The long term future of welfare

12 September 2012

It is impossible to think about the outlook for the Government’s finances without thinking about welfare spending. The Government spends more on welfare than on anything else. Part of this spending is cyclical and varies with the economy’s ups and downs. Another part is structural and varies when the rules of programmes or the underlying characteristics of the population change. As the population gets older this structural spending will, in the absence of reform, become more costly.

How the welfare system should adjust in the face of factors like population ageing was the subject of a Reformer lunch with Andrew Harrop, the General Secretary of the Fabian Society. This lunch was held under the Chatham House rule.

Pensioner benefits are going to play a more central role in driving overall welfare spending. Spending on pensioner benefits is already significant and has been projected to increase by 3 per cent of GDP over the next 50 years. Most of this increase will be driven by the “bulge” that occurs as the baby boomers move into retirement. The proposed increases in the state pension age have largely offset the cost of increases in longevity (when people live longer in retirement), but the fiscal effect of the large number of baby boomers reaching retirement age still requires addressing.

This increasing spending on pensions could change the role of welfare in two important ways. First, as spending on pensions is less heavily targeted than spending on working aged benefits, further shifting the balance between spending on out of work benefits and on pensioners could reduce the overall level of means testing. Yet rather than having a more universal system arise by default, it is important to recognise the debates around the use of universal and means tested programmes and to ask how means testing should vary with the lifecycle. The role of means testing should be a result of design not accident.

Increasing spending on pensions could also lead to welfare spending placing more emphasis on income smoothing rather than poverty reduction objectives. Yet income smoothing is not just the role of the State. People should expect to save more through their working lives and to use private tools such as insurance. People should also expect to increasingly consider how to release the equity built up in assets (such as the family home). But at the moment these private tools do not work as well as they should for too many families. People fail to shop around and need to use the full toolkit – which includes savings products (which can help smooth incomes) and also tools like insurance (which can not only smooth incomes but pool risk) and equity release (which can allow the value of existing assets to be drawn down). Families must access tools in a flexible way.

Demographic changes will not only impact on the level of welfare spending but also on the distribution of this spending. This change in the distribution of spending will take place in the face of radical changes in the needs of the community – with people living longer in retirement, more people combining work and retirement, a greater incidence of chronic health problems and a shrinking of the working aged population. This creates a real challenge as to find the headroom to address new needs the welfare state will need to reduce spending in areas where needs no longer exist. Politically this will require hard decisions and honesty over the need for families, employers and communities to take more responsibility for themselves.

Reform roundtable seminar on “The long term future of welfare”, introduced by Andrew Harrop, General Secretary of the Fabian Society, on Wednesday 5 September 2012.

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