Kristian Niemietz Blog

published on the Institute of Economic Affairs (IEA) blog, August 2009

Allister Heath once labelled Gordon Brown “a man who seems to love making simple things as complicated as possible”. A recent analysis of the benefit system by the Centre for Policy Studies shows that in this respect, Brown is in good company.

Suppose the government considers societal group X, recipients of X-benefits, as materially disadvantaged, and wants to give them a hand. It would then probably raise the level of X-benefits, right?

Wrong. In the UK benefit system, things are not that simple. To support group X, the government would probably add an “X-premium” to Benefit I, raise the income limit beyond which members of X face withdrawal of Benefit II, and grant them a special lower withdrawal rate for Benefit III. However, the higher amount of Benefit III would be partially offset by a reduction in the amount of Benefit IV, while Benefit II would be liable to income tax and National Insurance (NI). Benefit I is tax-exempt and not counted against other benefits, but recipients of Benefit I lose entitlement to Benefit V, which is a necessary precondition for the receipt of Benefit VI and VII. Needless to say, the agencies administering these benefits use differing definitions of terms like “additional earnings”, “income” and “gainful employment”.

The CPS report argues that apart from the time and effort it takes to find one’s way through the labyrinth, the uncertainty created by the complex pattern of benefit interaction contributes to trapping people in poverty. Consider the case of a single mother in part-time employment, who receives multiple benefits, say Working Tax Credit, Child Tax Credit, Housing Benefit and Council Tax Benefit, and who is at the same time liable for income tax and NI contributions. For her, increasing work effort slightly can have repercussions on each of these variables. If the net effect is not straightforward to see, and if she may well be indiscernably better off than before - why bother?

The report proposes a four-step-plan for a radical simplification of the system. Variables like the definition of income, the tax treatment of benefits and personal allowances would be standardised. The chaotic relationship between benefits would be replaced by a situation in which one redistributive instrument serves one redistributive purpose. Benefits with similar aims would be merged, withdrawal rates aligned, and all benefits would be administered by the same agency.

Not bad at all for a start. But if we really want to break up the poverty trap, simplification can only be the trailblazer (as the CPS report readily acknowledges). Even a very simple benefit system can make it economically irrational for its dependants to seek work, and discourage those who have taken the first step to go further. Even a very simple system can be hugely wasteful, by redistributing large amounts among the middle classes instead of targeting the poorest.

A full-blown reform would clear the way out of the pit. It would end the current no-strings-attached welfare provision along the lines of the Wisconsin model, stop paying benefits to reasonably well-off people, and substantially raise the personal income tax and NI allowance to boost work incentives. Simplification, and the transparency that comes along with it, may well be the conditio sine qua non.