The two biggest drivers of government spending, welfare and the NHS, will continue to dominate the political agenda this Parliament. Thanks to Monday’s vote in the House of Lords, delaying changes to tax credits, a £4bn hole in the government’s spending plans has now opened up. As ministers rethink their plans, they should address another area of welfare policy that has gone off track. Reforming the way that benefits for both pensioners and working age people are increased each year (“uprated”) offers the chancellor an opportunity to both save money and create a fairer welfare system.
Since 2010, the Treasury has tightened the annual increase in benefits for people of working age. In 2013, George Osborne capped growth in the value of the majority of benefits at 1 per cent for three years. Earlier this year, he introduced a four year freeze in their value from 2016.
Ministers have also switched the standard measure used to uprate benefits from the Retail Price Index to the Consumer Price Index (CPI). At the time, the chancellor argued that CPI best reflected the inflation experiences of beneficiaries. This was the right intention, but CPI does not fit the bill. Last year, the Office for National Statistics found that low income households persistently experience higher inflation rates than headline CPI. Evidence from Australia supports this picture.
Pensioners, meanwhile, have done much better. Since 2011, the state pension has been protected by the “triple lock”, which ensures that it rises each year by the highest of earnings, prices or 2.5 per cent.
Again, the chancellor is right on the principle, but wrong on the delivery. Linking pensions to earnings ensures that those unable to work benefit from the improving living standards of those that can. But the triple lock is expensive, costing £6bn a year more than a pure earnings link. With pensioners now enjoying higher incomes on average than working age people once housing costs are taken into account, this rigid commitment is hard to defend.
The chancellor could strike a better balance by abandoning the triple lock and linking the state pension to a proportion of wages during normal economic times. This would retain an earnings link, but the Treasury would still have the option of being more generous during periods of high inflation. If the chancellor decided to return the state pension to the proportion of wages seen in 2010, he could save £20.9bn over the next five years.
This saving could fund a fairer deal for working age people. The government should create a new index that specifically tracks the inflation experiences of those receiving welfare. Reversing the freeze, and uprating major benefits and tax credits by this new measure, would protect the living standards of working age people. This policy would cost £13bn over the next five years, but taken together with changes to the state pension, the package would save the Treasury a total of £8bn.
Since becoming chancellor, Osborne has consistently protected pensioners at the expense of working age people. Now more than ever, ministers are in need of ideas that make welfare not only cheaper, but also fairer. Uprating reform presents an opportunity to do just that.