Right from the start, the guiding question behind the coalition’s fiscal strategy has been ‘Which consolidation measures are least likely to get us into trouble?’ rather than ‘Which consolidation measures are strategically most sensible?’ The result, evident in the previous budget reports and the ‘Comprehensive’ Spending Review, has been a strategy of salami slicing, with random caps and freezes here and there. The Autumn Statement has continued this approach seamlessly.
Take welfare. The strategically sensible thing to do would be to not just shave a few pounds off the welfare bill, but to also improve work incentives in the process. Benefit spending always goes up in a recession, but the key challenge is to reintegrate people into the labour market as quickly as possible, before worklessness becomes self-perpetuating. After the recession of the early 1980s, for example, the labour market did revive, but for many, it was already too late. Employment rates among low-skilled men did not recover to their pre-recession level.
Of course, work incentives are not the only determinant of labour market outcomes, but they are one important factor over which the government has a relatively high degree of control even in the short run. The crucial variable here is the replacement rate among welfare recipients: the ratio of non-work income to the income they could realistically earn in employment.
There is a relatively direct way in which fiscal policy affects the replacement rate: some income transfers are conditional on work, while most are not. If you want to keep replacement rates low, go easy on the former, but don’t be too squeamish on the latter. In practice, it is not quite that simple, because a lot of benefits can be received both in work and out of work – but you get the idea.
So far, the coalition has mostly done the opposite. Last year, it increased Child Tax Credit, a transfer which is not work-contingent, by a higher rate than the uprating formula provided for. At the same time, the basic rate of Working Tax Credit (WTC), a transfer which is work-contingent, was frozen. So was the 30-hour element, an additional tranche of WTC which is activated once a recipient works for at least 30 hours per week. The implications for work incentives were not huge, but they were a step in the wrong direction: it made part-time work less attractive relative to worklessness, and more attractive relative to full-time work.
In comparison, the announcements in the Autumn Statement represent a tiny improvement. The increase in the Personal Allowance will improve the situation of the low-paid, both in absolute terms, and relative to those not working. In combination with limiting the increase in benefit rates to 1%, which is below the projected rate of inflation, this will lead to a decrease in the replacement rate.
Not too bad, but the government could have achieved a bigger bang for its buck by being just a little bit more strategic. Instead of applying a uniform 1% rate, work-related benefits should have been uprated at least in line with inflation, while using a rate slightly below 1% for benefits unrelated to work. This is an example of the kind of strategic savings which, if coupled with other reforms and kept up for a number of years, would not just produce short-term savings but beneficial dynamic effects as well.