How to reduce the reliance on benefits: cut welfare or raise the minimum wage?

Lower benefits in the form of tax credits might mean greater productivity and higher wages. But would a rise in the minimum wage be better?

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Which is best: cutting benefits or raising the minumum wage?

I wrote last week about the way in which the UK benefits system affects productivity. The basic case is that tax credits encourage those in low-income jobs to work part time rather than full time, and that this has an impact on the efficiency of the economy.

This isn't going unnoticed David Cameron has spoken about how keen he is to sort out the tax credit system but I was interested to see that in this week's Sunday Times, David Smith noted that there is "plenty of evidence that benefit and tax credit rules do affect the hours that people are willing to work, and their willingness to receive bonuses."

He also referred to a Low Pay Commission report out earlier this year which I hadn't seen. The report "found that over half of employers found that employees did not [work] more hours, because it would affect their entitlement to in-work benefits. This was particularly the case among lone parents at 16 hours, and single adults at 30 hours, in each case the threshold for receiving tax credits and other benefits."

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Those still in any doubt about how our welfare system distorts our economy should look to a new report out from the Centre for Policy Studies. It claims that 51.5% of UK households still receive more in welfare (cash and 'in kind', which includes education and the NHS) than they pay in tax (direct and indirect). That's up from around 45% at the turn of the century but, on the plus side, down from a peak of just over 53%.

The report makes the case very clearly for two things. First cutting taxes on the low paid (despite getting 57% of their gross income in cash benefits, the lowest-paid quintile in the UK still end up paying an average of some £4,900 in tax over the year) and for "the urgent need for more profound supply-side reforms which raise productivity and real earnings."

The problem, of course, is knowing which bit to start with. Less welfare in the form of tax credits might mean greater productivity and hence higher wages. But might a sharp rise in the minimum wage work faster? Higher wages might drive higher productivity, which might drive even higher wages. Then the welfare bill would fall automatically and hence less welfare would be considered to be needed. Tricky one isn't it?

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Merryn Somerset Webb

Merryn Somerset Webb started her career in Tokyo at public broadcaster NHK before becoming a Japanese equity broker at what was then Warburgs. She went on to work at SBC and UBS without moving from her desk in Kamiyacho (it was the age of mergers).

After five years in Japan she returned to work in the UK at Paribas. This soon became BNP Paribas. Again, no desk move was required. On leaving the City, Merryn helped The Week magazine with its City pages before becoming the launch editor of MoneyWeek in 2000 and taking on columns first in the Sunday Times and then in 2009 in the Financial Times

Twenty years on, MoneyWeek is the best-selling financial magazine in the UK. Merryn was its Editor in Chief until 2022. She is now a senior columnist at Bloomberg and host of the Merryn Talks Money podcast -  but still writes for Moneyweek monthly. 

Merryn is also is a non executive director of two investment trusts – BlackRock Throgmorton, and the Murray Income Investment Trust.