Universal credit was introduced in 2012, with the intention of simplifying the overcomplicated welfare system. Conversely, Universal Credit has turned out to be far more complicated than was initially intended, insofar as a radical overhaul of the welfare system is necessary. The replacement of both the bureaucratic, means-tested tax credits and Universal Credit, with a Negative Income Tax instead incorporated into the tax system, will drastically simplify the tax code, whilst taking low-paid earners out of paying income tax altogether. A Negative Income Tax will ensure that work always pays more than being unemployed; at the same time, topping up the salaries of low-wage workers.
The current state of welfare
The cost of administering welfare programs in the UK has only increased over the past decades. Since the establishment of the ‘welfare state’ in the 1940s, benefit spending as a percentage of GDP has only grown – from 4% in 1948 to 14% by 2010. Public expenditure on benefit programs is set to continue on the same trajectory in the coming years, forcing governments to either raise taxes or reduce spending in other departments. Neither of these are desirable and thus responsibly reforming welfare payments is a better solution to this growing crisis.
In addition, the current welfare system is outdated, due to the changing conditions of the labour market, particularly in the last 30 years. Lower trade barriers, automation, and more affordable transportation have brought millions of additional low-skilled employees onto the global labour market. While this has improved average living standards and productivity, it has also generated a group of people whose relative position has deteriorated significantly: low-skilled employees in industrialised countries. The outdated government welfare system has acted as a temporary stop-gap to this issue, however as aforementioned, these are costly and ineffective in preventing people from falling into the poverty trap. As a result, in-work poverty among working adults has come to fruition, with policies such as minimum wages, in-work cash benefits and tax credits only adding to the problem. Thus, our current welfare system needs to be restructured to adjust to the changing labour market, to support both unemployed and low-wage workers.
It is worth mentioning the bureaucracy involved in delivering these programs, which is both cumbersome and unnecessary. The Department for Work and Pensions employs around 34,000 full-time staff, costing up to £6 billion. These are needless administrative costs, which can easily be avoided, were a Negative Income Tax introduced, given that the latter would be merged into the existing tax system.
A Negative Income Tax
Economist Milton Friedman popularised the idea of a Negative Income Tax, a welfare system that standardises and simplifies benefits for low-income individuals. If an individual earns no money, then a NIT would be paid at the highest rate, comprising their entire income. However, as an individual earns more, their NIT payment is gradually reduced, until eventually, the individual begins paying tax. As was the intention with Universal Credit, a NIT would ensure that an individual is always better off by having greater take-home pay. Such a system eliminates bureaucracy and the complication of tax credits, whilst most importantly ensuring that the recipient is free to choose how to spend these funds.
An example of this would be setting a personal allowance to £25,000, with a subsidy rate of 50%, and a flat-tax rate of 50%. Under such a system, an individual earning £25,000 annually, wouldn’t pay any income tax, nor receive any money from the government. An individual earning £15,000 likewise wouldn’t pay any income tax, however, they would receive 50% of the difference between their income and the personal allowance – in this case, £5,000 (50% of £10,000). On the flip side, an individual earning £145,000, would pay 50% of the difference between their income and the personal allowance – in this case, £60,000 (50% of £120,000).
Experimentations with a Negative Income Tax system have been successful. During the 1960s and 1970s, trials took place in some American cities and states, including the likes of Seattle, Denver and Iowa. Whilst there was a slight reduction in the number of hours worked, poverty in these regions was greatly reduced and spending on social services fell lower than was previously necessary. In Manitoba, the NIT experiment managed to lift 1,000 families out of poverty altogether.
Given the current failures of the current welfare system, with the newly introduced Universal Credit failing to live up to the demands of the 21st century, a Negative Income Tax system. The proposed NIT system would replace most benefits and tax credits, drastically simplifying the welfare state and ensuring that everyone would be better off working.