Linking Benefits to Earnings: Two Possibilites
The Government, as has been widely reported in the past couple of days, is apparently once again looking at linking benefits to earnings rather than inflation.
As Jim Pickard notes at the FT Westminster blog the Prime Minister floated this idea earlier in the year:
It might be better to link benefits to prices unless wages have slowed – in which case they could be linked to wages.
Let’s first be clear what the Prime Minister appears to be suggesting here 0 he’s not talking about linking benefits to earnings, he’s talking of uprating benefits by the lower of inflation or earnings. That matters – firstly because the norm is for earnings to rise faster than prices. Real wages have risen in most years in the UK since the Second World War, driving living standards higher.
An excellent report out today from the Resolution Foundation finds that although real median wages have fallen by 0.3% a year since 2003, they grew by 1.6% a year between 1986 and 2002. The post-war norm is for real wages to rise, i.e. for earnings growth to be higher than inflation.
It is worth remembering that benefits were linked to earnings until 1980, at which the point the Thatcher government changed the link to prices in order to save money. This has had a major impact on benefit levels:
the Conservative government broke the earnings-benefits link in 1980 precisely to run down benefit levels compared to the incomes of working people, and it has never been put back. In 1980, unemployment benefits were a fifth of average earnings; today they are a tenth.
The Guardian today persuasively argues against the Government’s mooted proposals on grounds of equity and fairness. But there is another question – would such a scheme (pegging benefits to the lower of inflation or earnings) actually save much cash?
The most recent OBR forecasts show that from early next year, the Government expects average earnings to be rising faster than inflation. Benefit uprating is done on September figures and this year the OBR is forecasting Q3 CPI of 2.6% compared to average earnings growth of 1.9%. But for 2013 the figures are 1.9% for CPI and 3.3% for earnings. By 2016 the OBR expects CPI to be 2.0% and earnings growth to have reached 4.6%.
So for this proposal to link benefits to the lower of earnings or wages to ‘work’ on its own terms and actually save the Treasury money one of two things must be true.
Either the Government is being hugely short-termist and actually talking about just a one year cut in uprating (2012) which will cause a lot of pain but not actually have a major impact on the deficit at all or the government has become hugely pessimistic on future earnings growth and thinks we are set for a long period of earnings growth that is slower than wage growth. In other words falling living standards for those in work for the next few years.
Neither possibility is especially cheering.
Or of course talk of linking to earnings is just a smoke screen for an outright freeze, in which case the Government should drop the talk of earnings.