Where’s welfare going?

Welfare has borne the brunt of the coalition’s austerity cuts and George Osborne threatens that another £10 billion will be slashed after the next election, should the Conservatives remain in office.

Plenty for the Opposition to get its teeth stuck into then. But Labour should look to the horizon, not just prepare for trench warfare.  Politicians spend too much of their time fighting on the detail of welfare, and not enough thinking about the fundamentals. We need to ask what is welfare here for and what we want it to do, not just today, but in 30 or 50 years’ time?

In my view welfare has six aims, which command varying degrees of support from across the political spectrum:

1. Preventing poverty (the political argument is over how poverty should be defined, not whether it’s a problem)
2. Incentivising work, progression in work and private saving or insurance (pretty much everyone supports this in principle; the devil is in the detail)
3. Smoothing lifetime welfare, to respond to times when incomes are lower or costs are higher (I thought this argument commanded political support across the board, but at a seminar a couple of weeks ago I heard it challenged, which suggests the Tory right may not be as supportive of the state pension system as I’d thought)
4. Stabilising the economy (we tend to forget that welfare bills are meant to rise during a recession and this helps shore up consumer demand)
5. Responding to market failures (many in Labour circles have started to conceptualise some of welfare as a ‘sticking plaster’ for economic failure such as poverty-pay or excessive rents)
6. Reducing economic inequality (an extension of pure poverty reduction, for those who think welfare is also a means of redistributing geographically around the country and tackling income disparities across the whole income spectrum).

In truth, most of these aims can and should be objectives of the tax system as well. Welfare and tax ought to be designed as a single endeavour, with careful evaluation of whether changes to tax will achieve goals better than spending. Indeed, in the long-term many hope that tax and welfare will gradually merge, although the roadblocks are formidable. But even when we just consider the welfare system, it’s clear that some policies achieve these aims better than others.

In particular, ‘universal’ welfare is almost always a better response that means-tested targeting. That’s self-evidently true in the case of incentivising work and saving (means-testing is a huge disincentive) and helping smooth lifetime welfare (something that’s not just for the poor). But empirically it is also true when it comes to the aims of preventing poverty and reducing inequality, as I wrote in The Coalition and Universalism earlier this year. Universal entitlements funded through progressive taxation are an effective way of distributing across the income distribution. They even turn out to be better at preventing poverty, since they build solidarity so that people are more tolerant of pro-poor spending.

But of course universalism is not cheap. All other things being equal it costs much more than targeted welfare. So the question for the long-term is when do we want universalism and what can we afford? Despite all the recent cuts over the next half century welfare in the UK will become more universal, for the simple reason that most of our old-age welfare is universal and most of our working-age welfare is means-tested. According to the Office of Budget Responsibility spending on the state pension system will rise from 43% of welfare spending in 2010 to around 56% in the 2060s (by when more of the pension system will also be universal).

This shift back towards universalism is welcome, but it does beg the question whether a move on this scale should be planned rather more coherently. Shouldn’t we rationally design a blended universal/targeted system rather than just let today’s mess evolve chaotically? In particular, can we develop policy for different age-groups in the round?

Our current policies lock the UK on a two-track welfare future, with old-age welfare looking in pretty good shape and working-age welfare a total disaster.  Looking at pensions first, over the last decade politicians from all parties have signed-up to a long-term system which looks rational, generous and affordable. The Turner Commission reforms along with subsequent refinements will have the effect of reducing poverty, incentivising work and saving, and improving lifetime income-smoothing across the income distribution. There are three key reasons why the pension reforms are likely to succeed: they rationally combine public and private systems; the state contribution is mainly through a universal entitlement; and the settlement will maintain itself over time because payments are indexed to earnings.

These important reforms have a price of course. Spending on the state pension system will rise by around 3% of GDP from 2020 to 2060, reflecting the costs of the reforms as well as the large size of the baby boom generation (rising costs aren’t affected by increasing life expectancy, which are now more or less offset by planned rises in the State Pension Age). Whether you think this extra spending is affordable is probably down to your politics (although the Office of Budget Responsibility suggests it can be paid for by very modest tax rises or spending cuts elsewhere). The alternatives to stumping-up don’t look pretty however: either much poorer pensioners or diverting a lot more of the family budget to saving.

None of this means that old-age provision is perfect or that every single example of universal entitlement should be a timeless feature of the welfare state. With pensioners growing richer and working-age families bearing the brunt of austerity it is reasonable to debate boundaries. But items like the Winter Fuel Payment and free bus travel make up only a small percentage of old-age welfare spending. It is the overall design principles of the state pension system that matter and must be conserved. Indeed we should consider how similar thinking can be applied to working-age benefits. The next phase of welfare reform should take the best of what has been achieved for pensioners and apply it to everyone else. Above all that means more universalism and sustainable indexation.

Indexation is a dry topic, but over decades it makes a huge difference to people’s wellbeing. Since the 1980s the main welfare benefits have only kept up with prices, with earnings racing ahead by half as much again. By 2007 basic benefit for a single adult was worth just 15% of average earnings, compared to 24% in 1981. This has helped to widen inequalities and entrench poverty, especially amongst people out of work without children.

As a consequence, if current policies continue, the OBR projects that spending on working-age welfare will halve from 6% of GDP today to roughly 3% of GDP in twenty years’ time. Far from the welfare budget spiralling out of control, the problem is that policies will lead to the shrinking of welfare spending at great human cost.

If policy makers were to agree that spending on working-age welfare should remain roughly constant as a share of the economy over time, we could then have a rational debate on how to use the two or three per cent of GDP that we can expect to gradually become available.  It could be devoted simply to re-indexing benefits to earnings (not simply in the rare years when earnings fall behind prices, but for good). However there are other good calls on any extra welfare spending that would compete for any extra money.

First of all, too little money has been allocated to Universal Credit to achieve its objective of ‘making work pay’. The entitlement offers very poor incentives for second earners to go to work and for anyone with moderate or high childcare costs. Improving this situation implies a more generous and expensive system that stretches much further up the earnings distribution, making Universal Credit more like the original conception of tax credits. The logic of ‘work incentives’ is a return to a far less targeted, semi-universal system (what Gordon Brown called ‘progressive universalism’ and Harriet Harman ‘affluence testing’).

Or we could spend more on full-blown universalism. Working-age universal entitlements have been amongst the worst hit areas of welfare – take for instance child benefit, personal independence payment and contributory employment and support allowance. With universalism being chipped away, it feels like it’s time to go back to first principles: we should consider how to design universal entitlements that best advance the aims of welfare, at the most affordable price.

To my mind the top priorities are support with the costs of childcare and more generous state insurance when people lose their jobs through unemployment and disability. From next year the maximum most people with a working partner or savings can expect from the state is £1,900 for unemployment or £5,200 for being out of work through ill-health – not much at a time of crisis after a working life spent paying national insurance.

Achieving both fair indexation and more universalism won’t be affordable without saving money somewhere. However, the best hope for combining stable levels of spending with rational and humane long-term policies lies in economic reform not cuts. After all, unlike with pensions, much of working-age welfare is a cost of economic ‘failure’, such as involuntary worklessness, excessive housing costs and poverty pay. Billions could be saved by addressing these problems at source.

The key question is whether policies can be identified which will achieve a reordering of the economy without damaging prospects for growth.  This debate is gathering momentum in Labour circles and is discussed in the recent Fabian book, The Shape of Things to Come. In the short run the discussion is couched in terms of ‘savings without cuts’ but we should also plan ahead to a time after the deficit is closed. Then the aim can be to keep the share of GDP spent on working-age welfare stable and plough back savings from reduced economic failure into new or more generous entitlements.

To make any of this happen, however, Labour must now start to embrace economic reforms of sufficient magnitude to have a material effect on welfare spending. A substantial rise in the national minimum wage and action to contain spiralling rents should come first.