-15 (£2.5 billion p.a. or less than 1.5 % of the social protection budget) could mean departmental spending only needs to be cut by 4.1% against baselines

Three areas of concern • Middle class welfare: many households simultaneously receive assistance from and pay substantial taxes to the government. This money-go-round leads to administration and compliance costs and taxes being higher • Assistance for working age households: assistance to the poor is carried in a “leaky bucket” with administration and compliance costs and people being discouraged from making the right decisions • The cost of pensions: the growing cost of welfare commitments threatens to swamp attempts to reduce the deficit • This report focuses on the first two issues

The money-go-round • Data for the most recent year (2008-09) show that £31.8 billion was spent on providing benefits to the middle classes and above • £23.8 billion of this spending was received by the non-retired and £8.0 billion by the retired • This estimate of middle class welfare represents around a quarter of spending on cash benefits contained in these data (which is not all spending) • This estimate is conservative. The threshold is relatively generous and some benefits are recorded as reductions in tax liability (e.g., the component of tax credits that offset income tax)

The money-go-round • Based on a 25% increase in incomes between 1998-99 and 2008-09 the cost of middle class welfare has increased from £17.1 billion to £31.8 billion, or from 17% to 24% of spending on total benefits. The worst targeted benefits are:

The money-go-round • The tax-benefit position of the middle classes also reflects changes in taxation and benefits in kind. Including these in the calculations shows (calculations exclude taxes and spending unable to be attributed to families):

The money-go-round • The increase in the middle income tax burden has been significant • Since 1997 the tax burden has increasingly shifted towards income and away from indirect taxation • The increase in direct taxation facing middle income families was 30.5%, the increase in indirect taxation 8.0% • From 2000-01 to 2008-09 personal taxes rose by £6 a day for the average worker, due to increases in National Insurance Contributions and a failure to increase tax thresholds fully in line with earnings (fiscal drag)

The money-go-round • This average hides differences in the treatment of non-retired and retired households • Non-retired households: net effect -£2.6 billion (tax burdens growing faster than benefits received) • Retired households: net effect £3.1 billion (benefits received growing faster than taxes paid) • Reinforces REFORM research on the IPOD generation: younger generations face higher future tax burdens, lower levels of public spending, greater levels of student debt and greater difficulty in accumulating housing assets

Taper design • A major reform of the number of and types of benefits has been proposed. There would be fewer benefits, a generous earnings’ disregard that would vary by family characteristics (e.g., marital status, numbers of children, housing status) and a uniform taper rate (e.g., 55%) • Reforms motivated by concerns with: • Complexity: 51 benefits with a range of targeting criteria and abatement schedules. DWP decision makers’ guides total over 8,000 pages. Complexity is reflected in administration and compliance costs, rates of fraud and error and take up • Poor incentives: poverty traps occur when people find that entering into (or remaining in) work or increasing work effort is not worthwhile. May also lead to marriage penalties – where married couples are disadvantaged relative to separated ones

Taper design • Recent government estimates put the cost of benefit and tax credit fraud at £5.2 billion a year • In 2009-10 the Department for Work and Pensions spent £6.57 billion on administration. Of this £3.3 billion was spent on administering benefits for working age people • In 2009-10 Jobcentre Plus spent £3.7 billion on administration • The latest assessment for fraud and error found total overpayments to cost £3.1 billion in 2009-10, or 2.1% of total expenditure

Taper design • Data from 2007-08 show that the level of pension credit take-up by caseload is between 61% and 70%. Take-up of the guarantee credit only, which is paid to the poorest pensioners, is higher, at between 72% and 81% • Survey data suggest that take-up rate for Disability Living Allowance could be between 30% and 50% • But, HMRC data estimated that take-up rates for Child Tax Credit between 86% and 92% for expenditure. Take up of this programme falls with income. Take up rates of families out of work are around 97% and is lowest for families with incomes over £50,000 p.a.

Taper design • Taper design is not a silver bullet • Impossible to make work pay for all. Improving incentives at the very bottom worsens incentives further up the income distribution. More generous earnings’ disregards and lower taper rates will discourage second earners from working • People are not only motivated by financial incentives. Factors such as childcare, work tests (conditionality) and culture also influence labour supply (esp. of lone parents) • The margins on which behaviour change may not be clear (e.g., people do not chose to work one hour, or one more hour, but discrete combinations of hours (e.g., 16 or 30 hours))

Taper design • Little evidence that generous earnings’ disregards encourage labour supply: • US evidence shows that increases in earnings’ disregards under TANF reforms did not increase labour supply • Benefits of disregards were too complex to understand • Not the appropriate margin – improve incentives for a few hours work but discourage entry at higher hours or incomes (e.g., full time work) • Encouraged mixing welfare and work rather than full independence. Some people reduce work effort and incomes • There is mixed evidence that micro-jobs (low-wage part time employment) lead to full-time employment. May simply encourage greater churn in the labour market rather than progression to full-time work

Delivering welfare • Simplification must be the goal but some complexity is necessary. While the direction of simplicity is right there are practical barriers to simplification: • Fairness – a simpler system means that some differences in people’s circumstances (and how these change) will no longer be taken into account when assessing assistance • Fiscal cost – simplification tends to be expensive • If simplification of the welfare system was easy it would have been done by now

Delivering welfare • As well as a ‘big bang’ approach – simplification can come through a gradual process: • Rules for benefit eligibility can be made to conform to each other • Overlaps between benefits can be eliminated and then combined individually where appropriate • Review the distinction between contributory and non-contributory benefits • Removal of hours based thresholds would be a good target for simplification • Opportunities to streamline processes and automate flow of information must be built upon

Delivering welfare • The Work Programme (a single back to work programme for the unemployed) needs two things – committed people and a framework • The framework should address capacity issues: • Small scale of organisations compared to the commercial sector • Need for working capital (providing resources up front for a payment by results scheme) • Addressing scale: greater use of joint ventures between welfare to work services, offender organisations, housing associations, etc • Market structure: allow for provider entry and exit to support innovation

Delivering welfare • Addressing working capital: the DEL-AME switch needs to look like an investment not a gamble – otherwise credible, stable providers won’t take part: • Greater understanding of costs and outcomes of helping people into work (need to know which segments of labour market will be most affected by consolidation and their specific needs) • Creating the incentives to keep people in work without creating too much risk for providers • Learn lessons as programme evolves • Outcomes also reflect the labour market context (need to create an environment in which private sector employment can grow)

Recommendations

For further informati0n Please feel free to contact any of the REFORM team (020 7799 6699) or Patrick Nolan, Chief Economist, patrick.nolan@reform.co.uk, 020 3327 1185 Thomas Cawston, Researcher, thomas.cawston@reform.co.uk, 020 3327 1183 The REFORM website (www.reform.co.uk) for: The money-go-round: cutting the cost of welfare Budget 2010: taking the tough choices The first hundred days: welfare, education, public services and the deficit, health

The Money-Go-Round Cutting the Cost of Welfare