In this article I consider a “madcap scheme”.
The “Poverty Trap” (also known as the “unemployment trap” or the “welfare trap”) means any situation where the costs of moving into work are greater than the increase in income, caused by means-tested benefits.
A very simplistic example would be where the government gave £5,000 to everyone with a salary below £10,000. Someone with a salary of £9,999 would receive an additional £5,000 from the government, bringing their total income to £14,999. Imagine such a person was offered a better job or position, requiring slightly longer hours, more of their skills, or more responsibility, with a salary increase of £1000. Performing such a job would increase the wealth of society. But the person would not take it. For with a salary of £10,999, they would no longer receive benefits, so their total income would be £10,999. By working more, they would decrease their income by £4,000. So of course, while in an undistorted market they could better themselves by working more, with government distortions they would have no incentive to learn new skills or get a better job.
In practice, welfare payments are distributed by the government according to a much more complicated system. Usually they are not cut off suddenly, but phased out. But means-tested welfare, i.e. welfare that depends on your circumstances, will always mean that the pay increase from working better or longer will be less than it would be in a free market. There will be less incentive to work better or longer. The poverty trap discourages people from getting off welfare and bettering themselves with their own efforts.
In extreme real cases, working can indeed reduce income in absolute terms. Chris Dillow points out:
Our existing system already subsidizes idleness. Some people prefer to stay on benefits because they’d lose these if they went out to work. Take a married couple, both out of work. One’s offered a 16-hour week job at the minimum wage. How much better off are they if they take the job? Not at all – they are about 5% worse off. Table 1.4a of this massive pdf shows.
Sure, I’ve taken an extreme example. But it’s easy to find replacement ratios for part-time jobs of over 70%. For many, then, the financial gains from working are so small that the hassle’s not worth it.
As one commenter on Peter Hitchens’ blog said,
“A safety net is exactly what social security should be – not a way of life. I would suggest, however, that with 5.4 million people languishing on out-of-work benefits, Britain’s welfare system is more ‘comfort blanket’ than ‘safety net.’”
The solution is to make benefits non-means-tested. This means giving the same welfare payments to everyone, regardless of their income. Obviously there would be exceptions for the disabled, but for ordinary people, welfare payments should be the same, whether you are unemployed or a millionaire.
That way, working an hour at a job which pays £5/hour, increases your income by £5, instead of by some amount less than £5.
What we should do is replace all social security by giving every adult in the country £5,000, cash, with no conditions. My economics teacher at school suggested this briefly as a “madcap scheme”, but this idea is actually not as mad as it seems. I believe it should gain wide acceptance. It should be acceptable to both the left and the right. For those on the left who really want to help the poor, rather than just increase their dependence on the rulers, it maintains their income but massively simplifies how they get it. It frees them having to spend a lot of time dealing with the state, and allows them to pursue a more fulfilling life doing what they want, without discouraging them from working. For those on the right, it is certainly an improvement, because it removes the disincentive to work that goes with the current welfare system.
This is a Basic Income system, which could be implemented either as a “Citizen’s dividend” or the negative income tax advocated by Milton Friedman.
I was reminded of the Basic Income idea by Charles Murray’s book “In Our Hands”.
Another commenter on Hitchens’ blog described the book thus:
“For anyone who is interested in welfare reform, can I commend the works of Charles Murray. His thesis: the state [despite its good intentions] is inevitably wasteful and inefficient. As well as morally neutral, spawning vast bureaucracies etc.etc. The solution: end all redistributive welfare INCLUDING THE NHS. Cut out government and give the money straight to the people. To receive a monthly sum, people must be: over 21, have a bank account, have a British passport, to get a monthly sum (£10,000 pa) for life. Two rules only: they MUST buy health insurance, and they must invest in a pension plan. After that, they can do whatever they like.
The human urge to do what is best for the self (denied by the left) then comes into play. Because not getting a job, getting married and having babies too young hurts, and the counterpoint pays, people will behave in ways that are constructive, not destructive.”
Chris Dillow surveys some arguments here.
James Bartholomew describes it here:
“His idea, briefly, is this: that the government should give every person US$10,000 a year in place of all welfare benefits, retirement payments and healthcare. Of this, US$3,000 would have to be used to buy health insurance.
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He said he was not primarily concerned that the welfare state costs too much “though it does”, nor that it tends to make things worse “though it does” but that it “drains” the life out of people – particularly the spiritual life and sense of meaning.
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He said that if his plan were introduced, behaviour would be affected. There would be ‘feedback loops’. I think he implied that a girl would be less inclined to get pregnant out of wedlock if she knew she would get no extra money from the government. She would also be able to get money from the father because his regular money from the government would be paid to a known bank account and money could be taken from it. This would, Murray suggested, affect his behaviour, too. He would be more cautious about making women pregnant.
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I am struck first of all by how he admitted that this was a compromise. He said he was making an offer to the Left. They would be allowed to keep big spending – since his plan would continue big state spending. But it would be in a different form that would curtail many of the bad effects of state welfare.Many times I have been asked, when giving talks about my book, ‘so what is the answer?’ I have always felt it is impossible to give a satisfactory answer. The ideal solution – minimal state welfare – would probably not be politically acceptable in a democracy. But reforms that would be politically acceptable would probably not be radical enough to make a ‘good society’.”
As Sean Gabb says,
“Something we should leave substantially alone is the welfare state. The main assumption behind which the present ruling class justifies its looting of the taxpayers is that any cuts in public spending must fall on the welfare budget.
Of course, it is a false assumption, but it does not help that libertarians have always made a great noise about the corrupting effects of state welfare, and that libertarian schemes of improvement always give prominence to privatising or abolishing it. This shows a failure of political understanding.
All else aside, it would be madness to give the now displaced ruling class an issue on which it might claw its way back from oblivion. It may be regrettable, but most people in England like welfare. They like the thought that if they lose their jobs, they will receive some basic support, and that if they fall ill, they will receive treatment free at the point of use. That is what is wanted, and that is what a government of reaction must continue providing.”
I disagree with Murray about health insurance. Instead I would pay some of the money into Personal Health Accounts, as described by Hannan and Carswell in “The Plan”, because these also increase the incentive to use the money wisely.
All other social security would be ended, including the minimum wage, council housing and the NHS. Hannan and Carswell explain how the transition could be made from the NHS to private healthcare. There would be no difference in income for those living in places like London where living costs are higher. As one commenter on Chris Dillow’s blog said, “If I live in an expensive area and lose my job, and can’t find a new one, I will have to move somewhere cheap. Why is it beyond the pale for an unemployed CBI-only person living in London to consider moving himself to a cheaper town or city?” Another replied sarcastically, “it is universally recognised as an affront to civilisation and all we hold dear to suggest that someone who isn’t inclined to should leave London.”
There would be no child benefit. This would remove the incentive to have children, and indeed would give an incentive not to have children. Removing child benefit normally seems harsh because it penalises the child for the decision of the parent – a child does not choose to be born. But in this case it would be okay because the family would still be guaranteed enough income to live on.
The commenter on Hitchens’ blog said,
“I asked George Osbourne about the theories of Murray. His reply: I had lunch with him last week! But there are things I don’t believe in. Translation [to me]: I don’t possess the necessary size of testicles to do it.”
Tomorrow, I’ll be considering “tradable citizenship”.
Tags: equality, society, statism, welfare state
Interesting stuff. I studied the poverty trap in some depth last year as part of an economics dissertation on tax policy. The situation is incredibly alarming – taking into account the “withdrawal rate” at which means-tested benefits are reduced as income rises (giving the “effective marginal tax rate”), the people who pay most tax in Britain today are its poorest. The Institute of Fiscal Studies’ analysis shows that 13% of UK workers face a marginal tax rate in excess of 70%, and over 3 million workers (7%) face a rate of over 90%! This astonishing fact can be demonstrated by a simple numerical example: a single man earning £5225 (the Earnings Threshold) pays no tax on his income, and receives tax credits worth £2433, giving a total income of £7658. If he takes up a new job worth £7455, his Income Tax is £223, his NI contribution is £245 and his tax credits are now only £1608, giving a total income of £8595. Though his gross income has increased 43%, his net income has increased by only 12%. HM Government has extracted 73% ([43-12]/43) of his marginal income! This is a real example using 2007 figures, and does not include other benefits like housing benefit which would make the result even worse.
You’ll notice that the main problem here is Gordon Brown’s pet project, tax credits (a project ironically often credited with making great strides against poverty). Only since the first Labour budget of 1999 has the situation become so severe, as an IFS study has shown. The effective marginal tax rate paid by the 10% of workers facing the highest rate has increased dramatically from around 40% pre-1997 to 68% today.
Interestingly, this disastrous policy is now being copied by Barack Obama, whose assertions that “no-one earning less than $250k will pay a penny more” under his tax plans are simply false if you look at the effective tax rate. See this excellent article for a fuller explanation: http://www.american.com/archive/2008/august-08-08/the-folly-of-obama2019s-tax-plan.
However, the idea of universal payments (which would considerably ease the disincentives problem, though it would still exist to some extent) would not be workable. If you total the benefits received by those on low incomes, it is far, far higher than £5,000 a year (if we’re including housing costs, NHS, all social security, and particularly state care for the elderly). The reason the state is at present able to cover this is that most tax is paid by the richest and then redistributed (I don’t have the figures to hand, but for example the richest 10% pay much more than 10% of total taxes collected). So there is a huge imbalance in how these services are paid for. Were you to privatise these services, and eliminate welfare, replacing it with a universal payment, the universal payment (because it is the same for everyone) would necessarily be much lower than it would need to be to cover the costs associated with the services withdrawn, because they are disproportionately used by those on lower incomes. Since many people rely on services that cost far in excess of the £5,000 payment, their standard of living would decrease substantially.
So I agree with a Friedman-esque simplification of welfare by which the tangle of welfare payments is replaced by a single annual cheque. But we need some form of progressive system in order to provide a basic living standard for all. And any form of redistribution is guaranteed to cause disincentives because it distorts the market. So we want to ensure there is a safety net, and we want to minimise work disincentives. In that case, we need some form of redistribution, but we must handle it carefully. The problem is getting the balance right between what is an acceptable amount of welfare, and disincentives to work – ensuring no-one faces a marginal tax rate in excess of 50% would be a good start. This balancing act is what Labour, in its well-meaning but hapless experiment with tax credits, got spectacularly wrong, and we see its effects throughout Britain’s inner cities.
A most interesting phenomenon is that Murray’s plan, which he published while under the auspices of the American Enterprise Institute (GOP insider think-tank), would, if adopted by the current GOP candidates, not only immediately terminate the financial crisis and sweep the election for them, but it would permanently destroy the political machinery of the Democratic Party’s public sector rent-seeking.
Why is it, do you think, that the GOP is so intent on its own demise that it rejects its own insiders who would let it demolish the opposition in the near term as well as the long term? We can ignore, for the sake of argument, that it would also save the economy.