An interesting article by Stephanie Flanders, the BBC’s Economics editor. She asks just how much (or how little) the pound in our pocket is now worth. With inflation above target, growth very slow and tax and benefit changes to cut the government deficit, everyone is feeling the squeeze. A key fact that Flanders identifies is that only those in the highest income quintile have actually lost from changes in the tax and benefits system: everyone else has (or will) gain. A very interesting read!
The shrinking pound in your pocket BBC News, Stephanomics (21/3/11)
Questions
- What are the main factors that have contributed to lower living standards this year? Explain how each factor works.
- What changes to taxes and benefits have occurred and what changes can we expect over the coming months and years? Who is likely (a) benefit and (b) lose from each change?
- Is it right that the richest families have been affected the most? Find an economic argument for both sides of the debate.
- Why have pensioners lost relatively more than other groups?
One of the key areas discussed in the election was welfare and in particular what to do about those who remain long term dependent on welfare. How can the UK government encourage people back to work? A key issue is the poverty trap: some people are simply better off living on benefits than they are getting a job. Here, we’re talking about the marginal-tax-plus-lost-benefit rate. When you start earning, you get taxed, pay national insurance contributions and lose some of your benefits. All this leads to a situation where work doesn’t pay.
In a paper ‘Escaping the Poverty Trap’ by Lawrence Kay, he considered how much better off people are moving from different benefits into work, taking into account the high costs of actually finding a job and then starting work. He found that after 16 hours of work, someone on Job-seekers’ allowance would be £15.07 poorer and someone on Employment and Support Allowance would be £39.35 worse off. In many cases, people were facing a marginal effective tax rate in excess of 100%. Given this, it’s hardly surprising that Lawrence Kay found that ‘Long term welfare claims have been Britain’s blight for many years’.
However, the Coalition has plans to change this and make sure that those in work are paid more and are better off than those on benefits. By making working life a more attractive option, this should encourage those for whom work doesn’t pay to enter the labour force. This will obviously benefit them, increase the potential output of the economy (hence growth) and improve net taxes, as tax revenue rises and benefits expenditure falls. While this may not lead to tax cuts for those in work (as benefits spending falls), it may mean that more tax revenue is devoted to areas such as health and education or that the government can close the budget deficit.
The ‘universal credit’ aims to simplify the current system and make work pay, by re-introducing a culture of work in households. There is also a plan to place sanctions on those turning down work and place a cap on benefits to any single family. There was also be tax changes aimed at helping those moving into work keep more of their money, thereby removing, or at least reducing, the poverty trap. However, some families will lose out – as the IFS noted, any reform ‘creates winners and losers’. However, the reforms are a step in the right direction. As David Cameron said:
“I think that will, over time, solve the whole poverty trap issue that has bedeviled governments of all colours.”
The Labour party does back some of the changes, but questions whether there is enough help for people finding work. Another issue that must be considered is while it is undoubtedly a good plan to encourage more people to move into work and off benefits, which jobs will they move into? With unemployment still high, now is not exactly the best time to be looking for a job. However, whatever the state of the economy, providing incentives for people to move from benefits into work is definitely a good plan, but of course the methods used will be under constant scrutiny.
Articles
Iain Duncan Smith sets out Welfare Reform Bill plans BBC News (17/2/11)
Bill ditches housing benefit cut The Press Association (17/2/11)
Life on benefits is no longer an option Mail Online, James Chapman (17/2/11)
Universal Credit welfare switch ‘to hit 1.4m homes’ BBC News (12/1/11)
Nick Clegg blocks housing benefit cut for jobless Guardian, Patrick Wintour (17/2/11)
It’s time to end this addiction to benefits Telegraph (17/2/11)
Report
Escaping the Poverty Trap Policy Exchange, Lawrence Kay 2010
Questions
- What is the poverty trap? Which factors make it worse?
- Why does the poverty trap act as a labour supply disincentive for those on benefits?
- If taxes of those in work have to be increased, what happens to their incentive to work more hours? Think about the income and substitution effects of a real wage change.
- Why is it that working may not pay?
- How does the Universal Credit aim to alleviate the poverty trap? Who are likely to be the winners and losers from the government’s proposed welfare reforms?
- What is a marginal-tax-plus-lost-benefit rate? How do you calculate it?
- Are there any other policies that could also reduce the poverty trap? How effective are they likely to be?
On November 11, the government published a White Paper on welfare reform. Central to the proposals is the replacing of the range of out-of-work benefits, housing benefit and tax credits with a single universal benefit. The system will be introduced for new claimants in 2013 and for those currently on benefits sometime after 2015.
When the unemployed find work, the benefit will be withdrawn at a rate of 65p of each £1 earned. At present, because of the complexity of the system, some claimants on multiple benefits can find that the withdrawal rate is almost 100%. When income tax is added in, the tax-plus-lost-benefit rate does sometimes exceed 100%. Thus some people find themselves in a poverty trap, whereby it’s not worth getting a job. It’s financially benefical to stay on benefits.
The other crucial element of the proposal is to deny people benefits who turn down a legitimate job.
a. Failure to meet a requirement to prepare for work (applicable to jobseekers and those in the Employment and Support Allowance Work-Related Activity Group) will lead to 100 per cent of payments ceasing until the recipient re-complies with requirements and for a fixed period after re-compliance (fixed period sanctions start at one week, rising to two, then four weeks with each subsequent failure to comply).
b. Failure to actively seek employment or be available for work will lead to payment ceasing for four weeks for a first failure and up to three months for a second.
c. The most serious failures that apply only to jobseekers will lead to Jobseeker’s Allowance payment ceasing for a fixed period of at least three months (longer for repeat offences). Actions that could trigger this level of penalty include failure to accept a reasonable job offer, failure to apply for a job or failure to attend Mandatory Work Activity.
The following podcasts and articles look at the details of the proposals and discuss their merits and drawbacks,
Podcasts and webcasts
Not going to work if you can is ‘not an option’ ITV, part of speech by Iain Duncan Smith (11/11/10)
IDS: Staying on benefits ‘irrational choice’ BBC Today Programme, Chris Buckler, Iain Duncan Smith Smith (11/11/10)
Iain Duncan Smith unveils new benefits system BBC News (11/11/10)
Welfare reform success ‘far from certain’ BBC Today Programme, Norman Smith (11/11/10)
Articles
Benefits system overhaul ‘to make work pay’ BBC News (11/11/10)
At-a-glance: Benefits overhaul BBC News (11/11/10)
Benefits explained: A basic guide to entitlements BBC News (11/11/10)
Is welfare reform doomed to fail? BBC News, Norman Smith (11/11/10)
A bold and principled approach to benefits Telegraph (11/11/10)
Reshaping the benefits system The Economist, Blighty blog (11/11/10)
Unemployment benefits shake-up ‘a fair deal’ Independent (11/11/10)
Tougher welfare sanctions spark ‘destitution’ warnings Independent (11/11/10)
Iain Duncan Smith: it’s a sin that people fail to take up work Guardian, Patrick Wintour, Randeep Ramesh and Hélène Mulholland (11/11/10)
Preacher Duncan Smith aims for holy grail of welfare policy Guardian, Randeep Ramesh (11/11/10)
Documents, official information and data
Universal Credit: welfare that works Department for Work and Pensions, Links to White Paper (11/11/10)
Benefits and financial support Directgov
Economic and Labour Market Review (see tables in Chapters 2 and 6), National Statistics
Questions
- Explain what is meant by the ‘poverty trap’ (or ‘welfare trap’).
- Summarise the reforms to benefits proposed in the White Paper.
- Examine whether the Coalition government’s proposal for a universal benefit will lead to greater fairness.
- Will a withdrawal rate of 65% provide a strong incentive for people out of work to take a job?
- Why may some be paying a combined tax-plus-lost-benefit rate of 76%?
- Why is there an inherent trade-off between making work pay (and thus eliminating the poverty trap) and keeping the cost of welfare benefits down? Would reducing the level of benefit be an appropriate answer to this trade-off?
- One aim of the benefits reform is to reduce unemployment. What type of unemployment is likely to be affected?
- Find out the current level of unemployment and the level of job vacancies and, in the light of this, comment on the likely effectiveness of the policy in reducing unemployment (a) shortly after the new system is introduced; (b) over the longer term.
Whenever a sporting event comes around, there is mad frenzy from countries across the world to enter a bid – this was entirely evident with the 2018 World Cup bids! And it’s not really surprising with the attention that the World Cup and the Olympics receive. Hundreds of thousands of spectators, billions of pounds worth of investment in infrastructure, thousands of jobs created and television deals in every country of the world.
However, why is it that every sporting event of this magnitude fails to come in on budget? The costs are always underestimated. The Athens Olympics was supposed to cost £1.5 billion, but ended up costing over 10 times as much. It is also suggested that it may have played a part in the current Greek financial crisis. The 2002 Japanese World Cup had little effect on the struggling Japanese economy. The London 2012 Olympics was estimated to cost £2.35 billion, but suggestions say it will now cost taxpayers some £20 billion, although budget cuts are inevitable. What about South Africa? Costs of $300 million were estimated for stadiums and infrastructure, with a boost to GDP of $2.9 billion. However, $300 million was not even sufficient to renovate Soccer City (where the first and final game will be held). Add on to this over $1 billion to rebuild the rest of the stadiums and then take into account rising inflation, which has caused inevitable cost over-runs.
On top of this, every country says ‘look at the benefits’ when they enter their bid. However, economists have suggested that there are actually minimal employment benefits in the long term. Obviously there is substantial investment in infrastructure leading up to the World Cup, which will benefit locals, but the overall boost to GDP is not expected to be significant. A similar thing can be seen with the London Olympics. In the study by PriceWaterhouseCoopers in 2005, there were estimates of a direct gain to London’s GDP of £5900 million between 2005 and 2016. However, UK GDP would only rise by £1936 million. Some of the costly stadiums that were built for the Portuguese European Championships were simply knocked down after the event.
So, what can we expect from South Africa? There have been many criticisms of poor ticket sales and that this World Cup is only for the rich. Street sellers have been booted out of their normal selling ground, as they do not have the necessary permits to sell and cannot afford to buy the permits anyway. Whilst transport has been improved, there are still concerns about the distance that has to be travelled between stadiums and this has put off many potential spectators. However, the Super 14 Southern Hemisphere Rugby tournament was staged in South Africa, with the final at the end of May and the event was successful. Transport worked perfectly, spectators arrived by the thousand and it is hoped that this is a positive omen for the fast approaching World Cup!
Articles
Saved by the Ball Times Online (5/6/10)
South Africa World Cup just for the rich BBC News (10/5/10)
Footing South Africa’s World Cup bill BBC News (4/6/10)
Will South Africa reap rewards from hosting the tournament? Peace FM Online (5/6/10)
Did 2004 Olympics spark Greek financial crisis The Associated Press (4/6/10)
Cost of 2012 Olympic pool triples BBC News (8/4/08)
Watchdog attcks ‘astonishing’ £5bn rise in cost of 2012 games Times Online (22/4/08)
South Africa World Cup costs above budget Reuters (13/8/08)
Reports and papers
Olympic game impact Study PriceWaterhouseCoopers December 2005
A Cost-Benefit Analysis of an Olympic Games Queen’s Economics Department Working Paper No. 1097, Darren McHugh, Queen’s University (Canada) (August 2006)
Questions
- Why do costs tend to be under-estimated and benefits over-estimated?
- What technique could be used to determine whether a sporting event, such as the World Cup, should go ahead? Can you apply this to the London 2012 Olympics?
- How is the multiplier effect relevant to a sporting event, such as the World Cup or the 2012 Olympics?
- To what extent do you think the Athens Olympics contributed to the Greek Financial Crisis? Could the same thing happen with London?
- What might happen to the South African exchange rate during the South African World cup and the sterling exchange rate during the London 2012 Olympics?
- How has inflation affected the budget of South Africa?
’The steepest and longest recession of any developed country since World War II.’ This has been the case for Ireland, which has seen national income fall by 20% since 2007. Many countries across the globe have experienced pretty bad recessions, but what makes Ireland stand out is how it has been dealt with.
In the UK, the government has continued spending in a bid to stimulate the economy and to use Gordon Brown’s phrase from 2008, we have aimed to ‘spend our way out of recession’. Ireland, however, did not have that option. With too much borrowing, Ireland was unable to stimulate the economy and needed to cut its debts in order to maintain its credibility in the eurozone. Last year, significant cuts in government spending were accompanied by tax rises equal to 5% of GDP. Similar action is to be expected in the UK following the election, where popular benefits may have to be reduced, as transfer payments do account for the majority of government spending. Whoever is in government following the election will have some hard decisions to make and everyone will be affected. Read the article below and listen to the interview and think about what the UK can learn from Ireland.
Irish lessons for the UK (including interview) BBC Stephanomics (9/4/10)
Questions
- In the interview, Brian Lenihan said that the UK was expecting too much from the falling value of sterling. What was the UK expecting following significant depreciations in the value of sterling and why has that not happened?
- What is a deflationary spiral? Why has it caused Ireland’s public debt to rise so much?
- Why does Brian Lenihan argue that there are limits to how much taxes can be increased? What are diminishing returns to taxation?
- Would the UK be any better off had we joined the euro? What about other countries: would they have benefited had we joined the euro?