Fairness and the welfare bill

Today's row over benefits was optional: the government, by all accounts, did not need to have a parliamentary vote on the decision to raise most benefits by only 1% a year between now and 2015. But if you want to squeeze public spending as much as the government does, most economists would say that debates about welfare are not optional at all.

The debate has been portrayed as an argument over "skivers versus strivers". But others might say it was a debate about the nature of the welfare state.

The welfare budget is 30% of government spending; if you're trying to squeeze public spending, it's inevitable that you will end up trying to squeeze welfare.

And if you've ruled out most of the cuts which would directly affect retired households, as David Cameron did, during the 2010 election, there are only two potential targets for welfare cuts left: working age households that work, and those that don't.

The policy being debated today will affect both, though workless households will lose most. The policy will also leave them relatively more exposed to inflationary shocks.

According to the IFS, about 9.5 million households will be affected by the new policy on uprating - or about half of the working age households in Britain. About seven million of these "losers" will contain someone in work, and could lose, on average, around £165 a year by 2015-16.

But that hides a very wide variation. The loss for about three million of those working households will be more like £75 a year and will come only from the real cut in the value of child benefit. The roughly 2.5 million non-working households who also lose out will be worse affected, as a general rule: their average loss will be about £215 a year.

Is this fair? As ever, it depends on your definition of fairness. It might also depend partly on how you view the role of the benefit system.

When benefits started, they were thought of as insurance, to protect you from certain big events in life for which you might or might not be well prepared. Some, like retirement, were entirely predictable. Others, like unemployment, were not. The contributory principle said you got more or less what you paid in, if and when these life-changing events occurred.

Two things have happened since then: the first is that the benefit system has become much less contributory, meaning that benefits are increasingly tied, not to your contribution, but to your situation. The second, only partly related to the first, is that the system has come to involve a much larger share of working age households.

The latest figures from the ONS show that, on average, the bottom 60% of UK households by income get more out of the system in benefits, tax credits and public services than they put back in the form of taxes in 2010-11.

Obviously, a significant chunk of those households are retired people, who pay less tax. If you exclude them from the calculation, the bottom 40% are clear winners, and the 20% in the middle pay almost exactly what they get back.

In 2010-11, the average gross (before tax) income at this part of the income distribution, was £33,186. If you subtract direct and indirect taxes from that income, then add back what families get from the state in cash and in-kind benefits, the ONS reckons you get a "final income", net of taxes and benefits, of £32,305 - just slightly less than they earned in the first place.

It is these kinds of statistics that prompt critics, such as the Reform think-tank, to talk about the "money-go-round" of welfare. Their point is that the middle classes may get more now from the state than they got 20 years ago, but they have usually had to shell out more taxes to pay for those extra benefits.

Gordon Brown reckoned that the more you gave the middle classes in tax credits and other benefits, the more they will support the welfare system as a whole. Some of the welfare cuts being implemented by the coalition are putting that belief to the test. But the change in uprating for the next few years is a reform which asks most working age households to contribute, regardless of circumstance.

If you think fairness is about treating different households equally, then you will think it's fair. If you think, rather, that fairness means "asking those with the broadest shoulders to carry the heaviest burden", then you might not think this particular change is fair. But ministers are right to point out that households dependent on benefits have seen faster growth in their incomes recently than many in work.

If the forecasters are right in their predictions for inflation over the next few years, today's uprating move will mean that the benefits fall by 4% in real terms between 2013 and 2015. As it happens, average weekly earnings have fallen by almost exactly that amount, in real terms, since the coalition came to power (see my last blog), while benefits have consistently been uprated in line with inflation.

Iain Duncan Smith says the gap is even wider if you go back five years: people on out of work benefits have seen their incomes rise by 20% over that period, while average earnings have risen by 12%.

As I pointed out a while ago, one consequence of uprating benefits with inflation at a time of flat or falling real wages has been to help narrow the gap between rich and poor. It is one big reason why 2011 saw the largest one-year decline in income inequality in a generation.

This cut in the real value of benefits between 2013 and 2015 may undo some of that. But probably a better objection to this policy is that it leaves the poorest households very exposed to inflationary shocks.

We don't actually know what inflation will be over the next few years. The majority of forecasters expect it to continue to be weak - because they don't think there's much chance of a rapid economic recovery which pushes up domestic prices or wages, and because they think the new sources of energy coming on stream in the US and elsewhere will help keep a lid on the world price of oil and gas.

If those forecasts are right, inflation in the UK will be lower in the next few years than it has been since 2009, and the real value of benefits will fall by not much more than 1% a year, between now and 2015, as a result of this policy.

But quite a lot of economists think that, sooner or later, the hundreds of billions that the Bank of England and other central banks have been pumping into the global economy will come back to bite us, in the form of runaway inflation. That is unlikely to happen right away, but others think there could be another surge in global commodity prices this year, which the Bank of England will not able to prevent filtering into inflation.

If either or both of those things happens, this policy would mean that households who depend on benefits for all or most of their income could see their real incomes fall by a lot more than 4% between now and the next election. But right now, ministers would probably say that runaway inflation was not their number one concern.