The BBC have an article in the ‘Magazine’ section of their news website in which they encourage readers to ‘Rip up the benefits system’. Despite initial appearances, this isn’t the moment at which the BBC finally decided to abandon their journalistic integrity and just let whoever was trolling around in ‘Have Your Say’ loose across the entire website. The article is in fact an attempt to highlight some of the problems that all governments face in reforming the benefits system. Specifically, it discusses – with the aid of handy illustrative graphs – a supposedly intractable Catch 22:
On the one hand, if someone who starts work has their benefits withdrawn too quickly, they can end up with virtually the same income for a whole lot more effort, and this is a powerful disincentive to starting work. On the other hand, if benefits are allowed to taper more gradually, this can result in people who are earning a lot of money still receiving some benefits/ tax credits. The real heart of the Catch 22, as the BBC describe it, is that any action the government takes to incentivise work will require a long, slow tapering-off of benefits, which will result in the well-paid continuing to receive some income. Conversely, any government action designed to make sure the well-paid get nothing requires a more rapid tapering-off of benefit, which results in the low-paid also losing benefits income more rapidly, damaging their incentive to work.
The BBC end their article by encouraging their readers to put forward their own solutions to the problem, so, in that spirit, allow me to present you with my solution:
- For each individual out of work, set a personalised minimum in-work income threshold at 150% of their income from all benefits.
- When this person finds work, their income from all sources (benefits and work) can reach their minimum income threshold before they lose a penny of benefits, or pay a penny in income tax or national insurance. The opportunity to increase one’s income by half would act as a powerful incentive to start work.
- For a person whose income is above their personalised threshold, the rate at which they lose their benefit income is staged. For example, a person could see their net income from all sources increase: by 80p for every extra pound of gross income between 101-110% of their minimum income threshold; by 75p for every extra pound of gross income between 111-120%; by 50p for every extra pound between 121% and 130%; and by 25p for every extra pound above that, until such time as their benefit income had fallen to zero. This would ensure there was still a significant incentive to work longer hours, while also ensuring that the better off saw their benefit income decrease at a faster rate than the less well-paid.
- This personalised approach could be combined with an absolute threshold set relative to the median average wage, above which anyone still receiving benefit income would see it fall back much faster. This would help to minimise the extent to which higher earners were subsidised, irrespective of their personal circumstances.
- It should be noted that the net effect of this system is not to completely remove all disincentives. Rather, they are shifted up the income scale, meaning that the incentive to begin low-paid work is achieved at the cost of reducing the incentive to move from low-paid to better-paid work. I would argue this is less problematic. Once a person is in work, there’s a likelihood that other incentives – greater responsibility or authority; more interesting or varied duties; the opportunity to out-compete colleagues – will act as a pressure towards career advancement, even if the financial incentives are lessened.
- It should also be noted that, in order for a person’s net income to behave in the way described, the tax and benefit systems would have to work in harmony. But this would seem to make sense anyway; the present system, under which the government takes away with one hand, only to give back in the form of means-tested tax credits with the other, makes no sense.
There’s an obvious caveat to all of this, related to the fact that the Catch 22 is not fully described in the BBC article. The real Catch 22 is that the government want to provide help to the poorest (they claim…), create an incentive to move into work, and avoid subsidising the well off – but they want to combine all that with a reduction in the overall cost of the benefits system. Without access to detailed figures I can’t be sure, but I wouldn’t be confident that this scheme would save money, even in the long run. Since it calls for the less well-paid to receive significant extra income from the government, in fact, it would almost certainly be necessary to increase the amount of tax paid by the better off. My scheme is a (modestly) redistributive one, and I’m very comfortable with that. I suspect, however, that our current government would be less attracted to the socialist principle of ‘To each according to need; from each according to ability to pay.’
In fact, if you think about it in a more fundamental way, there’s an even more substantial problem; namely that the benefits system was never intended to subsidise those who are in employment. It was intended to act as a safety-net for those who were unable to work, either because of unemployment or sickness. When it’s used to subsidise those who are in full-time work, it becomes, in effect, an incentive to employers to exploit their staff. Allow me to explain.
In order to be able to dedicate their time to carrying on their employer’s business, an employee has to be able to afford to provide food, clothing, shelter and, where necessary, care for themselves and their dependents. This means that, if an employer wants an employee to be dedicated to their service, they have to pay them sufficient to enable them to meet their commitments. Looked at properly, these are unavoidable business costs, just like the costs of buying in services like electricity and ICT.
There are many good employers who pay liveable wages to their employees, either because experience has taught them that this is the way to attract the best staff, or because they have been forced into it by a sufficiently organised workforce, or for straightforward ethical reasons. There are also bad employers who don’t. Unless the economic system is fully regulated, there’s always going to be a differential between what good and bad employers pay, with the latter always striving to pay as little as possible. The problem is that a system of in-work benefits allows a bad employer to get away with paying less than they otherwise could. An employee can accept – and hence a bad employer offer – an otherwise unliveable wage because they know the shortfall will be made up in benefits.
These benefits are ultimately funded by tax, and the bulk of tax is paid by businesses rather than individuals. This means that the in-work benefits that make it possible for employees to accept unliveable wages are, largely, paid for by employers. If all businesses paid their employees the same, this would still be a bizarrely complex economic system – think of all the bureaucrats required to collect money from a company and then arrange for its delivery to the employees of the same company – but it would at least be fair.
The problem is that not all businesses pay their staff the same. Some good employers already pay their own staff a liveable wage, but then have, through a collectively pooled tax system, to subsidise the staff paid an unliveable wage by bad employers. When it’s borne in mind that good and bad employers may be direct competitors, the situation is revealed as untenable. Essentially, a bad employer is able to offer lower prices because the government are compelling the good employer to cover part of their business costs for them. This is obviously unfair, but it’s worse than that. Faced with a competitor charging less, the good employer has no other option but to cut their own prices, even if this means cutting wages, and hence driving down income across the board.
This is what I mean when I say that a system of in-work benefits acts as an incentive to employers to exploit their staff. Not only does the system make it possible for bad employers to pay less than the full costs of the labour they employ, it also forces otherwise good employers to pay less in order to remain competitive. It’s natural to think of in-work benefits as a subsidy provided to the poorly-paid, and the kind of thing, therefore, that left-wingers like me ought to be in favour of. Certainly, given the choice between the low paid being thoroughly immiserated or helped by a system of targeted benefits, I would always opt for the latter. The problem is that, by subsidising exploited employees, in-work benefits also indirectly subsidise exploitative employers.
There is, I think, a solution to this problem, which would also act as a way of ending the poverty trap, and providing an incentive to work, and – the holy grail! – reducing the overall cost of the benefits system. It’s really a very simple solution: increase the minimum wage from its present level (where a full-time job paid at this rate is barely liveable for a person with no dependents and low housing costs) to a level that accurately reflects real living costs. This would have the effect of forcing bad employers to meet the full costs of running their business. It would also, at a stroke, take many working people out of the benefits system altogether, not by reducing their income, but by increasing it to the point where they are no longer entitled to means-tested benefits. At the same time, the dramatic increase in the income differential between a life on benefits and a life in work would provide a clear incentive, for those who are able to, to move off benefits and into work. The combined effect of all of these changes would be to substantially reduce the overall cost of the benefit system.
When it comes down to it, discussions about how to ‘close the poverty trap’ or ‘end welfare dependency’ are actually discussions about how to make work pay enough to look attractive. The easiest way to achieve this isn’t to fiddle around with bureaucratic government schemes, or to make low-paid work appear more attractive by cutting out-of-work benefits to the point where they no longer fulfil their purpose. The easiest solution to the problem of how to make work pay is simply to make work pay.