The Coalition, benefit cuts, and income inequality

This is a piece that first appeared in One Society‘s ‘half-term report’ on the Coalition Government and inequality (references and footnotes available in the full report). The whole (short!) edited volume is also worth a read, containing articles by Kate Pickett, Chris Goulden, and Stewart Lansley among others.

On one level, the question of whether benefit cuts lead to higher income inequality is simple to answer.  Poorer people are more likely to claim benefits, ergo cutting benefits has less effect on people with high incomes – and from the 2010 Emergency Budget to the 2012 Budget, there were £19bn of net cuts due by 2014-15.[1]  Prof John Hills, the former chair of the National Equality Panel, calculates that £1000 of deficit reduction spread equally over all benefits and services will cut incomes of the poorest fifth by 12%, but less than 1% for the richest fifth.[2] In contrast, deficit reduction through equal rises across all taxes has roughly the same effect (a 3.5% reduction) on all.

However, the answer becomes more complex when we see the different ways that deficit reduction can be enacted.  Both benefit cuts and tax rises can be particularly targeted on the poor or rich; the Coalition can point to greater means-testing of Child Benefit as a benefits cut that is not targeting poorer people.  (This ignores the long-term political impacts of cutting universal benefits, (Baumberg, 2012)).  David Cameron has therefore argued (back in March 2009) that “fiscal responsibility needs a social conscience, or it is not responsible at all.”

In this short piece I review the likely impact of the Coalition’s benefits policy on income inequality – firstly looking at the ‘next day’ impact of the changes, and then (more speculatively) how this will influence inequality by changing people’s behaviour.  (To make this task manageable I do not look at the impact of social care or public service cuts).

Who has lost what?

In the light of a bewildering array of different reforms {Welsh Government, 2012 #351}, we can see the broader picture using modelling from the Institute of Fiscal Studies (IFS) – noting that this includes tax changes as well as benefit cuts.  At first glance this seems to support Cameron’s claim that ‘we are all in this together’; the poorest tenth of households with children will lose slightly more 2011-2014 than slightly richer households, but this is still less than the richest tenth, and we are all reasonably similarly affected (a reduction in income of 5-7%; Figure 3.2b in Browne, 2012).

Yet we onlycome to this conclusion if we include changes that came into effect during the Coalition but due to policies already announced by Labour in April 2010.[4]  This argument came to a head at the time of the 2010 Comprehensive Spending Review, where the Coalition added another £7bn of benefit cuts to £11bn of cuts in the emergency budget earlier in 2010.  The Coalition argued that they should take credit for Labour’s (pro-poor) changes, but sceptics may feel it is slightly generous to credit governments with responsibility for every action in train that they do not disrupt.

This is still not the full picture.  The coming years (2013-2018) also the introduction of ‘Universal Credit’ (UC) – an amalgam of several means-tested benefits and tax credits intended to simplify an undoubtedly complex system.  Well over 1m people will see their entitlements reduced under UC (though there is transitional protection), but over 2m will receive more, at an estimated initial cost of £2bn (Brewer et al., 2011b).  And UC taken on its own – without the highly regressive changes announced by the Coalition in 2010 – is progressive; an early IFS estimate[6] (Brewer et al., 2011b) put the net gains as 5% of income for the poorest tenth, with negligible effects on the richest four deciles.

So what happens if we put UC together with the earlier, regressive cuts, and separate these out from the policies previously announced by Labour?  The latest picture available is only for households with children; it excludes the changes in the 2012 Budget[7] and transitional protections, and is clearly not the final word on the matter.[8]  Still, Figure 1 gives us the best overview of how the different sets of policies combine.   The policies implemented in 2011 (including those announced by Labour) reduce inequality – but later changes are regressive, the poorest tenth of households with children lose over 5% of their income, while the richest tenth lose 2%.

Benefits and behavioural change

So far these numbers all refer to the ‘next day’ change in people’s finances, but people’s behaviour may also change.  Iain Duncan Smith hopes that people will move into work, and recently claimed that “UC will ensure the vast majority of children will be lifted out of poverty if at least one parent works 35 hours a week at the minimum wage.” Early estimates suggested that UC genuinely does increase the incentive to work, particularly at low earning levels, and despite reduced work incentives for second earners (Brewer et al., 2011b).

There are however reasons to be less optimistic.  Firstly, IFS modelling (strangely) suggests that employment impacts will have small impacts on poverty levels, partly because this will in-turn raise the poverty line, and partly due to continuing in-work poverty (Brewer et al., 2011a:18-19).  Secondly, the simplification and improved incentives from UC are damaged by increasing complexity and means-testing in other parts of the system.  Council Tax Benefit is being transferred to local authorities, while the proliferation of different means-tested fee/bursary schemes across different universities leads to small patches of disincentives to earn more.

It is therefore plausible that more people are encouraged to work, but the extent of both (i) employment changes and (ii) impacts on inequality are likely to be more limited than some suggest – and this is even without considering Housing Benefit changes which might force people to move further away from jobs, the possible rise of low-paid ‘mini-jobs’, and doubts that the IT systems underlying UC will work effectively.

Another unknown impact is whether more eligible people will take-up UC than the benefits that preceded it.  The expectation is that it will; indeed, the IFS assume that take-up will be at least the level of current Tax Credits, and tests the impact of even higher levels given that UC “is likely to be easier and less confusing to claim” (Brewer et al., 2011a:38), and the less-stigmatising nature of tax credits may also rub off on UC.  If non-take-up in UC is half the level that of IFS baseline assumption, a further 1m people will be taken out of poverty in 2020.  However, tax credits may instead become tarred with the greater stigma associated with benefits, particularly given some of UC’s more stringent requirements: in-work conditionality is being introduced, and people with savings above £16,000 are disbarred from the system.

In both cases, then, behavioural change may reduce inequality – but we will only know by how much after the policies have been introduced (and even then, disentangling such effects will be a challenge).

Conclusion

Two years into the Coalition, the already-announced benefit cuts and tax changes are likely to increase income inequality – as we would expect them to.  The Coalition did follow through with progressive policies announced by Labour in 2010, but it takes a charitable observer to attribute full credit for this to the Coalition (although it should equally be noted that Labour has also said that they would have introduced unspecified cuts).

The remaining changes are broadly regressive: the introduction of Universal Credit in itself may reduce inequality (through its short-term impacts and improved work incentives), but this is largely outweighed by the scale of the benefit cuts announced in 2010.  And this is not the end of the matter; not only is the largest cut a change to benefit uprating that multiplies year-on-year (Sutherland et al., 2008), but there is the threat of a further £8bn of benefit cuts later in 2012.  As we continue our path through austerity, we will continue to face choices that have greater and lesser impacts on income inequality in Britain.