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30 October 2015
In 1972 (and to great fanfare), a £10 annual Christmas Bonus was unveiled for many welfare recipients. With inflation running at 7.2 per cent, the Government was concerned that incomes were being eaten away by rising prices. A bonus, it was hoped, would soften the blow.
The bonus still exists today, but is a shadow of its former self. Remarkably, its cash value has not changed for 43 years; its real value is less than a tenth of what it was. This is because it has never been ‘uprated’ – that is, had a mechanism for increasing its value to account for changing economic circumstances, such as inflation, each year. Uprating plays a crucial role in ensuring benefits continue to function as originally envisaged. In recent years, governments have unveiled a series of reforms to uprating. But as our new report Updating uprating: towards a fairer system details, these measures have created a less fair, and more unsustainable, system.
The first candidate for reform is the ‘triple lock’, a mechanism introduced in 2011 which increases the State Pension by the highest of the Consumer Price Index (CPI), earnings or 2.5 per cent. Even though pensioner incomes are now higher than average, the triple lock will see the State Pension grow faster than wages in the long run. This policy is not only expensive – costing £6 billion a year, half the savings the Conservatives need to find in the welfare bill by 2019/20. It is also unnecessary. The Government could link the State Pension to earnings, as well as offer protection against price increases during periods of below inflation wage growth, through an Australian-styled ‘relative earnings link’. Implemented today, a relative earnings link (REL) could save the Government £21 billion over the next five years.
These savings could be used to fund a new settlement for working-age people who lost income due to recent uprating policy decisions. In 2012, the Government announced many benefits – including Jobseeker’s Allowance – would grow by only 1 per cent in cash terms for the three years to 2016. This cap was turned into a freeze this summer, which will hold benefits constant for the next four years. But when the freeze is lifted, there still won’t be a reprieve. Benefits will be linked to CPI, which reports inflation at a lower level compared to other measures.
This package of measures will see the purchasing power of working-age welfare recipients wane. Reversing the freeze would be a good first step, but the longer-term issue would still remain. CPI is a macroeconomic measure of inflation that was never designed to reflect the price experiences of households. As a result, evidence from the Office for National Statistics indicates CPI understates the true level of inflation experienced by beneficiaries. Indeed, our report estimates that CPI-indexation would have reduced the purchasing power of welfare recipients by 4.3 per cent between 2002-03 and 2013-14.
In order to maintain real purchasing power, linking benefits to a new index designed specifically to capture the price experiences of beneficiaries would be a welcome move. If implemented today, this Benefit Uprating Index (BUI) would see recipients of JSA and ESA Work Related Activity Group £193 a year better off in real terms by 2021. Of course, this would come at a price. BUI uprating of tax credits and four key benefits would cost £13 billion over the next five years, although more than three-quarters of this expenditure comes from reversing the freeze.
This package of reforms would deliver a fairer, and more sustainable, welfare system – as well as saving government £8 billion. To ensure that other benefits do not go the way of the Christmas Bonus, it may be time to look again at uprating policy.