Let it go Chancellor. Why Philip Hammond should revisit the benefit freeze in next month’s Budget

Published on Tax and Welfare

The weather might be un-seasonally warm just now, but millions of household budgets are in the grip of a four-year freeze that’s about to get colder still. For decades, the government’s default position has been to uprate the value of working-age benefits each April in line with the rate of inflation prevailing in the previous September. But this convention has been placed on temporary hold since April 2016, with the impact of the freeze building over time. Inflation figures released today show just how chilling year three is set to be. It will be the deepest freeze yet.

Following the 2015 general election, George Osborne introduced a series of working-age welfare cuts that were expected to generate savings in the region of £13 billion by the end of the decade. Those cuts included reductions in both Universal Credit work allowances and the family element of benefit awards, along with the limiting of support to the first two children in a family. But the four-year freeze on benefits was the single biggest element.

And with inflation having come in at a higher level than was previously predicted when estimated back in Spring 2016, the savings from this part of the package are set to rise higher still. By 2020, the estimate is that the freeze will have saved the Exchequer some £4.7 billion a year, a full £1.2 billion more than previously forecast. Around half of those additional savings are likely to stem from next year’s freeze alone. CPI stands at 3 per cent making year three of the benefit freeze worth £1.9 billion.

That may be a boon for HMT finances, but the obvious flipside is a harder impact on families. In total, 7.3 million children will be affected – covering half of all families with kids – not to mention 0.8 million people looking for work and 2.4 million disabled people. The greatest losses will be felt by working families, with the figure below showing how the annual cash losses are expected to range from £115 for a single unemployed person to £315 a year for a working couple with two children.

Of course, higher inflation is often associated with a booming economy and higher pay. But the nature of the current inflation spike means that few of the three million working families’ affected by the freeze will find any comfort in the form of offsetting pay rises. That’s because today’s inflation is largely being driven by the rising costs of imports associated with the sharp post-referendum devaluation of sterling. Nominal earnings haven’t responded, meaning a return of the pay squeeze. Against that backdrop, the benefit freeze operates as a second hit on many.

The ‘option’ of earning more in order to offset any benefit losses is made harder still by the high withdrawal rates – the amount of support that is withdrawn for each additional pound that is earned – that exist in both the current tax credit system and the new Universal Credit.  For example, under Universal Credit compensating for a loss of £230 a year would require a working family with children to earn an additional £920 a year. That is less than the (sizeable) expected increase for a full-time worker on the National Living Wage (£780).

With the first Autumn Budget fast approaching, does the Chancellor have time to change course? Having reset the fiscal rules in readiness for Brexit, he came out of the Spring Budget with an apparent £26 billion of headroom relative to his overall fiscal ‘mandate’ – more than enough to revisit the welfare cuts. But Philip Hammond was always clear that he had no intention of utilising that space in any significant way. And that resolve is likely to be all the firmer given the likelihood of a very substantial downgrading of the OBR’s growth forecasts at next month’s Budget.

Certainly there appears to be substantially less capacity for the sorts of grand giveaways that some Conservatives might favour in response to their poor showing in the election. But the tighter fiscal outlook does nothing to reduce the urgency of tackling the living standards crisis facing those lower and middle income households so passionately advocated for by the Prime Minister.

Of course taking action comes with a price tag, but the good news for the Chancellor is that there are opportunities for rebalancing within the existing envelope.

For example, freezing the Personal Tax Allowance (PTA) for one year would save around £2 billion – conveniently similar to the £1.9 billion cost of thawing next year’s benefit freeze. Holding the PTA where it is for a year would of course constitute a tax rise for those earning more than the current threshold. But the scale of April 2017’s above-inflation increase in the PTA means the threshold would still be higher in April 2018 than it would have been under the default approach of inflation uprating. A single-year freeze would also leave the government on course for meeting the long-standing pledge to raise the tax threshold to £12,500 by the early-2020s.

Crucially, as the chart below shows, around three-quarters of the money saved by the government under this move would flow from the richest half of households. Indeed, a one-year PTA freeze would have almost exactly the opposite effect of the welfare freeze.

Budgets invariably involve some tough decisions, and the combination of a renewed pay squeeze along with an expected downgrading of the OBR’s outlook for the public finances mean that next month’s will be no different. But doing nothing on benefits isn’t an option. Any failure to act risks ushering in a period of rising inequality on a scale not seen since Margaret Thatcher’s final term. And it would be the first time in forever that widening income gaps coincided with actual year-on-year falls in income at the bottom of the distribution. For both economic and political reasons the Chancellor must surely look again at the benefit freeze and decide to let it go.