Saturday, 14 January 2012

Going Beyond the Universal Credit - The next steps in welfare reform

 The current government has launched the largest reform of the UK welfare system since 1945. The British welfare system developed out of the Centuries old Poor Law in the early 20th Century. From 1945-1950 it was transformed from a limited and conditional system into a universal safety net to protect people 'from cradle to grave'. The system grew steadily more expensive and under the 1979-97 Conservative government conditionality and limits were re-introduced in an attempt to control costs. The Labour government of 1997-2010 introduced various new benefits and dramatically increased spending but also continued introducing means testing and attaching conditions to welfare.

Now means testing is perfectly sensible as far as it goes. However, it also leads to a significant unintended consequence. The means testing of various branches of welfare (JSA, ESA, housing benefit, council tax benefits and tax credits) involves people steadily losing welfare income the further their income goes above a threshold until they get nothing. For each extra pound they earn they lose, say, 20p of benefit. But millions of people are on 3 or 4 benefits at the same time. Losing 20p or so of income from each benefit and paying taxes means an effective tax rate of 90%+. In other words if someone on benefits gets a job they can find themselves no better off that being on welfare, and can even end up with less money. This welfare trap hits millions of people. Our standard suite of unemployment benefits involves JSA, council Tax benefits and Housing benefit. That is enough that if a person gets a job for a few hours a week they will lose all the extra money they earn and possibly more.

This is especially true for those with marginal, part-time or temporary employment prospects. The risk with any such work may be that a person may end up both with less money, and being thrown out of the welfare system, meaning that if their job ends or they find themselves incapable of completing it they may face re-applying for a range of benefits, a process taking months and involving climbing a mountain of bureaucracy. For those in difficult financial situations the stress of the risk of this occurring provides a significant incentive for people to actively avoid part-time or marginal work that does not provide an assurance that the person will be propelled well beyond benefits. But these marginal and temporary jobs are very important because they keep people in contact with the jobs market allowing them to maintain skills and experience, and to provide them with the basic sense of control over their own future that is essential to maintaining the morale to keep slogging away finding a real job. Hence the welfare trap is a particular problem precisely for those people from the most deprived and welfare dependent communities and backgrounds.

The Universal Credit was a centre plank of the Conservative manifesto in the 2010 election.  The idea is to solve this problem by combining all benefits into a single payment that would then have a single 'withdrawal' rate to make sure that for each pound of extra income earned welfare recipients kept at least some of the money, or as the slogan put it 'making work pay'. Allowing people to keep some of their benefits for a while when starting work, and removing benefits steadily in a manner insuring people always have a financial incentive to do an extra hour of work. The estimated extra cost of this is £3 billion a year upfront but will hopefully pay for itself in the long term by ensuring people always have an incentive to be seeking any work they can, keeping them in contact with the job market, maintaining skills and experience and hopefully meaning over time more people move from welfare into work permanently.

This is an ingenious solution to the welfare trap that exists for earned income. This welfare trap comes about through the fact that the system is a hodge-podge of different responses to particular problems. The overall effect of all these solutions was never considered holistically and hence the dramatic perverse incentives were not noticed and a system that is meant to not just keep people alive but also empower them to improve their own situation can become for many a system that traps that at a level just above subsistence. Those on welfare find themselves in a situation totally different from that facing most people. Working harder and 'earning' money often does not bring the prospect of increased income and security but at best working harder for the same money, or at worst facing greater poverty and stress. The Universal Credit attempts to correct this situation, ensuring that the welfare system acts as a trampoline not just a safety net and always involves an at least quasi-normal relation between working harder and having more money

It is possible to go beyond the reforms that make up the Universal Credit and and structurally improve the welfare system even further using the same principles and , making it even more of a springboard.  There is not just a welfare trap in Income, there is also a less well known (and admittedly less significant) welfare trap in savings.  In addition to the income means test there is also a savings mean test that is applied. For many benefits if you have cash savings of more than £16,000 then you cannot access welfare.  In particular there is a standard £6,000 threshold, below which one receives full benefits and then for each £250 of savings one has over the threshold the person loses £1 a week of benefit income.  This is quite reasonable.  If people have considerable cash savings it is reasonable that they draw on these rather than getting help from the government. The problem is the upper threshold of £16,000. As one'sone's income suddenly drops to zero. For example, someone who is unemployed with savings of £15,000 can receive around £102 a week in welfare.  Someone with £16,500 in savings will receive nothing.      

This means that if you are in a position where you have some cash savings, but not considerably more than £16,000, say in the £6,000-£20,000 range, and you think you may need to access welfare at some point in the short or medium term then you have a strong incentive to not save any of the money you earn.  You are better off spending it all, knowing that if you lose your job or your income you will then be able to safely access welfare, rather than saving the money, both forgoing buying stuff now and risking that you would just have to spend it all and then access welfare, leaving you in exactly the same position after considerable stress in the intervening period.

This is socially damaging in the long term. For most people wealth is empowering, it gives people security and a control over their own life.  Once people have a bit of wealth it makes it easier to get more wealth and stand on their own two feet going onward. More widely there is a strong correlation between wealth and social mobility, health, and a whole other raft of statistics. From a financial perspective people having some wealth in turn makes them less likely to need to access welfare or government support in the future. As with the income welfare trap it is also those with little wealth, or otherwise marginal financial situations, who are in most need of encouragement and support in gaining this security and safety net whereas in reality through our welfare system they are the ones being particularly discouraged.

This issue also applies to considerable numbers of people. Especially because in our society wealth is even more unequally distributed than income, and this distribution has been becoming more and more unequal over the last several years. There is an easy way to solve this problem though, and by using the mechanism already built into the welfare system, without the need for  dramatic re-engineering, like the Universal credit.  Two simple steps would largely remove this problem: firstly, increasing the ceiling for benefits withdrawal from £16,000->£26,000 and slightly adjusting the withdrawal rate to a loss of £1 a week in income for each £200 of savings over the threshold.  These two steps would largely remove the cliff-edge, leaving only a small step. For example, current unemployment benefits are about £135 a week for a single person. As savings increase from £6,000->£16,000 this reduces from £140->£100 and then falls straight to £0.  Under these changes as savings move from £6,000->£16,000->£20,000 welfare income falls from £140->£90->£40 and only then falls to £0.

This approach reduces the size of the drop by more than half, while also allowing people to get considerably further clear of Broke before it kicks in and hence significantly reduces the disincentive to save money. It does also maintain a reasonable upper limit, avoiding dragging more and more people into the welfare net, and also avoiding a situation of needing to process claims for a few pounds a week of welfare. These limits are always a compromise, but I think this would be a far better compromise than the current one. It also should not cost that much money. Steepening the withdrawal slightly from £1 for every £250 to £1 for every £200 would save some money.  Also for a number of people it would mean placing them on a smaller amount of weekly welfare, rather than forcing them to wear down their savings until they go below £16,000 and then putting them on a larger weekly sum of welfare, making the overall increase in cost minor.

The way to look at this is like this: The welfare system and public services are the way we redistribute wealth.  They provide access for all citizen to services and support that would normally require each citizen to have considerable amounts of money to buy.  The top 10% have 100 times as much wealth as the bottom 10%.  But it has been calculated that the wealth that would be required to buy the bundle of public services and welfare that each person has an entitlement to is about £100,000.  This is the common inheritance we give to each citizen, and that reduces the disparity in wealth to 10:1. Like I said, real wealth is empowering and gives people security and chances.  These reforms would shape this common inheritance to ensure that, like real wealth, it also acts to empower and secure people; acting as a springboard not just a safety net.

Another possible reform in relation to the savings means test for welfare relates to the definition of 'savings'. This encompasses financial savings apart from equity in a property.  This produces a sizable distortion though in favour of those who own housing against those who rent. In other words if you have £20,000 in savings and use the money to rent a property, you have no access to welfare; if you use that money to get £20,000 of equity in a house so you don't have to rent you do have access to welfare. This makes sense in terms that wealth bound up in a house is obviously not wealth that can be used to pay bills and buy food and support a family in a time when money is short.  But in terms of fairness it cannot really be justified. There are ways for people who's wealth is in housing equity to contribute that money against the cost of welfare which don't involve kicking them out of their homes. For example in terms of some amount of housing equity above a certain minimum, say £20,000, passing over to the government according to a tariff related to the amount of welfare received. The government would then get that share of the equity when the house was sold, or when the owner died in a manner similar to private equity release schemes. This would be an admittedly slow burning way for home owners to contribute towards welfare, in the same way that those without housing equity would have to.  But over the long term it may be worth it for the government, and would even-out a significant disparity between homeowners and non-homeowners and even go some of the way towards meeting the cost of the reform to savings means testing outlined above.

A third important structural improvement to the welfare system would be to overhaul the point which a partner's income affects a person's eligibility for welfare support.  I will now explain what that means in English.  I've already mentioned the Means test that is used to check eligibility for welfare both with reference to savings and income, and how this can produce severe disincentives for people on welfare to work or save. The means test doesn't just take into account the income and savings of the person applying for welfare, but also that of their spouse or partner.  Again, in principle, this is quite reasonable. Of course in situations where one partner has considerable money or income they should support their partner once their eligibility to contributory welfare runs out rather than relying on the state indefinitely.  The problem comes in the details. The means test is currently set at an absurdly low level. A partner's savings are assessed as the same as the applicant's savings and the threshold for income is only about £8,000. This basically means that if a partner has any job or savings then a person cannot access welfare beyond the time limited contributory benefits.

This is not just a point of academic interest. One area where this hits quite savagely is in respect to one of the government's current welfare cuts, which was voted down in the House of Lords and discussed on Newsnight only this week. This is a proposal to limit Contributory ESA to 1 year.  Now, ESA is the main benefit given to people who cannot hold down a job due to sickness or disability. It is meant for people who are too ill or disabled to go through the ordinary Job seekers program. Like JSA it effectively acts as a general income for people while they are out at work. Until now though, unlike JSA, contributory ESA has not had a time limit.  The government is attempting to introduce a 1 year time limit, after which people will either move onto Income-tested ESA or lose support.

The government argues that contributory JSA is limited to 6 months, so why should the equivalent for those Sick or Disabled and out of work, ESA, be different? And points out that there is still Income based ESA to support those with no financial resources.  The problem first comes because the connection between ESA and JSA is tenuous at best in this instance. JSA is meant to be distinctly short-term.  For many ESA will be extremely long-term, even with the government's most optimistic assumptions, meaning that it becomes that much more important that it does actually provide a family with a sufficient income to survive over the long term.  But mainly it's because, as I said, the government's definition of financial resources is frankly laughable. Any family with a Sick or Disabled member that also has either any savings or a partner earning almost any money will get no support. Firstly, this creats a quite savage work disincentive for families with a disabled or Sick member.  Secondly, families with a sick or disabled member already have a poverty rate double that of other comparable families and, thirdly, the individuals within these families on average have costs 25% greater than a non-Sick or Disabled person. The considerable and additional financial pressure of this measure will hence almost certainly push most of the three hundred thousand households affected into poverty, or push them even deeper therein if they are there already.

I am a (extremely small) part of a campaign to lobby against these and other proposed cuts to support for sick and disabled people, something I've written about before here (at length) and here (at considerably less length). Among a few other things this campaign has focused on opposing the introduction of this time limit to contributory ESA.  The government has repeatedly responded that Income based ESA will still be there for those who fail the means test and they are right as far as that goes.  But the real issue is that the means test itself is fundamentally broken, particularly in regard to savings and the level of a partner's income allowed. If the means test for ESA was set at a sensible level then limiting contributory ESA would be an entirely reasonable policy. But it's not and so it isn't.  Unfortunately this gives the whole argument a slightly false character, because the issue under discussion isn't the real issue. In the long term it would be far better to properly consider and overhaul the means test with relation to both savings and the partner's income, certainly for benefits solely relating to the sick and disabled but also (though with less urgency) more generally.

A review could consider ideas such as introducing a taper with relation to partner income, as has been suggested with the Universal credit and with the savings means test in order to counter the extreme work disincentive this creates. Also, calculating a separate means test threshold for sickness & disability benefits like ESA, taking into account the estimated average 25% higher costs experienced by families with a disabled or sick member and the likelihood that disability benefits will be claimed for much longer periods than the Dole, to ensure it does guarantee a sustainable income for families who have to struggle with the reality of a member who is disabled or suffering from long term sickness.

All these ideas are ways of making our welfare system work better through structural change rather than just spending ever increasing amounts of money. Even if these ideas are dismissed as rubbish I very much think this approach is sound. We must holistically consider the structural effects of each piece how we administer and deliver our welfare system and the unintended consequences and side effects it can produce, rather than just looking at the needs each benefit is meant to cover. This gives us the chance to come up with new ideas to shape the whole system for the better and ensure it fulfils its potential and purpose to act not just a safety net but also as a springboard to support people to build a better life for themselves. The Universal Credit is a good start but the government should be already be looking to go beyond it to the next reforms that can shape our welfare system for the better.


George Kendall said...

Hi Stephen, thanks for the post.

If I'm not mistaken, all the Conservative manifesto says on Universal Credit is "We will investigate how to simplify the benefit system in order to improve incentives to work", so I'm afraid Universal Credit was not a centre plank of the Conservative manifesto in the 2010 election.

There was well-reported resistence from the Treasury in 2010, and it was reported that George Osborne was extremely resistent to the idea.

Of course this only makes the achievement of Ian Duncan Smith and his Coalition allies in getting this through parliament all the more impressive. It's a marvellous policy, supported by many not just in the Conservative party.

Stephen Wigmore said...

I'm not sure about the actual manifesto text, but certainly the Universal Credit had been widely discussed before hand as Ian Duncan Smith's big idea that he was going into government to make a reality.

I'm glad the the Lib Dems have been relatively supportive of the Universal Credit, and even Labour have had to go silent on the issue. I only hope that we can see this as a first step towards creating a better welfare system, and that we can re-invest some of the savings achieved from the recent cuts welfare to achieve this.

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