Autumn Statement: the salami-slicing continues

 

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. 

we should not ignore the effect of indirect tax here either. One reason why inflation was so high was because of the VAT rise. Workers cannot be compensated for this without unemployment rising and so real wages fell. Those on out-of-work benefits were entirely compensated. So the uprating was inclusive of compensation for a tax rise, compensation that no working person could have received.
Kristian - Hard to disagree with your points. However, when we look at work incentives, we should simultaneously look at employment incentives. Incentivising people to take work is important, but if there are not willing employers it may not get us very far. What the government should do is to cut the cost of employing people - and the most obvious way to do this is by cutting (and eventually eliminating) employers' NI contributions, which constitute a tax on jobs.
Hi Kristian, could you possibly point me in the direction of some robust econometric evidence that shows causation running from the replacement rate to unemployment? I teach unemployment in the 1930s and the initial attempts to show causation (Benjamin and Kochin) fall down under more rigorous analysis. thanks

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