Universal Credit: a good idea but certainly no cure-all

The DWP is getting serious about the plans to merge a host of existing benefits into a Universal Credit (UC) with a single taper rate. There are two main aims. One is to simplify the system to increase its predictability (and in order to reduce waste and fraud). The other is to make benefits partially portable into working life, so that recipients who move into work can be sure they will gain from doing so. By moving people into work, Iain Duncan Smith believes that the system will ultimately save £9bn annually. 

UC may well achieve the first aim, which would already be a big improvement. Greater predictability could well have an employment-boosting effect of its own, even if it did not, in itself, improve the financial payoff from moving into work. To use an analogy: suppose a restaurant, R1, always delivers food of a quality level “Q”. In the competing restaurant R2, the quality level is also Q on average, but it varies greatly with each visit: it can be well above, but also well below Q, so by choosing R2, you can be in for a very pleasant, but also for a very unpleasant surprise. While there are some consumers who enjoy gambles, we know empirically that most will prefer R1 (assuming, of course, that R1 and R2 are otherwise identical).   

For people who are in receipt of more than two benefit types, or who receive benefits while simultaneously paying income tax and NIC, increasing their workload is not unlike going to restaurant R2. Since benefits interact with one another and with the tax system in complex ways, it is hard to predict what the impact on disposable income will be in an individual case. This uncertainty is exacerbated by the possibility of tax credit repayments, where people have to pay back previously received income supplements.

However, there is good reason to be suspicious of the alleged £9bn savings. The Universal Credit is meant to have a lower taper rate than the combined taper rates of the present benefit system. In very crude terms, this can be thought of as in the graph below, where the blue line would represent the present system: as income increases, benefits are withdrawn quickly. (In reality, this is of course anything but a straight line). UC would look more like the red line, where benefits are withdrawn more slowly.

 

Apparently, IDS expects a lot of people to move from the intercept with the Y-axis (=worklessness), or from a position like A (=minor employment), to a position like B (=several days a week of paid work). But a lower taper rate also enlarges the circle of recipients. This entails extra costs, even if none of the new recipients change their behaviour. But some of them could very well switch from a position like C (=full-time work) to B, where they would enjoy more leisure while earning as much, or nearly as much, as before. This would lead to higher benefit payments to people who don’t need them.

One could argue that if UC helps to overcome chronic worklessness, then the fact that some people are taking a free ride is a tolerable side-effect. But at the very least, since we cannot know exactly how people will respond to the new incentive structure, UC should not be promoted as a big cash cow.

Government changes are often promoted on the basis of large benefits or savings, which ultimately fail to appear to anything like the extent promised.Often there is considerable uncertainty about the net effects of changes, and politicians are naturally inclined to give themselves the benefit of any doubt.Moreover, there is not much ‘incentive’ to be honest. By the time the results are available, the government may have changed, or the minister concerned; and anyway, not many people are going to bother to look at the ‘facts’ years after the change.Where does that leave us? With the very sound advice from the Book of Common Prayer: ‘Put not your trust in princes.’

The graph is particularly instructive. The negative effect of a lower taper rate on work incentives higher up the income scale can obviously be reduced if the initial benefit rates themselves are lowered. Reducing the payments would also produce significant savings for taxpayers along with improved work incentives.

Hooray for UC/SUT! You make some fair points, but remember is that benefit withdrawal is exactly like taxation, so there is a Laffer Curve to means testing in the same way as to taxation generally. The cost-minimising benefit withdrawal rate is probably the same as the revenue maximising tax rate on lower earners, which I believe is 60%. Seeing as Employer’s NIC is about 10% of gross wages + Employer’s NIC already, this means the cost-minimising benefit withdrawal rate (inclusive of any PAYE deducted) must be 50% (which handily enough can be dealt with via the PAYE system, no need for DWP officials and form filling.Click my name for link to article I wrote.

Good point and fair conclusion. But to play devil’s advocate: if moving to a lower taper-rate increases the government’s welfare budget, any way of funding that budget is likely to reduce the real value of pay and benefits, whether through increasing the tax burden somewhere within the economy, or by devaluing money. Someone at C on your scale would have to accept a greater reduction in their real net income than you allow, in order to enjoy more leisure at point B. I expect that most people would view that as somewhere between difficult (bills to pay, employers to satisfy) and undesirable.

How often do people turn down an offer of a pay rise and ask instead for reduced hours? As an employer, I’ve never had that experience.And would it do any harm if a minority chose that route? Is it fair to call that “free-riding”, when someone at B is still paying much more in taxes than they are gaining in benefits, i.e. a net contributor?There’s no such thing as a free lunch or a policy without negative consequences for someone, but reducing the disincentives to work for those trapped in poverty must surely weigh very heavily against any disadvantages.

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