A real escape from the poverty trap

According to the Financial Times last week, new research shows that a minimum wage won't help the poor much at all. Thanks to benefit clawbacks and taxes, the paper said, much of the extra cash paid out by employers, if a minimum wage is introduced, will go to the government and not the low paid.

That, said the FT's headline writer, was an unpalatable truth for supporters of the minimum wage to swallow. Is it surprising then, asked the correspondent, that some people think there is no need for a minimum wage at all?

But the FT completely missed the point. And it clearly didn't look at the new research very closely. Yes, the study does indeed show that for many low-paid people, increases in wages are clawed back through the tax and benefit system. And yes, it is true that tackling this benefit trap is critical if we are to get people both into work and out of low-wage poverty. But no, the research does not show that a minimum wage is pointless. Quite the reverse; without a minimum wage, any attempt to solve that benefit trap will fail.

Consider the new study on which the FT based its claims. Academic Holly Sutherland of the Applied Economics Unit at Cambridge University has analysed the links between a minimum wage and in-work benefits for a new report by the Employment Policy Institute, due to be published next month.

In the report Ms Sutherland says: "A national minimum wage would have a significant impact on the incomes of low-paid workers and affect work incentives. But for many families the gains from a national minimum wage would be offset by tax increases and reductions in in-work social security benefits."

Take the case of a security guard on pounds 2.80 an hour, whose wife stays at home to look after their two children aged under five. He works 38 hours a week, and pulls in pounds 106.40 for his pains. It isn't much - but it is enough to incur tax on every extra pound at 20 per cent and National Insurance contributions of 10 per cent.

The family is entitled to Family Credit, Housing Benefit and Council Tax Benefit because its income is so low. But these are withdrawn at a steep rate. Suppose, then, that our security guard gets an extra hour's overtime, which pays him an extra pounds 2.80 that week. The taxman takes the first bite: 56p vanishes in tax, and 28p in National Insurance. Then the Benefits Agency steps in to withdraw a further pounds 1.38 of Family Credit, 38p of Housing Benefit and 12p of Council Tax Benefit. So he is left with only 8p extra to take home (just 3 per cent of his extra gross pay). Shocking, isn't it?

It is easy to see why people get trapped in poverty, either on low pay or out of work altogether. After all, why on earth would you work harder for just 8p an hour? Why go to the bother of doing overtime, pursuing promotion for a small pay rise, or even accepting such a low-paid job in the first place?

As Ms Sutherland points out, the same kinds of withdrawal rates operate if wages are pushed up by minimum wage legislation rather than overtime. Imagine what would happen to that same family if a minimum wage were introduced at pounds 3.70 an hour. Despite the 32 per cent increase in his pay, the security guard only gets to take home an extra pounds 1.05 a week. Even if his wage rose to pounds 4.30 an hour, his family would still only be pounds 1.72 better off a week.

But this doesn't mean that a minimum wage is useless. Far from it. In fact, a minimum wage is an important pre- condition for the kinds of benefit reforms needed to ease people out of that benefit trap.

The fundamental task is to stop the state taking away so much of every extra pound someone earns. In the short term that is bound to cost money, even if savings accrue in the long term by getting people out of poverty and unemployment. And where better to get the money to kickstart those reforms than from the extra tax revenue given to the government by the minimum wage?

As Ms Sutherland's research shows, a minimum wage of pounds 3.70 boosts the Treasury coffers by pounds 1.8bn. Just think what you could do with that kind of money. Raising Family Credit by pounds 13 a week costs a mere pounds 300m. Reducing the Housing Benefit taper - the rate at which benefits are withdrawn - from 65 per cent to 30 per cent would cost pounds 1bn. Neither of these reforms provides a simple solution to the benefit trap - sadly, no such solution exists - but they are options worth considering and which would become more affordable with the proceeds from a minimum wage.

There is a broader point here. The purpose of the minimum wage is not simply to raise the cash needed to solve the benefit trap, it is to place a floor under in-work benefits so that they can be made to work more effectively.

At the moment, a canny employer, who knows that his employees' incomes will receive a generous top-up from the state, can get away with cutting their wages and letting the taxpayer take the strain. Private landlords have done exactly that for tenants on housing benefit, pushing up rents because they know the state will foot the bill. In the circumstances, then, increasing in-work benefits such as Family Credit or Housing Benefit could fail to be cost- effective because the employers, rather than their low-paid employees, would absorb some of the extra cash.

But introduce a minimum wage and the whole game changes. Suddenly, employers have a floor below which they cannot go. Suddenly, changing those in-work benefits becomes worth while.

A minimum wage may not provide all the answers. Thus far, and only thus far, the Financial Times is right. But it is a sensible way to ensure that the reforms which can directly loosen the jaws of the poverty trap will really work.