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The coalition's welfare cap puts politics before policy

Osborne has failed to design the cap in a way that will advance structural reforms to housing and wages.

The need for structural reforms.
George Osborne stands with his Treasury team before the Budget. Photograph: Getty Images.

As expected, today’s Budget included further details about the long-trailed "welfare cap". A rough calculation suggests it will cover over 90 per cent of benefit and tax credit expenditure, excluding the Basic State Pension, with only those most cyclical elements, linked to Jobseeker's Allowance left outside. Interestingly, the extra childcare support announced by the government yesterday will fall within its scope.

Most significantly, the Chancellor set the level of the cap, which in the first instance will simply track the current OBR projections for spending on those benefits and tax credits in scope (starting in 2015/16 and extending over the following five years). This reflects coalition reality: the Liberal Democrats have long signalled their unwillingness to sign off further social security cuts that would have been required to set a cap below the forecast. This means that, for now, the "cap" has no policy effect: the government is simply committing to operate future policy on the basis of not overshooting the (current) estimate for welfare spending over the coming years.

Of course the real political impact of today’s announcement will come as the general election draws closer. It is a racing certainty that the Conservatives will pledge to lower the cap in their manifesto, to make room for tax cuts, faster deficit reduction or even (if they wanted to make life particularly difficult for Labour) an increase in NHS spending. They will hope to paint both the other main parties as defenders of higher welfare expenditure, which polls tell them is unpopular with large sections of voters.

Labour has already taken steps to protect itself against this well-telegraphed political move, by highlighting how working families would be in the front line of further assaults on benefits and tax credits and that a plan for generating genuine savings (not just arbitrary cuts) requires reforms that address the structural drivers of social security spending – like unemployment, low pay and an inadequate supply of affordable homes.

Given this goal – shifting the balance of expenditure from the "costs of failure" to productive investments – the principle of a "welfare cap" should not be dismissed out of hand. The Chancellor is right to say that there is currently little strategic decision making about social security spending and little attention is paid to (or action following from) expenditure overshooting the forecast.

To take the most egregious example: the large rises in Housing Benefit expenditure in the twenty years before the financial crisis, at a time when the number of households receiving help to pay the rent stayed broadly flat, should have triggered a major focus on those trends, leading to serious reform of policy and spending. It did not – and the consequence was extreme vulnerability of the benefits system to an economic shock, with large numbers of people in more expensive private rented accommodation. When the crisis hit, Housing Benefit shot up and in response we have seen a series of arbitrary attempts to hack back costs (like the "bedroom tax") which are entirely unrelated to the causes of rising expenditure in the first place.

Given the medium-term pressure on the public finances, forcing more strategic decision making about welfare spending is essential. But in this context, the Chancellor has today lent too heavily on the political dividing line and not enough on designing the cap in a way that would advance structural reforms. While set over five years, on a rolling basis, the government’s cap will "bite" on an annual basis, with an OBR warning about overshooting in an Autumn Statement requiring compensating action in the following Budget. This will drive emergency cuts, not long-term savings. Also, what was sorely lacking today was any serious analysis from the OBR about the trends and drivers of welfare spending, which is vital for policy makers and the public to understand the factors underpinning why expenditure is rising (or falling).

Two other points are worth noting. First, the cap has been set in nominal (cash) terms. This means that higher expenditure driven by inflation will trigger policy action, which risks locking in lower living standards for those reliant on benefits. General prices rises, feeding though into uprating decisions, does not count as a structural driver of spending. The Chancellor set out a "margin of error" of two per cent around the forecast which will not trigger action. This is in line with forecasts for CPI over the forthcoming years.

Second, the cap makes no distinction between contributions-based and incomes-based benefit spending, consistent with the drift of social security policy over the last three decades. However they are different and should be treated so. Entitlement to contributory benefits should stand outside the mainstream of government revenues, with its financing secured by National Insurance Contributions. Taking National Insurance benefits out of the cap and strengthening the integrity of the National Insurance Fund could play a big part in advancing political aspirations to restore the contributory principle in the years ahead.