The perils of welfare dependency – but not the kind you’re thinking of

Published on Tax and Welfare

For the entire 30 years of my working life, reforms to our welfare system have marched to the drumbeat of calls to reduce “dependency”, by getting more people out to work. So hard have governments tried to achieve this aim that they have created a new kind of dependency, this time among working families receiving huge sums in tax credits. Even though this can sometimes mean giving someone as much state support in work as they would have got out of work (especially if working requires expensive, state-supported childcare costs), it has brought huge benefits to families. Not only can working feel good in itself (though not in all jobs), but the combination of state handouts with wages has brought many families out of poverty.

But this new kind of dependency has its downside. It potentially lets employers off the hook by making low pay seem tolerable. It traps families on incomes that are often still not adequate, as my latest report on minimum income standards, just published by the Joseph Rowntree Foundation, confirms. The trap is created by the sharp withdrawal of the state assistance as your earnings rise, so typically you have to earn £4 to become £1 better off.

And perhaps most perilous in the present climate, it makes low paid families with children incredibly vulnerable to the effect of cuts in this support on which they have become so dependent. This was hammered home in our latest minimum income standard calculations. Our headline finding has been something of a wake-up call: a typical low income family with children needs to earn over 20% more today than they did a year ago just to reach a minimum acceptable living standard.

How can this be? This huge increase is due in large part to a cut in the childcare element of the Working Tax Credit, from 80% to 70% of eligible childcare costs. This doesn’t sound dramatic, until you do the maths. A family with two young children paying out £200 a week in childcare will need to find an extra £20 a week. That’s £1000 a year. But suppose someone in that family extended their hours so that they earned an extra £1000 – would that be enough to make up for the shortfall? No, because the state would assess them as needing fewer tax credits on the higher income, and they’d also pay more taxes: in fact, they’d typically be only £270 better off. To recover the whole £1000, they’d have to increase their earnings by a massive £3700.

This example underlines two aspects of in-work dependency for families on low wages today. One is that the amount that the state gives you has become central to the very decision of whether you can afford to work at all. The other is that you are at the mercy of where the state sets the level of support, because your power to improve your net income above that point is slight. 

To wean working families off this level of dependency over the long term will be incredibly difficult. Reducing the level of support may not in itself cause employers to fill the breach, and risks causing severe hardship. A gradual move towards a better baseline of pay is the only real way to make progress. This makes the debate over living wages more pertinent than ever.