3 October 2022

The case for a real-terms benefit cut is weak – and it would be political madness


Kwasi Kwarteng’s reluctance to confirm that benefits will be uprated next year in line with inflation has fed speculation that the Government is considering a real-terms cut. My advice would be to squash this idea as soon as possible – mainly because it is bad economics. But it would be bad politics too, undoing any good done by the U-turn on the 45p income tax.

To recap, benefits are usually uprated in April in line with the CPI measure of inflation recorded in the previous September. This meant that benefits rose by just 3.1% in April this year (the inflation rate in September 2021), well below actual inflation of 9.0% in April itself.

The row about this at the time was partly defused by additional one-off payments to low-income households. But ministers also argued that benefit claimants could expect to catch up next year when payments were uprated in line with the September CPI (probably about 10%).

There seem to be three arguments in support of a smaller increase in benefits now.

In my view, the weakest is that it would somehow be ‘unfair’ for people on benefits to be protected against inflation when many others (who pay for benefits through their taxes) are seeing a real-terms cut in their incomes.

This argument might work if we were talking about pay increases for, say, people working in the public sector who already earn more than the average. But those who rely on benefits are, by definition, poorer than the average. It makes no sense to penalise them.

A better argument is that benefit claimants are already being compensated for higher inflation in other ways, including the additional cost-of-living support and discounts on energy bills. Raising benefits by the full amount of inflation too would therefore be ‘double counting’. This makes more sense. These transfer payments are not reflected in the official measure of inflation because (unlike the #energypricecap) they do not reduce the unit cost of energy.

But it is still hard to see how the benefits uprating could be adjusted to allow for this fairly. In particular, this would open up a whole new can of worms.

If you argue that the additional cost-of-living support means that ‘real’ inflation for benefit claimants is lower than the average rate, others will point out that inflation is typically higher for poorer households.

One option might be some measure of CPI inflation excluding energy, but this is still likely to be around 7-8% in September. This would mean only a small saving for the Treasury compared with uprating at about 10%.

Another option (apparently the frontrunner) would be indexing benefits to average earnings, which would probably mean an increase of 5% to 6%. But the benefits system is meant to protect the most vulnerable during difficult economic times, not to ensure that they share the pain.

Linking benefits to earnings rather than inflation would also make no sense in the longer term, when earnings would be expected to outpace inflation.

The third argument is that there is a precedent – the temporary unpicking of the triple-lock on the state pension, which was also only increased this year by the September 2021 inflation rate of 3.1% rather than the (then higher) increase in average earnings.

But this is not a strong precedent. It was much easier to argue that the average earnings measure was distorted by the pandemic and that uprating in line with inflation instead was fair. Here, we are talking about a real-terms cut in benefits.

This also opens another can of worms. If you argue that working-age benefits shouldn’t be increased by the full amount of inflation, why should that not also apply to pensions (especially as the basic state pension is not means-tested)?

Indeed, the triple-lock on the state pension is a far bigger threat to the sustainability of the public finances. It has a ‘ratchet effect’, because pensioners participate in any upside during booms but are protected on the downside during recessions. As a result, the share of national income spent on paying state pensions will inexorably increase over time.

Campaigners argue that the UK state pension is relatively low. But this ignores other forms of income in retirement, including UK’s relatively well-developed system of private pensions. There are also many better ways to target pensioner poverty than a blanket increase in the state pension for all.

Finally, I am worried that the old Treasury orthodoxy is reasserting itself here. A narrative is already developing that there needs to be big and immediate cuts in public spending, including benefits, in order to pay for ‘big cuts’ in taxes.

Instead, ‘Trussonomics’ is about growing the economy, through a mix of tax cuts and supply-side reforms. This means that the burden of debt is reduced over time and that higher tax revenues can fund better public services – and a decent welfare safety net. If this means that borrowing has to take the strain in the near term, then so be it.

Any reforms to the benefit system in the coming months should therefore be limited to changes that improve incentives at the margin, rather than a real-terms cut across the board. And looking further ahead, the triple-lock has to go.

In short, the Government should be willing to make unpopular decisions, but the economic case for failing to uprate benefits in line with inflation is flimsy. Politically, it seems like madness.

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Julian Jessop is an independent economist.

Columns are the author's own opinion and do not necessarily reflect the views of CapX.