An incomplete cap on welfare spending risks long-term fiscal ruin

YESTERDAY’S Spending Round was an opportunity for George Osborne to establish his reforming credentials. A key element to this was the announcement of a cap on overall welfare spending, which will arrive in April 2015, to “improve spending control, support fiscal consolidation and ensure that welfare remains affordable”.

The chancellor was right to turn his attention to this. According to the Treasury, in 2013-14, resource annually managed expenditure – essentially non-departmental current spending – will reach £334bn (the largest component of which is welfare), accounting for almost half of all government expenditure. But this has been a blind spot when it comes to bringing the public finances under control. Over the last three years, while the money spent by departments directly has fallen in real terms, spending on transfers has increased significantly. If no action is taken, this imbalance will continue to grow.

Designing a cap, however, is not as simple as it seems. It would be unwise to include the so-called automatic stabilisers – those parts of welfare spending that vary with the economic cycle, like Jobseeker’s Allowance. Osborne announced that the cap would cover tax credits, housing benefit, disability benefits, and pensioner benefits. This last category is of particular importance, as pensioner benefits account for the largest share of social security spending.

Pensioners receive 68 per cent of all benefits paid out by the Department for Work and Pensions (DWP), and 55 per cent of all social security spending (which includes tax credits). But when push came to shove, the chancellor shied away from real reform: he excluded the state pension.

This means that, of all the government spending on pensioner benefits, 70 per cent will not be considered in the cap. This is close to 50 per cent of all benefits paid out by the DWP.

Getting on top of spending on pensioners is not just vital for Britain’s short term financial health, but also reflects long-term pressures. The baby boomers are starting to retire in large numbers, people are living longer and fertility rates are low. Someone entering retirement in 2010 had a one in six chance of spending three decades in retirement. In 2035, the odds of spending 30 years in retirement (taking into account current plans for the state pension age) are one in four. Not only is the state pension growing in cost due to the generous rises guaranteed by the triple lock, but current plans for the state retirement age do not come close to addressing increased longevity.

Earlier this month, Ed Balls suggested that Labour would include pensions in a cap on welfare spending. He said: “It’s important to look across the whole welfare state to say what are the drivers of expenditure… the majority of most welfare spending is in fact going to people over 60. That’s the truth, and we should look across the piece.”

Osborne’s cap on welfare spending is a step in the right direction, and opens up a debate that many politicians have avoided until now. But it should only be the beginning.

Kimberley Trewhitt is a senior researcher at the independent think tank Reform.