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10 April 2008

The big benefit cheat

Billions of pounds flow into the Exchequer by stealth but it is not the middle classes who are losin

By Donald Hirsch

Twenty years ago, a single manual worker on half the average earnings would, if they lost their job, get from the state 30 per cent of their previous wages to keep them afloat while they looked for new work. Today, this has fallen to just 21 per cent. Yet during this period, no chancellor has stood up on Budget day to announce a cut in unemployment benefits.

And 20 years ago, a well-to-do married man on twice the average earnings handed over just under a quarter of his income in tax and National Insurance. Today he pays nearly a third. Yet no chancellor has stood up (not since Denis Healey in 1975) to announce a rise in income tax rates; indeed, the headline basic rate has fallen from 25 per cent in 1988 to 20 per cent today.

We accept that disposable incomes depend heavily on decisions announced by government. But they are also hugely influenced by what the government does not announce. Taxation by “stealth” plays a growing part in revenue raising, but the political discourse overemphasises its effects on “Middle England” – often a euphemism for the better-off. In fact, a similar phenomenon is taking much more from those in society who are worst-off. If the trend remains unchecked, it will result in a huge increase in inequality.

The startling facts about this slow but steady shifting of resources are set out in a report published on 9 April which, for the first time, analyses the long-term effects of the current system of uprating benefits, tax credits and taxation thresholds. Produced for the Joseph Rowntree Foundation by a high-powered team of academics led by Professor Holly Sutherland of the University of Essex, the report estimates that operating this system for 20 years would divert an extra £50bn a year to the Treasury from personal incomes. That is more than £800 for every inhabitant of the UK.

Where does all this money come from? In the new tax year, which started on 6 April, most tax thresholds and benefit rates rose automatically in line with price inflation. This is slower than the rise in average earnings.

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The effect of earnings going up faster than tax thresholds is that the Treasury is taxing a greater proportion of our incomes. For the better-off, it is subjecting more income to the higher rate of 40 per cent.

At the other end of the income scale, people who lose their jobs must face a greater cut in living standards as a result of switching from earnings to benefits than they did in the past. And the Treasury needs to spend a smaller proportion of its growing tax yield on each person who is out of work.

Such changes look very minor on a year-by- year basis. On 6 April, a single unemployed person’s weekly disposable income after paying the rent rose, in line with prices, by just £1.35, to £60.50. Had benefits been pegged to average earnings, this would have risen by about another pound. Such seemingly small slippages accumulate over the years: earnings have risen by a half under Labour, but prices by only a quarter on the measure the government uses to uprate most benefits. An earnings link since 1971 would have put Jobseeker’s Allowance at about twice its present rate – roughly £120 a week.

Ad hoc redistribution

What this means is that we are, in effect, telling the worst-off people in the UK to live at the same standard as they did when Harold Wilson was facing Ted Heath across the despatch box, while the rest of us have become far better off. Sixty pounds a week cannot provide anything approximating to an acceptable standard of living relevant to Britain in 2008. But, despite that, the government shows no sign of wanting to prevent further deterioration in these, the lowest incomes in the country, compared with average incomes, decade after decade.

It is true that people on the highest incomes have also lost large amounts from inflation-only upratings. Chancellors of both parties have spent the past two decades quietly subjecting more of their earnings to higher-rate taxation. When Nigel Lawson introduced the present 40 per cent top rate in 1988, only 6 per cent of taxpayers had to pay it. This proportion has doubled, so that now one in eight people is paying higher-rate tax. This is nowhere near as universal as some newspaper commentators suggest when they complain about the overtaxing of “middle-class” salaries. Nonetheless, the Robin Hoods among us can be quietly pleased that someone on £60,000 a year is paying the 40 per cent tax rate on a third of his or her salary, rather than on, at most, 5 per cent of it, as people on equivalent incomes did in Lawson’s day.

Over the past ten years, fans of Gordon Brown’s surreptitious version of redistribution have been impressed by this device to raise more money for worthwhile public sector causes, largely from higher-rate taxpayers. It helps explain why he was able to increase money for health and edu cation, as well as give out billions to help low- income families with children to escape poverty, without either raising headline tax rates or breaking his borrowing rules.

Yet Brown’s redistributive largesse has been selective and ad hoc. Selective in the sense that most of the billions went to pensioners and families with children, while others on low incomes got nothing. And ad hoc in that the benefits and tax credits received by low-income families are still not uprated fast enough to raise their incomes automatically in line with earnings.

These families do well only by grace of the chancellor’s largesse at Budget time. Some of the extra billions are needed merely to prevent child poverty, measured in relative terms, from rising. If Budgets stuck to the standard uprating rules, child poverty, far from being eradicated, could rise to new record levels. No wonder that reducing it in line with targets has proved so difficult.

Fairer system

A fairer uprating system for taxes and benefits would be costly. A good deal of the £50bn extra that could be raised by the 2028 Budget under present rules may be needed to help pay for growing demands on public spending, especially due to ageing. It seems reasonable to plan in the future to spend more of our incomes through the public purse because in our lifetimes we will require more health care, more social care and public pensions paid over longer periods. This money needs to be drawn in large part from personal incomes and the slow shift from private pockets to the Exchequer may seem an ideal way to do it.

But here’s the catch. Groups at every point in the income distribution are affected by this phenomenon, yet the impact on the poor is greater than on the rich, by far. The research shows that as a result of this sluggish uprating regime, someone in the bottom fifth of the income distribution will on average lose about 17 per cent of their income, whereas someone in the top fifth will lose only 5 per cent. This is because uprating decisions apply to only part of the incomes of people paying taxes (the taxed portion), but to all of the incomes of people receiving benefits.

The authors of the Rowntree report show that it would be possible to use some of the £50bn to finance a rising public spending burden more fairly. For example, if the Exchequer could be content with £30bn instead, it could use the rest to ensure that everyone sacrificed about the same amount, as a percentage of income. This would mean that in 20 years both rich and poor would have incomes about 5 per cent lower, relative to earnings, than today. But as earnings will be much higher than now, nobody would be worse off in absolute terms, and neither would groups lose in relative terms if the burden were shared evenly.

At a time of severe Treasury prudence, the idea of £20bn less than projected in the public coffers, even two decades ahead, may look like pie in the sky. Yet times change, even for the Treasury. The case of pensioners, the one group now largely exempt from erosion of incomes through the uprating system, proves this point.

In the early Brown years, the focus for pensioners was on relieving poverty through a minimum income guarantee (now Pension Credit), which was raised sharply and then pegged to earnings. Not good enough, said the age lobby: pensioners hate having to claim this “poor relief”; the link between the retirement pension and average earnings should be restored. Following a groundswell of public support and the Turner Commission, the retirement pension will indeed be linked to earnings from about 2012 – a victory for Tony Blair’s No 10 over a resistant Treasury.

Winning similar measures to preserve the relative incomes of benefit recipients of working age is politically harder. Unemployed people are seen as less “deserving” than pensioners – although disabled people are also affected. Yet continuing with the present system will produce bizarre results. Already, a long-term unemployed person having to live on £60 a week sees their income double on their 60th birthday, when they become eligible for the Pension Credit. If present policies continue, one day they will see it quadruple. For some families, the old idea of relying on children to support you in your old age will be turned on its head.

Donald Hirsch is poverty adviser to the Joseph Rowntree Foundation. “The Impact of Benefit and Tax Uprating on Incomes and Poverty” by Holly Sutherland, Martin Evans, Ruth Hancock, John Hills and Francesca Zantomio is available from

On the edge

£4,000 average yearly benefits received by top fifth of households (average earnings £68,000)

£6,700 average yearly benefits received by lowest fifth of households (average earnings £4,200)

£60.50 disposable income of unemployed single person after rent

£155.60 average weekly spend of poorest tenth of households

£46.90 average weekly spend on food of all households

£58.50 average weekly spend on recreation of all households

Research by Simon Rudd and Jax Jacobsen

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