A new report from the IEA argues for the introduction of a Negative Income Tax

The IEA proposes a solution that would simplify the benefits system much further

In a new report released today, Transforming welfare - incentives, localisation and non-discrimination, the IEA endorses the general direction of the coalition’s welfare reforms, but sets out proposals for developing the policies to get more people off welfare and into work.

The government’s proposals take us in the same direction as the proposals in this paper but it is likely that many of the static and dynamic benefits of reform will be lost by the coalition as a result of an unwillingness to go far enough.

The proposals in this paper would substantially simplify the welfare system, putting in place better incentives to encourage work and discourage welfare dependency. They tackle the full extent of the system from middle class benefits to those who are unemployed, those working part-time and those on low full-time incomes. If adopted this system would see less money being spent on bureaucracy, more people in work and people keeping more of their own money in the first place. The key proposals include the following:

• Replacing benefits and tax credits with a Negative Income Tax – We propose replacing the complex benefit and tax credit system with a negative income tax which would dramatically simplify the way welfare is delivered. Crucially it would also eliminate the high withdrawal rates that are a disincentive to work and which to a significant extent will remain under the Universal Credit proposals. It would work by setting different allowances for different types of household. For example, if there were an allowance of £28,000 for every two-adult-two-children household, and a Negative Income Tax with a rate of -33%, a family earning £18,000 would receive an additional £3,333, topping up their disposable income to £21,333. They would not pay Income Tax, but they would not receive tax credits either – the problem of 'fiscal churning' would therefore be eliminated.

• Enormous reduction in middle-class benefits – ‘Middle-class’ benefits should be severely curtailed – but not simply by raising withdrawal rates, since this would disincentivise progress in the labour market. Under the negative income tax those on low incomes who need support would receive this through the negative income tax payment rather than through lots of small payments for child benefit, winter fuel, eye tests etc. With the abolition of middle class benefits complementary tax reductions could also be made.

• Introducing a local ‘workfare’ system – Work requirements generally should be a requirement to receive of out-of-work benefits, following the model tested in the US state of Wisconsin. Under a ‘workfare’ system, the daily life of benefit recipients should not be that different from the daily life of their working peers, which would both remove the stigma from recipients, and encourage them to look for full-time employment in the regular labour market. There should be continuing work requirements for those who are not in full-time work but who are claiming benefits. Schemes should be administered and funded at local level. Devolving power would allow experimentation and a diversity of schemes, allowing us to see which approaches work best. It would also provide a strong financial incentive for local authorities to get people back into work as soon as possible.

• Freeing labour and housing markets – Welfare reform would be much more effective if accompanied by a liberalisation of the labour and housing markets, for example through the reduction or abolition of the minimum wage and the liberalisation of the land-use planning system. Freeing up labour markets would make it easier for businesses to recruit workers, while reforming planning would make housing more affordable.

Mark Littlewood, Director General of the Institute of Economic Affairs, said:

“Iain Duncan Smith has rightly analysed the welfare problem, but is only part of the way to a welfare solution.

“Of course, we need to ensure that it pays to work. It’s insane that it can be more profitable to be on welfare than in employment. But even under these new proposals, some people entering the workforce will face effective tax rates of 65%. Is keeping just 35p in every pound of wages really enough of an incentive? Introducing a Negative Income Tax would simplify the benefits system even further, removing the hideously high withdrawal rates we currently have.

“Much more clarity is needed on the workfare proposals. It’s not enough to ensure that work pays, we also need to be conscious of the greater benefit of leisure time that is gained by those who don’t work. A localised, decentralised approach to workfare schemes would allow councils to experiment with a range of schemes for getting people back into work – and to learn from best practices, it would also provide a strong incentive for local councils to succeed. If run centrally from Whitehall, the plan will be a mess.”
 

Notes to editors

To arrange an interview with Mark Littlewood, IEA Director General, or Prof. Philip Booth, IEA Editorial Director, please contact Ruth Porter, Communications Manager, 077 5171 7781, 020 7799 8900, rporter@iea.org.uk.

The full report Transforming welfare - incentives, localisation and non-discrimination by Kristian Niemietz can be downloaded using the link above.

The mission of the Institute of Economic Affairs is to improve understanding of the fundamental institutions of a free society by analysing and expounding the role of markets in solving economic and social problems. The IEA is a registered educational charity and independent of all political parties.

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