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The problems with Labour's benefit loan plan

A salary insurance scheme would disincentive work, penalise low earners and likely prove unpopular.

Under the plan, people who qualify for contributory Jobseekers’ Allowance (JSA) would get an extra 70 per cent of their previous pay, capped at £200 a week. Photograph: Getty Images.

The Observer has reported that Labour is toying with a proposal from IPPR to give unemployed people loans to supplement their benefits. Under the plan, people who qualify for contributory Jobseekers’ Allowance (JSA) would get an extra 70 per cent of their previous pay, capped at £200 a week, which they would pay back like a tuition fee loan when they got a job. Here are four reasons why the plan isn’t a good idea.

It disincentives work

The proposal effectively increases the tax rate unemployed people face when they eventually return to work. Automatic deductions from salary to pay back a loan are, from the worker’s perspective, the same as an income tax. IPPR do not specify at what rate the loan would be paid back, but tuition fee loans, on which the proposal is modelled, deduct 9 per cent from graduates’ salaries past a £16,365 threshold. The unemployed could face what was effectively a substantial hike in the basic rate of income tax were they to find a job. This would have the opposite effect of 'making work pay' and potentially disincentive people from taking jobs. If redundant miners in the 80s had taken out these loans, structural unemployment in former mining areas could be even worse.

Loans are regressive

The longer you take to pay back a loan, the more you have to pay, and the more quickly you pay it back, the less you pay. This means people who go into high-paying jobs will end up paying a smaller amount back than people on lower incomes, because they accrue less interest. The opposite is true if the money is raised through progressive taxation. The IPPR proposal is to tie the rate of interest to inflation but with real earnings increasing at well below inflation, as a percentage of people’s incomes, the loan will continue to increase.

It will make over-leveraging worse

Households in the UK are seriously overleveraged on debt as a result of easy credit before the financial crisis. They are now in the process of paying down this debt. One effect of this de-leveraging is that the UK is facing a demand crisis because instead of people spending money on goods and services, they spend it paying down their loans. This has a knock-on effect on businesses, who do not invest because there is no one to buy their products, which all contributes to flat-lining growth. Encouraging unemployed people to take on more debt and forcing them to deleverage it when they get their job back will further exacerbate this problem and prolong the economic crisis.

It will be very unpopular

Once child benefit and housing benefit are taken into account, there would be thousands of cases where households who had not contributed were getting as much in non-repayable benefits as someone who had worked all their lives was getting in repayable benefit loans. The anti-welfare press would ruthlessly seize on this disparity as evidence that the system does not work for people who had paid in while giving people who never worked a free ride. The proposal has not been thought through and does not do what it sets out to do.

If Labour is going to pursue the contributory principle, it should do it properly and increase contributory JSA to 70 per cent of prior income, capped at £200 a week. IPPR estimates between 700,000 and 1,000,000 people are eligible for contributory JSA – roughly half of all JSA claimants. The total cost of all JSA is £4.9bn, so as a flagship welfare policy a substantial increase in the contributory element would have a cost in a similar region to the coalition’s £1.7bn a year Universal Credit. Labour will not convince people they are getting more out of the system unless they actually give them more.