Pensions and benefits: better apart?

3 Jun 13
The Treasury is clamping down on annually managed expenditure to cut the welfare bill. A far better strategy, argues James Lloyd, would be to split the DWP into two, with a ministry for working-age benefits and a separate department for ageing

By James Lloyd | 1 June 2013

The Treasury is clamping down on annually managed expenditure to cut the welfare bill. A far better strategy would be to split the DWP into two, with a ministry for working-age benefits and a separate department for ageing


The Treasury has long disliked those bits of entitlement-driven public ­spending it finds hard to control – known in Whitehall jargon as ‘annual managed expenditure’ or AME.

Having cut to the bone the more controllable bits of government spending subject to a ‘Departmental Expenditure Limit’ (DEL), the ­Treasury now wants to beef up its ability to cut away at AME, which makes up around half of government expenditure and includes welfare, debt interest and European Union contributions.

This, in a nutshell, is what lies behind the announcement in Budget 2013 that: ‘The government will strengthen the spending framework by introducing a firm limit on a significant proportion of AME, including areas of welfare expenditure. This will be designed in a way that allows the automatic stabilisers to operate to support the economy. Action to improve control over AME spending will ­support the delivery of fiscal consolidation.’

Some commentators see this move in purely political terms: the tactician George Osborne wants to define whole-of-government spending limits, thereby compelling Labour to sign up to them or be accused of planning to pile on more government borrowing.

However, the wider view is that the proposed AME limit is purely a device for fiscal consolidation, which the Treasury is reaching for because it has cut as much as it can from DEL expenditure. In particular, the Treasury wants to slap a cap on Iain Duncan Smith’s welfare budget, and leave it up to stakeholders, MPs and the Department for Work & Pensions to slug it out over whose benefits will be cut. Rather like ­Gordon’s Brown so-called ‘Golden Rule’, the AME limit is about creating fiscal rules and targets that will shape public debate – a political device to help achieve fiscal sustainability.

As others have noted, it’s important not to get ­over-excited about fundamental changes taking place to the UK welfare state. The Treasury has already highlighted that flexibility will be necessary when the economy contracts and the ‘automatic stabilisers’ of working-age welfare become more expensive. Just as with the ‘Golden Rule’, any rules or limits inserted into fiscal decision-making usually leave scope to be adjusted when convenient, and structural trends can always be presented as cyclical phenomena. Nevertheless, as a device to tackle structural growth in welfare spending, it’s worth asking how the AME limit will apply and what the result will be.  

So, if the AME limit comes into force on welfare expenditure, where does the Treasury think it will apply pressure? To identify the real target, the timing of the move is significant: the government could have introduced an AME limit in 2010 alongside the Budget for Office Responsibility, and used it to drive cuts to spending on DWP working-age benefits. Instead, the AME limit is being unsheathed as part of the June Spending Review after many working-age welfare cuts have already been pushed through.

This has led some to suggest that the real ­purpose of the AME limit is to foist cuts on those bits of universal welfare spending unaffected by austerity. These include the State Pension, older people’s disability benefits and entitlements such as Winter Fuel ­Payments and TV licences for the over-75s.

But if this is the ­Treasury’s logic, it’s pretty ­unfathomable in light of some recent policy decisions. Remember, having pocketed savings from switching the State Pension uprating from the Retail Prices Index to the Consumer Prices Index, the Treasury then signed off the annual ‘triple lock’ increase in its value – whichever is the highest of the rise in average UK earnings, the CPI or 2.5%.

As a result, public spending on the State Pension will, in 2013 prices, increase from £77bn in 2011 to £91bn in 2017, according to the DWP. If the Treasury now wants to use an AME limit on DWP welfare spending to unpick the ‘triple-lock’ guarantee, it poses the question: why did the Treasury sign this guarantee off in the first place?

If the AME limit is not about reducing the State Pension back to a means-tested rump, is it – as some think – a device to go after other universal pensioner entitlements?

This seems unlikely. Consider the numbers: the State Pension costs around £77bn per year, with means-tested Pension Credit costing a further £8bn. Winter Fuel Payments and TV licences cost around £3bn.

In fact, scrapping Winter Fuel Payments would – besides boosting the excess winter death rate and the cost of cold-related illness to the NHS – pay for only between one and two years of the annual increase in cost to the Exchequer of the State Pension.

Similarly, if the AME limit were used to push through means testing of pensioner entitlements by linking eligibility to receipt of means-tested Pension Credit, it is a lot of trouble just to raise rather small bits of money. It would also amplify all the longstanding problems of means testing older people: additional complexity; administrative costs; the failure of the Pension Credit system to reach some 1.3 million pensioners living in poverty; and the effect of means testing older people on incentives to save for retirement at a time when the government is nudging millions of low-paid workers into pension saving for the first time.

The fact is that this government has done more to bring about a universal, predictable, basic income offer to all pensioners in the UK than any other government has for years. It is a bold vision of support to older people, but one entirely inconsistent with a rigorous AME limit bearing down on DWP welfare expenditure.

All of this suggests the move to put limits on AME spending reflects desperation at 1 Horse Guards Road in response to sluggish gross domestic product and tax revenue: more of a panic measure than a strategy.  But given the fiscal outlook and the nature and drivers of AME welfare spending in coming years, are there other approaches that would be more effective at achieving the Treasury’s ultimate aim of fiscal sustainability?

An AME limit is undeniably a blunt, arbitrary tool for making decisions affecting millions of people. Applying it to DWP welfare budgets will set up contrived trade-offs between working-age income and disability support on the one hand, and universal pensioner spending on the other, just because these happen to be located in the same department.

The truth is that the real, structural drivers behind the DWP’s welfare-spending growth is population ageing, and it is far from clear that imposing forced, arbitrary limits on welfare budgets represents the best strategic response by policymakers.

This points to an obvious, if rather radical, ­alternative: split up the DWP. Aside from the DWP being specialists in processing payments, why exactly does the UK lump together the automatic stabilisers and safety net of working-age benefits together with universal pensioner entitlements and support? In what way is it logical to cast a single AME limit around all of this welfare expenditure?

Instead, a department for working-age benefits, free of a contrived AME limit, could provide the automatic stabilisers required by the economy, and focus on policy areas like getting the unemployed back into work and supporting disabled working-age adults.

A separate department for ageing could be ­responsible for centrally determined, universal spending on the retired population, such as the State Pension and pensioner ‘nudges’ such as the Winter Fuel Payment. Rather than a contrived AME limit, it could operate under the advice of a quasi-independent body ­responsible for monitoring longevity trends, and making recommendations on the State Pension Age, the value of the State Pension and other entitlements.

This sort of ‘standing commission’ has long been suggested in policy debates on ageing, including by the Turner commission on pensions. In fact, in the 2011 Budget, George Osborne himself announced a body to monitor longevity and make recommendations on State Pension Age changes, although it has not been heard of since.

The point is that in the face of an ageing ­population and rising demand, such a body could propose transparent changes to entitlements that balance fiscal sustainability and age-related rising demand. By always keeping an eye on affordability, it would also have a clear political role: shaping public expectations and attitudes (a bit like an AME limit) and recommending changes to the State Pension Age, which is still the most direct lever for bringing down ­age-related welfare spending.

But there are other benefits to a department for ageing. It could be the co-ordinator of all age-related policy and spending, which is currently hopelessly – and expensively – lacking in joined-up thinking or practice.

As the Strategic Society Centre argued in its report last year, Paying for ageing: decision time for households and the state, what is really required is a cross-departmental ‘holistic review’ of all public spending on older people. It would consider what outcomes such interdependent spending is trying to achieve in people’s lives, how value-for-money could be enhanced, and if older cohorts are to be expected to make additional contributions, what should this be and how?

As the centre’s report noted: ‘Fiscal policy-making must not be allowed to crowd out sensible policies on ageing.’ Unfortunately, it appears the proposed AME limit for welfare expenditure will do just this. It also smacks of the ‘draw a line on a graph’ Whitehall cliché about ­Treasury ­economists attempting to do policy analysis.

Instead, creating the institutional framework in Whitehall for rationally evaluating and setting all age-related spending would represent an effective, thought-through strategic response to an ageing ­society. This approach, not an arbitrary AME limit, would represent the best hope for reconciling fiscal sustainability with the structural drivers to growth in welfare spending in coming years.

James Lloyd is director of the Strategic Society Centre. This article was first published in the June issue of Public Finance magazine


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