Darling must cut UK’s huge welfare bill

February 17, 2013

Alistair Darling is staring into the abyss. Unless he makes severe cuts to government spending there is a real risk he will plunge the UK into another economic crisis.

Without a credible commitment to bring public expenditure down to sustainable levels, the bond investors funding Britain’s near £200 billion annual borrowing may demand a risk premium in the form of higher interest rates. A big rise in rates would in turn increase the cost of the government’s debt repayments, threatening a debt spiral which could jeopardise economic recovery.

Growth is already threatened by the well-known crowding out effect of public borrowing, which diverts resources from the productive parts of the economy. This may mean official growth forecasts are too optimistic, making cuts in spending even more necessary.

In the context of these grim economic realities, Darling cannot make savings of sufficient scale without tackling the major areas of government spending – health, education and, most importantly, welfare. Including state pensions, welfare benefits cost about £170 billion per year, around one in four pounds the government spends. This emphasises the magnitude of the problem. Even a highly contentious 10% across-the-board cut would save just £17 billion – worthwhile, but a fraction of what is needed.

Yet many welfare benefits are more about favouring particular groups of voters than providing a safety net to cover basic needs. For example, a whole host of payments have been introduced that favour the over-60s, including pension credits, winter fuel payments and free travel. These special benefits add up to at least £12 billion per year and often go to relatively well off households. They also reduce incentives to work and save.

A combination of phasing out special payments for the over-60s and reducing benefit rates by a relatively small percentage across the board would help ensure welfare played a proportionate role in rescuing the public finances. A failure to address Britain’s huge welfare bill in today’s PBR will augur very badly for the country’s economic future.

9 December 2009, IEA Blog

Filed under welfare Tagged with , , ,

Time preference, economic crisis and social decline

February 17, 2013

The last decade has been marked by a combination of low savings rates and high debt levels in both the USA and Britain. Indeed in 2005, the savings rate in the US reached zero, while 13 million adults in the UK – more than 1 in 4 – have no savings or investments.

The lack of savings, together with the readiness to take on debt, suggests that a high proportion of the population has a high time preference. In other words, the present is valued far more highly than the future.

Arguably the current financial crisis cannot be divorced from the short-term, “hand to mouth” culture that has come to dominate the USA and the UK. The widespread unwillingness to defer material gratification contributed to the debt bubble that precipitated the crash.

But the negative consequences do not end there. People with no savings are also more likely to have to rely on welfare-state safety nets when they lose their job or develop a health problem. They will also tend to be more reliant on state handouts in old age and may therefore vote for socialist political parties that promise to increase such benefits. There is also a strong association between high time preferences and criminality.

While it may be tempting to blame “cultural decline” for the phenomenon, the absence of saving in countries such as the UK may in reality be a rational response to artificial incentives created by government policy.

It is perhaps not that low saving causes welfare dependence but the prospect of welfare that causes low saving. Benefit claimants with more than £6,000 may face steep deductions in means-tested payments. If they have over £16,000 they may receive nothing. And when they reach old age, the availability of means-tested pension credits means low to middle income savers will be barely better off than their spendthrift contemporaries.

Another issue is long-term residential care for elderly. While savers will lose their assets, including their home, non-savers on state benefits will generally receive care free of charge – this is a tricky issue but, at the very least, those who do not save should not be able to expect a guarantee of the same standard of provision as those who pay for themselves.

All in all, the incentives for deferring gratification and saving are very weak. This problem should be addressed urgently through the reform of pensions and benefit systems in order to restore the social and economic benefits of a low time preference culture.

24 June 2009, IEA Blog

Filed under political economy, welfare Tagged with , ,