Iain Duncan Smith's benefit reform proposals have been given the green light. The government is determined to overhaul the tax credit and benefit system to make it simpler and ultimately cheaper. The plans are still sketchy, but it's worth considering the likelihood that the new system will save money once it's up and running. There are at least two reasons why the reforms will save money, but there are four reasons why it will cost more money.
There are two big savings in this new system.
• More people will move into employment, both because the system will be less risky for people who want to try out work and because the financial incentives to try a few hours’ work will be greater than they are under the current system.
• The joined-up administrative system, in which real-time tax information will be used to cross-check benefit claims, is likely to reduce fraud and error. How much of the £5bn can actually be saved is unknown, but most of the cost will remain.
On the cost side, there are two groups of people who will benefit from the new money. Money to these groups is the main reason why the reform is expensive.
• First, the reforms will give more money to people working a small number of hours per week. Currently the system gives little support to people until they reach the 16 hours-per-week mark. These 'hours rules' are likely to go in the new system, with more money going to people doing short-hours jobs.
• Second, by lowering the withdrawal rate, the system will bring more mid-income families onto the benefit system, entitling these – relatively better-off - people to some new cash. This probably isn't where the DWP would want to spend additional money, but it is unavoidable in a system that withdraws benefits more slowly.
There are two further areas of potentially large hidden costs to this reform. The extent of these costs depends upon how claimants respond to the new system.
• Simplification of the system is aimed at reducing fraud and error. But it's very likely that a simpler system will increase take-up of benefits among those currently put off by the complexity of it all. This will be expensive for the government. Currently take-up of available money is around 80% across the benefit system, with £16bn per year going unclaimed. If take-up in a simplified system were to rise to, say, 85% the exchequer would be on the hook for a further £4bn per year.
• There are currently millions of people working around 16 hours per week who will have an incentive to reduce their working hours. This will raise costs to the government in the form of higher benefit payments and lower tax revenue. The government plans to introduce conditionality on those working low hours will limit this effect but the administrative cost of an in-work conditionality system will probably be high.
Overall then, simplification might be desirable for other reasons, but it's difficult to see how the new system will save the exchequer any money in the long run.
Ian Mulheirn is director of the Social Market Foundation
