Politics
The big benefit cheat
Published 10 April 2008
Billions of pounds flow into the
Exchequer by stealth but it is not the middle classes who are losing out, it is
those with the lowest incomes.
And 20 years ago, a well-to-do married man on twice the average earnings
handed over just under a quarter of his income in tax and National Insurance.
Today he pays nearly a third. Yet no chancellor has stood up (not since Denis
Healey in 1975) to announce a rise in income tax rates; indeed, the headline
basic rate has fallen from 25 per cent in 1988 to 20 per cent today.
We accept that disposable incomes depend heavily on decisions announced
by government. But they are also hugely influenced by what the government does
not announce. Taxation by "stealth" plays a growing part in revenue
raising, but the political discourse overemphasises its effects on "Middle
England" - often a euphemism for the better-off. In fact, a similar
phenomenon is taking much more from those in society who are worst-off. If the
trend remains unchecked, it will result in a huge increase in inequality.
The startling facts about this slow but steady shifting of resources are
set out in a report published on 9 April which, for the first time, analyses
the long-term effects of the current system of uprating benefits, tax credits
and taxation thresholds. Produced for the Joseph Rowntree Foundation by a
high-powered team of academics led by Professor Holly Sutherland of the
University of Essex, the report estimates that operating this system for 20
years would divert an extra £50bn a year to the Treasury from personal incomes.
That is more than £800 for every inhabitant of the UK.
Where does all this money come from? In the new tax year, which started
on 6 April, most tax thresholds and benefit rates rose automatically in line
with price inflation. This is slower than the rise in average earnings.
The effect of earnings going up faster than tax thresholds is that the
Treasury is taxing a greater proportion of our incomes. For the better-off, it
is subjecting more income to the higher rate of 40 per cent.
At the other end of the income scale, people who lose their jobs must
face a greater cut in living standards as a result of switching from earnings
to benefits than they did in the past. And the Treasury needs to spend a
smaller proportion of its growing tax yield on each person who is out of work.
Such changes look very minor on a year-by- year basis. On 6 April, a
single unemployed person's weekly disposable income after paying the rent rose,
in line with prices, by just £1.35, to £60.50. Had benefits been pegged to
average earnings, this would have risen by about another pound. Such seemingly
small slippages accumulate over the years: earnings have risen by a half under
Labour, but prices by only a quarter on the measure the government uses to uprate
most benefits. An earnings link since 1971 would have put Jobseeker's Allowance
at about twice its present rate - roughly £120 a week.
Ad hoc redistribution
What this means is that we are, in effect, telling the worst-off people
in the UK to live at the same standard as they did when Harold Wilson was
facing Ted Heath across the despatch box, while the rest of us have become far
better off. Sixty pounds a week cannot provide anything approximating to an
acceptable standard of living relevant to Britain in 2008. But, despite that,
the government shows no sign of wanting to prevent further deterioration in
these, the lowest incomes in the country, compared with average incomes, decade
after decade.
It is true that people on the highest incomes have also lost large
amounts from inflation-only upratings. Chancellors of both parties have spent
the past two decades quietly subjecting more of their earnings to higher-rate
taxation. When Nigel Lawson introduced the present 40 per cent top rate in
1988, only 6 per cent of taxpayers had to pay it. This proportion has doubled,
so that now one in eight people is paying higher-rate tax. This is nowhere near
as universal as some newspaper commentators suggest when they complain about
the overtaxing of "middle-class" salaries. Nonetheless, the Robin
Hoods among us can be quietly pleased that someone on £60,000 a year is paying
the 40 per cent tax rate on a third of his or her salary, rather than on, at
most, 5 per cent of it, as people on equivalent incomes did in Lawson's day.
Over the past ten years, fans of Gordon Brown's surreptitious version of
redistribution have been impressed by this device to raise more money for
worthwhile public sector causes, largely from higher-rate taxpayers. It helps
explain why he was able to increase money for health and edu cation, as well as
give out billions to help low- income families with children to escape poverty,
without either raising headline tax rates or breaking his borrowing rules.
Yet Brown's redistributive largesse has been selective and ad hoc.
Selective in the sense that most of the billions went to pensioners and
families with children, while others on low incomes got nothing. And ad hoc in
that the benefits and tax credits received by low-income families are still not
uprated fast enough to raise their incomes automatically in line with earnings.
These families do well only by grace of the chancellor's largesse at
Budget time. Some of the extra billions are needed merely to prevent child
poverty, measured in relative terms, from rising. If Budgets stuck to the
standard uprating rules, child poverty, far from being eradicated, could rise
to new record levels. No wonder that reducing it in line with targets has
proved so difficult.
Fairer system
A fairer uprating system for taxes and benefits would be costly. A good
deal of the £50bn extra that could be raised by the 2028 Budget under present
rules may be needed to help pay for growing demands on public spending,
especially due to ageing. It seems reasonable to plan in the future to spend
more of our incomes through the public purse because in our lifetimes we will
require more health care, more social care and public pensions paid over longer
periods. This money needs to be drawn in large part from personal incomes and
the slow shift from private pockets to the Exchequer may seem an ideal way to
do it.
But here's the catch. Groups at every point in the income distribution
are affected by this phenomenon, yet the impact on the poor is greater than on
the rich, by far. The research shows that as a result of this sluggish uprating
regime, someone in the bottom fifth of the income distribution will on average
lose about 17 per cent of their income, whereas someone in the top fifth will
lose only 5 per cent. This is because uprating decisions apply to only part of
the incomes of people paying taxes (the taxed portion), but to all of the
incomes of people receiving benefits.
The authors of the Rowntree report show that it would be possible to use
some of the £50bn to finance a rising public spending burden more fairly. For
example, if the Exchequer could be content with £30bn instead, it could use the
rest to ensure that everyone sacrificed about the same amount, as a percentage
of income. This would mean that in 20 years both rich and poor would have
incomes about 5 per cent lower, relative to earnings, than today. But as
earnings will be much higher than now, nobody would be worse off in absolute
terms, and neither would groups lose in relative terms if the burden were shared
evenly.
At a time of severe Treasury prudence, the idea of £20bn less than
projected in the public coffers, even two decades ahead, may look like pie in
the sky. Yet times change, even for the Treasury. The case of pensioners, the
one group now largely exempt from erosion of incomes through the uprating
system, proves this point.
In the early Brown years, the focus for pensioners was on relieving
poverty through a minimum income guarantee (now Pension Credit), which was
raised sharply and then pegged to earnings. Not good enough, said the age
lobby: pensioners hate having to claim this "poor relief"; the link
between the retirement pension and average earnings should be restored.
Following a groundswell of public support and the Turner Commission, the retirement
pension will indeed be linked to earnings from about 2012 - a victory for Tony
Blair's No 10 over a resistant Treasury.
Winning similar measures to preserve the relative incomes of benefit
recipients of working age is politically harder. Unemployed people are seen as
less "deserving" than pensioners - although disabled people are also
affected. Yet continuing with the present system will produce bizarre results.
Already, a long-term unemployed person having to live on £60 a week sees their
income double on their 60th birthday, when they become eligible for the Pension
Credit. If present policies continue, one day they will see it quadruple. For
some families, the old idea of relying on children to support you in your old
age will be turned on its head.
Donald Hirsch is
poverty adviser to the Joseph Rowntree Foundation. "The Impact of Benefit
and Tax Uprating on Incomes and Poverty" by Holly Sutherland, Martin
Evans, Ruth Hancock, John Hills and Francesca Zantomio is available from http://www.jrf.org.uk
On the edge
£4,000 average yearly benefits received by top fifth of households (average
earnings £68,000)
£6,700 average yearly benefits received by lowest fifth of households (average
earnings £4,200)
£60.50 disposable income of unemployed single person after rent
£155.60 average weekly spend of poorest tenth of households
£46.90 average weekly spend on food of all households
£58.50 average weekly spend on recreation of all households