Published on 30 October 2015
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Each year, the Government increases – or ‘uprates’ – the value of social-security benefits. Fairness and sustainability have been at the forefront of policy in recent years, but the simplicity of these objectives obscures the trade-offs they entail. Welfare policy needs to protect the most vulnerable in society, while avoiding dependency. It must be fair to those in receipt of benefits, as well as those paying for them. Getting uprating policy right is an important part of satisfying the competing demands of a social-security system.
Historically, these goals have been pursued by uprating benefits in line with a measurement of price inflation: until 2010, this was Rossi, New Rossi or the Retail Price Index (RPI). Lately, however, Governments have upended this settlement. Against the backdrop of a significant budget deficit, the Coalition and then Conservative Government capped and then froze growth in the value of many working-age benefits. It was argued that at a time when inflation was outstripping wage growth this was a fair contribution to fiscal consolidation. This was a short-term measure, underpinned by a wholesale switch to the Consumer Price Index (CPI) as the default measurement of inflation. This, it was argued, was to more accurately reflect claimants’ experience of price changes. It cannot be overlooked that CPI typically returns a lower inflation reading than RPI. At the same time, since 2011, the State Pension has been uprated by the ‘triple lock’ – the highest of CPI inflation, average earnings or 2.5 per cent. The Government argues this policy protects pensioners’ standard of living, thereby rewarding them for a lifetime of labour.
This report evaluates the current approach to uprating policy and argues that these policies fail to achieve the central aims of sustainability and fairness. Improving economic conditions (with wages growth soon to return to pre-crisis levels) now render the freeze on working-age benefits superfluous. Rolling back this iniquitous measure should be a priority. But there is also a long-term issue. The use of CPI – a macroeconomic price indicator that persistently understates the price experiences of beneficiaries – to uprate benefits erodes the purchasing power of some of the poorest in society. The Government should therefore develop a new ‘Benefit Uprating Index’ (BUI), and use this measure to uprate the majority of working-age benefits as soon as this index has been quality assured.
These measures would, of course, come at a price. Uprating tax credits, Jobseeker’s Allowance, Employment Support Allowance, Disability Living Allowance, and Personal Independence Payments by BUI would cost HM Treasury an estimated £13 billion over the next five years. A considerable proportion of this expenditure, however, is derived from reversing the freeze. Indeed, if these payments were already CPI-linked, the additional cost would be £3 billion over five years.
Savings to fund this expenditure could be found by curtailing the future cost of the State Pension. As our population ages, expenditure on the State Pension as a proportion of GDP will inevitably grow. Yet by ensuring the State Pension grows faster than wages, the triple lock will increase government debt by 26 per cent of GDP over the next 50 years. The Government is right to want to both maintain an earnings link and protect pensioners against inflation. However these policy objectives could be achieved at less expense. The triple lock should be replaced with a relative earnings link, which pegs the State Pension to a proportion of wages in the medium term. By returning the State Pension to the proportion of earnings when the triple lock was first introduced, the Treasury could save £20.9 billion over the next five years.
This report argues that these policies should all be implemented together. If the Government does this, it is likely to make considerable savings. Over the course of the next five years, these policies would save a total £7.9 billion relative to the freeze, or£17.9 billion relative to a CPI-link. Not only are these considerable savings possible, but they represent the best way for the Government to meet the competing aims of uprating policy. To ensure fairness and sustainability, the Government should implement these reforms as a matter of priority.
Recommendation 1: The Government should develop a new index, the Benefit Uprating Index, and use it to uprate income-replacement and income-supplement benefits.
Recommendation 2: The UK Statistics Authority and Office for National Statistics should investigate the degree to which there is variation between the price experiences of different beneficiary groups. If the variation is significant and the cost of implementation not prohibitive, consideration should be given to using sub-indices within the BUI.
Recommendation 3: All extra-cost benefits except Local Housing Allowance should be uprated by the Benefit Uprating Index. As part of its investigation into sub-indices, the UK Statistics Authority and Office for National Statistics should explore whether households with children, those with disabilities, or those in need of care experience price changes in a significantly different fashion as to warrant the introduction of sub-indices for these groups.
Recommendation 4: The Government should replace the triple lock with a relative earnings link, a mechanism that pegs the value of the State Pension to wage growth
in the medium term but also protects pensioners from high inflation during periods of economic volatility.