Pre-Budget Report: Darling must cut UK’s huge welfare bill

Alistair Darling is staring into the abyss. Unless he makes severe cuts to government spending there is a real risk he will plunge the UK into another economic crisis.

Without a credible commitment to bring public expenditure down to sustainable levels, the bond investors funding Britain’s near £200 billion annual borrowing may demand a risk premium in the form of higher interest rates. A big rise in rates would in turn increase the cost of the government’s debt repayments, threatening a debt spiral which could jeopardise economic recovery.

Growth is already threatened by the well-known crowding out effect of public borrowing, which diverts resources from the productive parts of the economy. This may mean official growth forecasts are too optimistic, making cuts in spending even more necessary.

In the context of these grim economic realities, Darling cannot make savings of sufficient scale without tackling the major areas of government spending – health, education and, most importantly, welfare. Including state pensions, welfare benefits cost about £170 billion per year, around one in four pounds the government spends. This emphasises the magnitude of the problem. Even a highly contentious 10% across-the-board cut would save just £15 billion – worthwhile, but a fraction of what is needed.

Yet many welfare benefits are more about favouring particular groups of voters than providing a safety net to cover basic needs. For example, a whole host of payments have been introduced that favour the over-60s, including pension credits, winter fuel payments and free travel. These special benefits add up to at least £12 billion per year and often go to relatively well off households. They also reduce incentives to work and save.

A combination of phasing out special payments for the over-60s and reducing benefit rates by a relatively small percentage across the board would help ensure welfare played a proportionate role in rescuing the public finances. A failure to address Britain’s huge welfare bill in today’s PBR will augur very badly for the country’s economic future.

I believe two principles above all should guide a responsible Chancellor of the Exchequer in these difficult times. The first is to identify and publish the true position, as nearly as you can honestly judge it. The second is that there must be ‘no sacred cows’.On the basis of his record so far there seems little reason to expect that Alistair Darling will satisfy either of these principles. He has been absurdly optimistic and he has ring-fenced large swathes of government spending.

“Growth is already threatened by the well-known crowding out effect of public borrowing, which diverts resources from the productive parts of the economy.”What evidence do you have? To my mind the collapse in bank lending has had a dampening effect on the economy. Private demand is just not there. Surely the increase in govt borrowing is simply replacing that fall in demand. So its not crowding out the private sector since private sector demand left the stage before the increase in public borrowing began.

Barry – the problem with this argument is that every pound spent by the government has to come from somewhere (e.g. tax, borrowing, printing money). Public borrowing absorbs resources that might otherwise be available to the private sector. There is also the problem that expectations of tax rises and/or inflation to pay off the debt act as a deterrent to investment. Another important point is that government spending reflects the preferences of bureaucrats and politicians rather than individuals, so the two are not strictly comparable (hence, best not to rely on aggregates).

I can’t see how the winter fuel allowance can be justified for anyone in full-time work.
In-work benefits are supposed to be means-tested, aren’t they?

Len – the problem with means testing the winter fuel allowance would be the effect on work incentives (not to mention still greater intrusion into individuals’ private financial affairs). Having said this, the effect would be relatively small in this instance.

The winter fuel allowance should be scrapped. You don’t have to spend it on fuel in any case – it is just an age-related hand out. However, as a minimum it should be absorbed into the state pension and de facto, not paid to anybody below state pension age. The history, I think, is that it was paid to pensioners but then the government were taken to court for discrimination because that meant that males and females received it at different ages, so it was given to everybody at 60.

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