Getting rid of welfare dependency

In a recent report, Nima Sanandaji of the Captus think tank suggests that Sweden should look to the United States as an example in order to cut welfare dependency.

In the UK, attempts to combat welfare dependency have consistently failed. It is an inevitable consequence of the arithmetic of the system. However, the muddle over the 10p tax band suggests that the arithmetical competence of British politicians is shaky. Perhaps it is better in Sweden but who knows?

In Britain, the principle is that benefits are targeted. Consequently, people who fall into the target area, for example through sickness or loss of job, will tend to stay there. The difficulty is that benefits have to be set high enough to enable people to survive at at least a minimal standard, but to receive that same amount in take-home pay incurs an employer in a substantially higher total labour cost. It is simple arithmetic. Typically, every £1 an employee receives in real net purchasing power costs an employer over £1.80. The difference is made up of Employer's and Employee's National Insurance contributions, PAYE income tax and the VAT levied on what the employee spends. VAT levels (at 17.5% in the UK on non-food items) also mean that benefit levels themselves have to be about 10% higher that would otherwise be the case. This is money that is just churned in the system, being paid out with one hand and taken back with the other.

The effect of all these taxes on labour, goods, and services, is that it just is not worth employing anyone unless they are capable of adding a certain minimum level of value through their work. Anyone who is poorly qualified or in bad health will be excluded from the labour market.

And there is another side to this coin. There is a whole raft of low level jobs - mostly service activities like cleaning, which either do not get done at all or are mechanised and done badly, or are sent abroad to so-called Low Labour Cost countries.

So what is the solution? The answer is to look at the arithmetic. Taxes on labour should be reduced, and ultimately abolished, but not by reducing rates of tax. Tax cuts should take the form of increased in tax allowances so that low earners are taken out of the tax system altogether. And it needs to be recognised that taxes on basic goods and services mean that benefit levels have to be high enough to cover these costs, and so these costs need to be cut or abolished entirely. Third, benefit levels should, so far as possible, not be targeted but distributed to everyone, rich and poor alike - a kind of reverse poll tax. This is the so-called Basic Income.

How could such a fiscal system operate in practice? If existing taxes are to be phased out, they need to be replaced by something less damaging, of which the only realistic option is a tax on the assessed rental value of land, known as land value taxation (LVT). Since there are no deadweight losses from LVT, the reform would result in a substantial increase in the GNP; this deadweight loss to the UK economy due to the tax system is about 15% of GDP, suggesting that there is huge scope for replacing child benefits, jobseeker's allowance, incapacity benefit, retirement pensions and the like with a non-targeted scheme - which, apart from anything else would be vastly less costly to administer.

In round figures, there are 29 million in work, 700,000 vacancies, 800,000 jobseekers and 2.6 million on Incapacity Benefit - a high proportion of whom could do some kind of job if it was available worthwhile taking, which tends to bear out the the same point of an ongoing and avoidable loss to the economy in the order of 15%.

Obviously these reforms could not happen quickly but given the will, things could be moving in the right direction in ten years's time.