Friday, June 25, 2010

Game Changers

Still at the crease, and maybe even reshaping the game

The inestimable Ruth Lea described Tuesday's budget as a game changer. And she's right. Assuming Cam and George manage to deliver on their tough spending limits, they really will have changed the economic game from last weekend's grim nil-nil draw against Algeria to this weekend's 5-0 triumph over the Hun.


The thing is, there is a chance that Cam's government could turn out to be a game changer in all kinds of different areas. We've blogged our high hopes for Gove's school reforms many times. Elected sheriffs will be a big step in making the police once more accountable to local communities. An end to mass immigration will give us time to heal the wounds inflicted by Labour's self-serving open-door policy.

But one of the most important game changers could be the one being talked about by that most unlikely of high scorers - Iain Duncan Smith. Because IDS is planning to abolish welfare dependency.

Well, OK, "abolish" is is perhaps a bit strong - that would be like finding "the cure" for cancer. But based on his work at the Centre for Social Justice, IDS is going to mount an all-out assault on the welfare trap.

We're all familiar with the problem - 6 million people of working age are entirely dependent on welfare benefits for their incomes. Which means that each of our 29 million workers has to carry one-fifth of a non-worker (even setting aside the 22m children and pensioners).

And this is much more than simply the financial cost. It's well known that workless households are problem households, trapped in deprivation and under-achievement, and passing on that deprivation to their children. It is monstrous that after 15 years of growth, by 2008 we had the highest proportion of children growing up in workless households of any country in Europe (all charts are taken from the excellent CSJ Report Dynamic Benefits - Towards Welfare that Works):

But the question is what should we do about it?

IDS's recipe is simple - we must do whatever it takes to make work pay.

As things stand - despite all Labour's fine words - for very many welfare recipients work simply doesn't pay. Taking paid employment involves the loss of so much in terms of welfare benefits that they face eye-watering effective marginal tax rates - much higher than those faced by our banking friends down on the Wharf.

The following chart shows the average marginal tax rate (MTR) faced by a married couple with 2 children at increasing levels of earned income. As we can see, a couple earning £40k pa faces a marginal tax rate of 30% - ie for every extra pound they earn, they lose 30 pence in income tax and employees' National Insurance Contribution. But a couple earning just £10k pa is on a marginal tax rate of over 90%, once you take account of the benefits they lose from earning an extra pound of their own (2009 tax and benefit rates):

Now if you were facing a marginal tax rate of 90%+, would you feel incentivised to get off welfare and back to work? Honestly?

IDS is intending to cut these crippling marginal tax rates for the poor, and especially for those who are coming off welfare into work for the first time. Instead of losing 60, 70, or even 90% of every pound they earn, they'll hopefully lose 50% or less. There will be a clear financial advantage in going to work.

Ah you say, that's all fine and large, but where's the money coming from? To cut the marginal tax rates for the poor would cost a fortune. Indeed, IDS himself costed his CSJ proposals at £2.7bn pa initially (although longer-term the cost would disappear or even reverse reflecting the higher level of employment). We just don't have the money.

Which is why the cut in high marginal tax rates has to be part of a package. A package in which the financial rewards from work are boosted, but the rewards from remaining on benefits are cut.

As we've blogged before, one way of finding the money would be to redefine the poverty line. If instead of defining it as 60% of median income, we made it say 50% - where it always used to be -  we estimate we would save £20-30bn pa on the working age welfare bill (ie not affecting pensioners). And as we blogged here, after six decades of unparalled economic growth, nobody can seriously argue that 50% of today's median income is poor in any meaningful sense.

IDS should be bold. Yes, he'll pick up no end of flak from the poverty industry, but if he holds his nerve, he could actually turn out to be the biggest game changer of all.

Not bad for someone who was jeered off the pitch just 7 years ago, looking like he'd never play again.

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