Economics: Courageous road to a basic income

NO-ONE who has undergone the tortuous and demoralising process of claiming Income Support, Housing Benefit or Family Credit needs convincing that Britain's social security system is horribly complicated and user-unfriendly.

Kenneth Clarke, even without the benefit of personal experience, appears to have reached a similar conclusion. He has ordered the Treasury to assess the feasibility of 'Basic Income' schemes, which supporters believe would lift people from poverty and redistribute income more simply than the current tax and benefit systems.

Under the most ambitious Basic Income schemes, the state would pay every citizen (or family) just enough money to live on, without imposing conditions. The huge cost of this blanket benefit - which most of the recipients would not actually need - would be clawed back by taxing all other income at high rates. The idea of paying a benefit to everyone, duke or dustman, seems fantastic. But it is not as illogical as it looks.

A Basic Income large enough to cover modest living costs could make it possible to scrap the maze of means-tested benefits on which almost one in 10 of the population is now dependent - a higher proportion than at any time since the formation of the modern welfare state in 1948. By simplifying the interaction between the tax and benefit systems, Basic Income schemes might also cut administrative costs.

Means-tested benefits - of which Income Support and Family Credit are the most important - are expensive to administer and complicated to claim, as demonstrated by the fact that the Child Poverty Action Group's latest users' guide to such benefits runs to 488 closely printed pages.

The complexity of means testing, together with the social stigma attaching for many would-be claimants, means that a large share of the money available is never claimed.

The safety net of the means- tested benefits system also contains significant gaps, particularly affecting people in low-paid work (who cannot claim Income Support) and who are childless (unable claim Family Credit).

Mr Clarke is not the first Chancellor to be attracted by Basic Income schemes, which appear beguilingly simple in textbook diagrams. But adopting any of the more ambitious variants would be what the civil servants in Yes Minister used to describe as 'a courageous decision', when they wished to steer their political masters away from a vote-losing course.

It seems fanciful in the extreme to believe that even a political salesman as skilful as Mr Clarke could persuade many Conservative voters to pick up a multi- billion pound bill to lift a few more of their fellow citizens from poverty, when they are already facing the equivalent of another 7p in the pound on income tax to repair the hole in the public finances.

The introduction of a substantial Basic Income scheme would represent the most dramatic and expensive shake-up for the welfare state since the Beveridge Report was made flesh.

If the Basic Income was large enough to remove the need for means-tested benefits, the rate of tax imposed on other income would have to be much higher than it is now. But if, in order to save costs, the Basic Income was lower, a means-tested safety net would have to remain. There would then be little administrative saving, and the benefits system would be even more complicated.

In the straightforward case shown in the diagram, a single tax rate is levied on all income other than a Basic Income equivalent to the current level of Income Support. About pounds 3 of every extra pounds 4 earned would have to be handed to the taxman - about treble the 25 per cent Basic Income tax rate currently faced by most taxpayers. (This excludes 10 per cent more in national insurance contributions.)

This tax rate could be cut to 40 per cent, if families were treated as single units, so that couples received less Basic Income than two single people. But this would run entirely contrary to the Government's support for independent taxation of men and women.

This dilemma highlights one of the biggest obstacles to the integration of the tax and benefit systems: taxes are paid by individuals, while benefits are paid to families or households.

This means that a person's income-tax bill does not depend on the earnings or savings of their spouse or on the number and ages of their children, but that their entitlement to benefits does.

If the Inland Revenue were to take responsibility for a Basic Income scheme where the amount of benefit depended on the size and composition of the family, it would need far more information about taxpayers than it has at the moment, especially as most people never fill in a tax return.

Experiments with Basic Income in Denver and Seattle in the late 1960s and early 1970s also found that schemes that assessed households and individuals equally encouraged family breakdown, as people split up so they could obtain more benefit. There is already a bias against marriage in the British benefits system, but a family-assessed Basic Income scheme could well make it worse.

Practical and political difficulties suggest that a pure Basic Income scheme will have to remain a textbook curiosity, but the idea highlights some important problems with the current tax and benefit systems that could point the way to less disruptive reforms.

Most fundamentally, Basic Income schemes emphasise the unavoidable trade-off between the generosity of support for the less well-off and the tax rates needed to pay for it. The relatively well-off may soon have to decide whether they are prepared to pay more tax in order not to live in a society where they have to barricade themselves into high-security enclaves to avoid an impoverished and desperate underclass.

Basic Income schemes also concentrate our minds on how tax rates should change along the income scale. The Conservatives have long nurtured the perverse belief that the poor work harder if they are given less money, while the rich work harder if they are given more. They have trumpeted the halving of marginal tax rates on top earners during the 1980s but have only tinkered with the high rates of tax and benefit withdrawal at the bottom of the scale.

This may make political sense given the Conservatives' natural constituency, but the economic justification is much less convincing. A recent study of the impact of benefits and taxes on work incentives concluded that the marginal rates faced by relatively well- off full-time workers had little impact on how hard they worked, not least because most salaried jobs do not allow people to choose to work a little more in exchange for a small increase in income*.

In contrast, the high marginal rates at the low end of the income scale have a significant impact on work incentives, particularly in determining whether married women choose to work and for how many hours a week. This is an increasingly important group, as last Thursday's unemployment figures showed that eight out of every nine jobs created since the recession ended have gone to women, many in low-paid, part-time service jobs.

More could be done to make it worthwhile to take low-paid work. For example, Income Support is currently withdrawn pound for pound once single recipients earn more than pounds 5, as long as they work less than 16 hours a week and so are ineligible for Family Credit. Instead, recipients should lose perhaps only 50p for every pound they earn. This could be paid for by tightening the rules under which people on Income Support can have their mortgage payments paid. This help is withdrawn if people work 16 hours or more.

More ambitiously, the Chancellor could move a long way towards a Basic Income system by extending Family Credit to everyone or paying the cash value of tax allowances to those who currently earn too little to gain from them.

But both these options, like pure Basic Income schemes, would need higher tax rates to pay for them. Mr Clarke has yet to see the reaction to the tax increases he has already announced - it would certainly be courageous of him to risk any more for now.

* Welfare and Work Incentives, A B Atkinson & G V Mogensen, Clarendon Press, Oxford.

Christopher Huhne is on holiday