How to shrink the poverty trap

Jobseekers' Allowance recipients can pay 111% marginal tax rates on returning to work. Policy Exchange recommend letting them take home more of their earnings.

Our guest writer is Lawrence Kay, Economics Unit Research Fellow at Policy Exchange

Nobody I have ever met likes the idea of someone living in absolute poverty. The trauma of not having enough to eat or a place to sleep is sufficient for all of us to agree that everyone in Britain should have these things. In other words, the abolition of want is a near-universal principle held among Britons. Regardless of its form, the welfare state is going to be around for a lot longer.

But are there any consequences to us wanting to keep people out of poverty? It would be remarkable if this were not to have even some bad effects, would it not? The answer, of course, is the ‘poverty trap’. Whenever a government decides that it wants to give a person money while they are unemployed or not earning enough, it gives them a reason to think twice about trying to earn that money themselves. This is a problem that all governments face, but how bad is this problem in Britain’s benefit system?

Pretty bad, actually. In a Policy Exchange’s latest report out today we show how, when even the most straightforward costs of work are taken into account, the financial boost that benefit claimants get for working is tiny. For example, if you compare the income of a normal Jobseeker’s Allowance claimant over 25 (£122.42, a figure which includes other benefits, like help with council tax and housing) to what they would get after 40 hours work on the minimum wage, the overall gain is only £51. That works out at a paltry £1.28 per hour.

This occurs because as someone tries to leave benefits they start to lose the money they are getting from the government. The Jobseeker’s Allowance claimant loses £1 of the benefit for every £1 earned. This means that the abolition of poverty, plus the need to make sure the state does not end-up paying money to everyone and anyone, leads to a perverse outcome: the poorest people in Britain face the highest tax rates. Think about it: as they earn more, they lose benefits and start to pay tax, so their effective tax rate must be high. For the Jobseeker’s Allowance claimant the tax on deciding to work, say, 20 hours per week is 111%.

The answer to this, as our report argues, is to let people on all benefits keep more of their earnings as they work. By tightening the tax credits regime and other benefit spending we can save £6.5 billion on the overall welfare bill.  We can then put some of this money back into the system to allow anyone on welfare to take home £92.80 before their benefits start being squeezed.

Unemployment is only likely to get worse over the next year or so. It is vital that we make sure everyone on benefits can see a good financial reason to keep looking for the jobs available.

Like this article? Sign up to Left Foot Forward's weekday email for the latest progressive news and comment - and support campaigning journalism by making a donation today.