Should welfare benefits be increased to reduce inequality?

Readers Question: Should the government provide more welfare support programs such as child tax benefit and unemployment insurance in order to decrease economic inequality?

This is a classic dilemma that governments face. To simplify the argument.

  • Higher welfare benefits help to reduce inequality and reduce relative poverty. Higher benefits will give those on low income a better living standard and help contribute to a more cohesive society.

However, opponents argue that:

  • Increasing welfare benefits creates a disincentive to work. If welfare benefits are too generous, people may have a strong incentive to avoid work or work fewer hours. Furthermore, higher welfare payments increase the burden on the government requiring higher taxes and / or higher borrowing. Both taxes and borrowing place economic costs on society.

Both arguments have merits and setting the optimal level of benefits is not easy. It will partly depend which you feel is more important – reducing inequality in society or limiting the role of government and creating incentives to maximise individual incentives to work.

Between each polarised view, most economists would probably agree on certain principles which will be helpful in setting the level of welfare benefits.

  • Guaranteeing a minimum income to avoid absolute poverty is desirable.
  • It is important children are not too adversely affected by the choices of their parents.
  • Welfare benefits should be designed so there is always some incentive to work rather than stay on benefits. Ideally benefits would be temporary to help families through difficult times – not a permanent handout.
  • Welfare benefits should be deemed to be fair, easily accessible and available to all legitimate claimants.

Arguments for increasing welfare benefits

  • Reducing absolute / relative poverty. For families without work, welfare benefits help maintain a minimum standard of living. Without a minimum income, it will cause low living standards. For example, children in low income families may suffer inadequate diet and poorer health. Benefits can ensure everyone is able to afford important aspects of what we consider to be basic living standards.
  • Diminishing marginal utility of money. Progressive taxation which takes money from high earners and redistributes to low income earners can increase economic welfare because of the diminishing marginal utility of extra money. A millionaire will not be affected significantly by losing £1,000 in extra tax. However, if someone on very low income gains an extra £100, this can make a big difference to their quality of life. (e.g. people on low income can now afford a better diet)
  • Lower inequality reduces social problems. If people perceive there is vast inequality in society, it may increase resentment and increase the prevalence of crime, vandalism and general dissatisfaction. If welfare benefits provide basic living standards, it could contribute to greater social cohesion as those living in disadvantaged areas can see improvements in their living standards.
  • Children may gain better opportunities. If children are brought up in poverty it may affect their health and education. Increasing welfare benefits may help them gain a better education (e.g. less need to go out and work, but instead concentrate on studies). In the long-term this can create external benefits for society; if everyone has opportunity to gain education, it can increase long-term labour productivity.
  • Higher consumption. If there is income redistribution from high earners to low earners then overall consumption in the economy may rise. High earners have a high marginal propensity to save. Low income earners have a much higher marginal propensity to consume. In a recession, increasing welfare benefits could play a role in increasing the level of aggregate demand.

Arguments for reducing welfare benefits

  • Benefits can create a dependency culture. If people get used to receiving benefits, this may reduce the incentive to work. Critics of welfare systems point to how some families remain on benefits for considerable time period – negating the original idea of the welfare state to only provide temporary help in times of crisis.
  • Benefits can diminish self-esteem. A culture of benefit dependency can diminish peoples self-esteem because they don’t have the incentive to work and undertake a fulfilling job.
  • Cost. The UK has seen a sharp rise in the cost of the welfare state since it was introduced post 1945.

uk-benefit-spending-real-terms

This rising cost of welfare payments requires higher taxes, such as income tax and VAT. Higher income tax can cause additional disincentives to work.

Evaluation

  • When evaluating cost of welfare state, it is most helpful to compare spending as a % of GDP. If GDP rises, then arguably the real spending on welfare should increase. If benefits stayed stagnant when real incomes rose, we will see a rise in relative poverty.
  • For example, when looking at welfare spending as a % of GDP, the picture looks different.

welfare-spending-gdp

  • The disincentive effect of benefits is perhaps exaggerated. Given the relative low level of unemployment benefits in UK, I don’t feel there is a significant disincentive to get a job. It is often when several benefits, such as housing benefit, and child benefit are included, that certain families may start to have very high marginal tax rates from working longer hours.
  • In terms of child care benefit, I really doubt there is an incentive to have more children in order to receive more child care benefits. Some commentators have claimed single mothers had an incentive to have a child to jump the housing queue – though I don’t have time to investigate how reliable this claim was.
  • The government claim that their new ‘universal credit‘ is designed to prevent any disincentive to work through grading benefits carefully and only gradually reducing benefits when people start work.

Conclusion

To some extent all arguments here have validity. Benefits can play a role in preventing unnecessary poverty, especially during a recession, when people lose jobs through no fault of their own. But, at certain levels, benefits can create disincentives to work and create a substantial cost to government spending.

It is hard to strike the balance between reducing poverty and maintaining sufficient incentives and limit the cost to taxpayer. If you’ve ever been a situation of unemployment and poverty, you would probably tend to a more generous attitude. If you work hard at a low paid job,  you may feel aggrieved other people get similar amounts from benefits without working.

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