The rise in housing benefit is driven by a rise in need. No more, no less

It's not greed, it's not fraud, it's just more people needing help to live their lives, writes Declan Gaffney.

It’s safe to say that housing benefit has few defenders on any side of the political debate.

All parties agree that spending is out of control and needs to be reined in. The right has ruthlessly promoted the claim that housing subsidises the underserving poor to live in accommodation ordinary workers couldn’t afford. The left responds by saying that it is landlords rather than tenants who are milking the system. Thus Owen Jones writes:

Greedy landlords are fully aware that most cannot afford to pay their extortionate rents. But they also know that the taxpayer will step in and subsidise them with housing benefits… Instead of wasting billions on housing benefit, we could spend it on building housing, creating jobs and stimulating the economy.

What the left and right criticisms have in common is more important than what distinguishes them. Housing benefit exemplifies the gruesome two-step of current welfare debate.

  • Step one: claim that expenditure is at unprecedented and unsustainable levels.
  • Step two: blame this on some unpopular group milking the system—greedy landlords or irresponsible tenants—thus suggesting that expenditure can be cut or redirected to other purposes without pain.

Step two is wishful thinking, as I’ll argue below. Step one is easily dealt with. Look at this chart:

 

The green curve shows expenditure on housing benefit as a share of GDP, indexed to 1978/9, from that year to 2011/12. (It’s the share of GDP that counts when the sustainability of expenditure is at issue.) Spending now, four years after the onset of recession, is at almost exactly the same level as it was in 1995/6 four years after the last recession. In the intervening period it first fell dramatically as the impact of the early 90’s recession receded, then rose sharply when the global financial system collapsed in 2008/9. There has been no long-term upward trend since the early 1990's, so the rhetoric of unsustainability is completely misplaced.

The red curve on the chart, which takes out the effect on expenditure of changes in the number of claimants, shows that the recent rise in expenditure is overwhelmingly driven by the caseload (the dotted blue curve). It also allows us to see the impact of the switch from supply-side to demand-side funding during the late 1980s — that is, the switch from directly subsidising social rents and building homes to giving tenants the money to pay higher rents.

This doesn’t represent a change in overall expenditure but a redirection of subsidy to a different channel.1 The impacts of that switch, particularly on work incentives and poverty traps for lower income groups, have been hotly debated, but the point here is that this step change in housing benefit spending doesn’t represent an additional cost to taxpayers (except in the form of any negative impacts on employment). So even in this long-term perspective the notion that housing benefit represents an increasing burden on the Exchequer is wrong.

What about the other item on the charge sheet—that housing benefit expenditure is wasteful because either landlords or tenants are milking the system on a grand scale? Both these claims, if we are to make sense of them, involve similar economic assumptions.

To see this, consider how landlords might be able to raise rents above market level to capture the subsidy—bearing in mind that if rents aren’t above market level, there is no subsidy (left critics have been surprisingly uninterested in demonstrating this). The private rented market is dominated by small-scale, uncoordinated cottage industry operations, so we can rule out the notion that landlords are using market power to drive up rents. (An exception, but a small element in total spending, may be the market in temporary accommodation for people meeting local authority homelessness criteria).

The other possibility would be if tenants were to some extent indifferent to rent levels. That could allow landlords to use price discrimination (charging more to housing benefit claimants) to extract above-market rents from taxpayers. Alternatively, even if landlords didn’t use price discrimination, tenants might choose more desirable (expensive) properties if they weren’t worried about the rent—the government’s main argument for cutting entitlements. Thus the greedy landlord and irresponsible tenant stories turn on the same explanatory mechanism of tenants failing to respond to prices: they differ only in who is said to be extracting the unfair advantage.

Which raises the question: why would tenants be indifferent to rents? The higher the rent level, the more earned income will be subject to punitive marginal tax rates as housing benefit is withdrawn. You would have to suffer from extreme myopia or have minimal expectations of your future earning capacity not to take this into account in choosing accommodation. Add to this that about half of private rented sector claimants were living in their current accommodation before they made their claim, so they would have been making the same tradeoffs as anybody else when they chose where to live.2

Fortunately, all this can tested empirically.

London has the largest private rented sector in the country, a highly mobile population, substantial variations in rents between areas and (although Londoners hate to admit it) an excellent public transport system.

If housing benefit tenants care about rent levels, we would expect them to be in lower rent areas, subject of course to the availability of accommodation. If they didn’t care, we would expect them to be distributed across areas in accordance with the rental stock.

When a model in which the number of private sector claimants in each borough in 2010-11 is measured against (a) the size of the local private rented sector and (b) the lower 25 per cent of local rents, we find the latter "explains" 66 per cent of the variation in caseload between areas. Overall, a 1 per cent increase in rents implies a 1.7 per cent decrease in the number of claimants.3

Given this strong negative relationship between rent levels and private sector HB claims, the notion that landlords are capturing a large part of the subsidy by charging above market rents looks implausible.

This is even more the case when we look at what’s happened in London since the cuts to housing benefit in April 2011. Using the same model with post-reform data, there is no statistically significant change in the relationship between rents and caseload: even quite dramatic cuts to entitlements don’t seem to have made that much difference to the already very strong propensity for higher rents to drive down the number of claimants.

(This isn’t to say there has been no effect from the changes, but that if there has been, it’s small by comparison with what was already happening before they took place.)

At the same time, between 2011 and 2012, rents rose by 8 per cent in London, and they rose most for the type of larger property where the cuts had the most impact on tenants’ ability to pay—rents for three- and four-bed flats have risen by more than 10 per cent. So much for the government’s claims that rents are falling in response to the cuts

Given how much we spend on housing benefit in the private rented sector it would be surprising if there were no landlords taking advantage. But the hard lesson is that this probably has little impact on overall spending levels. Claims from the left that billions are being wasted "subsidising" private landlords are about as convincing as claims from the right that billions are being wasted subsidising irresponsible tenants to live in mansions.

There’s a longstanding debate about the merits of funding housing through demand rather than supply-side subsidy. (For a fair statement of the argument, see Shelter’s report). But suggesting that there’s a free pot of money available for housing investment in the form of subsidy captured by greedy landlords adds nothing to that debate.

If we want more housing investment, we’re going to have to pay for it some other way: perhaps by borrowing as Jonathan Portes has suggested. Taking that route would also have positive impacts on employment, thus reducing expenditure on housing benefit without hitting the incomes of struggling workers. But the welfare reform two-step is a distraction from the real issues, whether you lead with the right or the left.

1 See page 55 here.

2 See section 6.2 here.

3 Geek note: all variables in logarithms, all p-values <.01. The results are not driven by multi-collinearity between the independent variables.

A housing estate in Lambeth. Photograph: Getty Images

Declan Gaffney is a policy consultant specialising in social security, labour markets and equality. He blogs at l'Art Social

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We're racing towards another private debt crisis - so why did no one see it coming?

The Office for Budget Responsibility failed to foresee the rise in household debt. 

This is a call for a public inquiry on the current situation regarding private debt.

For almost a decade now, since 2007, we have been living a lie. And that lie is preparing to wreak havoc on our economy. If we do not create some kind of impartial forum to discuss what is actually happening, the results might well prove disastrous. 

The lie I am referring to is the idea that the financial crisis of 2008, and subsequent “Great Recession,” were caused by profligate government spending and subsequent public debt. The exact opposite is in fact the case. The crash happened because of dangerously high levels of private debt (a mortgage crisis specifically). And - this is the part we are not supposed to talk about—there is an inverse relation between public and private debt levels.

If the public sector reduces its debt, overall private sector debt goes up. That's what happened in the years leading up to 2008. Now austerity is making it happening again. And if we don't do something about it, the results will, inevitably, be another catastrophe.

The winners and losers of debt

These graphs show the relationship between public and private debt. They are both forecasts from the Office for Budget Responsibility, produced in 2015 and 2017. 

This is what the OBR was projecting what would happen around now back in 2015:

This year the OBR completely changed its forecast. This is how it now projects things are likely to turn out:

First, notice how both diagrams are symmetrical. What happens on top (that part of the economy that is in surplus) precisely mirrors what happens in the bottom (that part of the economy that is in deficit). This is called an “accounting identity.”

As in any ledger sheet, credits and debits have to match. The easiest way to understand this is to imagine there are just two actors, government, and the private sector. If the government borrows £100, and spends it, then the government has a debt of £100. But by spending, it has injected £100 more pounds into the private economy. In other words, -£100 for the government, +£100 for everyone else in the diagram. 

Similarly, if the government taxes someone for £100 , then the government is £100 richer but there’s £100 subtracted from the private economy (+£100 for government, -£100 for everybody else on the diagram).

So what implications does this kind of bookkeeping have for the overall economy? It means that if the government goes into surplus, then everyone else has to go into debt.

We tend to think of money as if it is a bunch of poker chips already lying around, but that’s not how it really works. Money has to be created. And money is created when banks make loans. Either the government borrows money and injects it into the economy, or private citizens borrow money from banks. Those banks don’t take the money from people’s savings or anywhere else, they just make it up. Anyone can write an IOU. But only banks are allowed to issue IOUs that the government will accept in payment for taxes. (In other words, there actually is a magic money tree. But only banks are allowed to use it.)

There are other factors. The UK has a huge trade deficit (blue), and that means the government (yellow) also has to run a deficit (print money, or more accurately, get banks to do it) to inject into the economy to pay for all those Chinese trainers, American iPads, and German cars. The total amount of money can also fluctuate. But the real point here is, the less the government is in debt, the more everyone else must be. Austerity measures will necessarily lead to rising levels of private debt. And this is exactly what has happened.

Now, if this seems to have very little to do with the way politicians talk about such matters, there's a simple reason: most politicians don’t actually know any of this. A recent survey showed 90 per cent of MPs don't even understand where money comes from (they think it's issued by the Royal Mint). In reality, debt is money. If no one owed anyone anything at all there would be no money and the economy would grind to a halt.

But of course debt has to be owed to someone. These charts show who owes what to whom.

The crisis in private debt

Bearing all this in mind, let's look at those diagrams again - keeping our eye particularly on the dark blue that represents household debt. In the first, 2015 version, the OBR duly noted that there was a substantial build-up of household debt in the years leading up to the crash of 2008. This is significant because it was the first time in British history that total household debts were higher than total household savings, and therefore the household sector itself was in deficit territory. (Corporations, at the same time, were raking in enormous profits.) But it also predicted this wouldn't happen again.

True, the OBR observed, austerity and the reduction of government deficits meant private debt levels would have to go up. However, the OBR economists insisted this wouldn't be a problem because the burden would fall not on households but on corporations. Business-friendly Tory policies would, they insisted, inspire a boom in corporate expansion, which would mean frenzied corporate borrowing (that huge red bulge below the line in the first diagram, which was supposed to eventually replace government deficits entirely). Ordinary households would have little or nothing to worry about.

This was total fantasy. No such frenzied boom took place.

In the second diagram, two years later, the OBR is forced to acknowledge this. Corporations are just raking in the profits and sitting on them. The household sector, on the other hand, is a rolling catastrophe. Austerity has meant falling wages, less government spending on social services (or anything else), and higher de facto taxes. This puts the squeeze on household budgets and people are forced to borrow. As a result, not only are households in overall deficit for the second time in British history, the situation is actually worse than it was in the years leading up to 2008.

And remember: it was a mortgage crisis that set off the 2008 crash, which almost destroyed the world economy and plunged millions into penury. Not a crisis in public debt. A crisis in private debt.

An inquiry

In 2015, around the time the original OBR predictions came out, I wrote an essay in the Guardian predicting that austerity and budget-balancing would create a disastrous crisis in private debt. Now it's so clearly, unmistakably, happening that even the OBR cannot deny it.

I believe the time has come for there be a public investigation - a formal public inquiry, in fact - into how this could be allowed to happen. After the 2008 crash, at least the economists in Treasury and the Bank of England could plausibly claim they hadn't completely understood the relation between private debt and financial instability. Now they simply have no excuse.

What on earth is an institution called the “Office for Budget Responsibility” credulously imagining corporate borrowing binges in order to suggest the government will balance the budget to no ill effects? How responsible is that? Even the second chart is extremely odd. Up to 2017, the top and bottom of the diagram are exact mirrors of one another, as they ought to be. However, in the projected future after 2017, the section below the line is much smaller than the section above, apparently seriously understating the amount both of future government, and future private, debt. In other words, the numbers don't add up.

The OBR told the New Statesman ​that it was not aware of any errors in its 2015 forecast for corporate sector net lending, and that the forecast was based on the available data. It said the forecast for business investment has been revised down because of the uncertainty created by Brexit. 

Still, if the “Office of Budget Responsibility” was true to its name, it should be sounding off the alarm bells right about now. So far all we've got is one mention of private debt and a mild warning about the rise of personal debt from the Bank of England, which did not however connect the problem to austerity, and one fairly strong statement from a maverick columnist in the Daily Mail. Otherwise, silence. 

The only plausible explanation is that institutions like the Treasury, OBR, and to a degree as well the Bank of England can't, by definition, warn against the dangers of austerity, however alarming the situation, because they have been set up the way they have in order to justify austerity. It's important to emphasise that most professional economists have never supported Conservative policies in this regard. The policy was adopted because it was convenient to politicians; institutions were set up in order to support it; economists were hired in order to come up with arguments for austerity, rather than to judge whether it would be a good idea. At present, this situation has led us to the brink of disaster.

The last time there was a financial crash, the Queen famously asked: why was no one able to foresee this? We now have the tools. Perhaps the most important task for a public inquiry will be to finally ask: what is the real purpose of the institutions that are supposed to foresee such matters, to what degree have they been politicised, and what would it take to turn them back into institutions that can at least inform us if we're staring into the lights of an oncoming train?