Welfare cuts won’t work, they’ll just make things worse

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First posted on February 2, 2013 by alittleecon

Welfare cuts won’t work, they’ll just make things worse

Cuts to welfare spending seem to be in the headlines daily nowadays.  Every time a bad bit of economic news is announced (which is often), the prospect of yet more welfare cuts seems to raise its ugly head.  Just this week, following the terrible Q4 growth figures, there was a story in the Independent about certain ministers who are pushing for further cuts to welfare.

There are a number of issues around welfare which are regularly discussed.  These include ‘fairness’ and ‘making work pay’.  A lot has been written on both sides of the arguments on this, so I’m going to focus on the likely economic impact of welfare cuts.

Now a key argument on welfare cuts is that the deficit needs to come down and everyone needs to contribute (we’re all in this together remember).  Putting aside the fact that I don’t think we should try to reduce the deficit at the expense of jobs or living standards, I want to look at whether the claim that welfare cuts help reduce the deficit stand up to scrutiny.

A lot of people would say that the purpose of working-age welfare benefits is to provide a subsistence level of income for those who are either unable to find work, or unable to work altogether due to ill health or disability.  While that’s true, welfare payments also serve a very important macroeconomic function.  They act as an ‘automatic stabiliser’.

What are automatic stabilisers?  From Wikipedia:

“In macroeconomics, automatic stabilizers describes how modern government budget policies, particularly income taxes and welfare spending, act to dampen fluctuations in real GDP.”

In other words, in a boom, the government collects more taxes and pays out less in benefits which helps put the brakes on to prevent the economy from overheating.  Conversely, in a slump (like the one we’re in now), less tax is collected and welfare payments soar as people lose their jobs and businesses make less sales.  This acts to prevent the economy going into free-fall.  The stronger the automatic stabilisers, the shallower are the slumps and the quicker are the recoveries.

In response to criticism of his economic policies, George Osborne has claimed his plan is flexible because he has “been prepared to let the automatic stabilisers operate..”.  I’m not sure what he means by that.  What would not letting them operate look like?  I suppose you could stop paying benefits to new claimants, or make people pay the same rate of tax even when their incomes fall, but no sane person would advocate that.  So in Osborne’s world, ‘flexibility’ seems to mean not taking complete leave of your senses.

In any case, the Government are not letting the automatic stabilisers operate, they are trying to weaken them all the time.  Bedroom taxes, Atos reassessments, cuts to council tax benefits, these all weaken the automatic stabilisers.  What does this mean?  It means that income will be taken out of the pockets of the poorest (who by the way spend most of their income), who then spend less in local businesses.  These businesses then make less sales, leading to the government collecting less in tax, while the businesses might decide they don’t longer need as many staff, or even go bust.

Spending is a circuit.  It goes round and round the system, not stopping after its first use.  The government thinks by cutting the amount it pays benefit claimants by x pounds, it will save x pounds.  It’s easy to see the flaw in this logic though. If you give someone £100 less in benefits, that’s £100 less going into the economy.  Someone else has lost £100 in income (unless that person’s taxes are cut by the same amount, but the Government are not proposing to cut taxes).  The actual saving for the Government will not be £100, but a figure much much smaller.  It could even be negative if the cuts further depress employment.  The welfare bill could actually go up.

This, in a nutshell then is why cutting spending by x pounds is only cutting the deficit by (-)y pounds.  This confuses all sorts of people who are starting to claim austerity is not happening because the deficit is rising.

What the cuts to welfare also mean is that the next time there is a crisis, it will be much deeper, because our new, weakened automatic stabilisers are not strong enough to stop the slide and spark the recovery.

There’s actually a strong case for strengthening the automatic stabilisers.  You could do this on the tax side by perhaps linking national insurance rates to the unemployment rate, or on the welfare side by guaranteeing jobs for those who are made redundant following an economic slump.

Cutting welfare in a slump is a very dumb thing to try to do.  It won’t work and will make things worse.  They will be disastrous on an individual level for many families bearing the brunt of these cuts.  With jobs not being created in sufficient number (no matter what the Government tries to say), there’s no possible way the cuts can act as an ‘incentive to work’, and as we’ve just seen, in macroeconomic terms, weakening automatic stabilisers in a slump is an awful idea.  Dumb, dumb, dumb.

Other posts by alittleecon:

The Fiscal Cliff is just another disaster-politics scam in action

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Professors Michael Hudson, James K Galbraith and Bill Black variously describe the so-called ‘fiscal cliff’ as a scam, a Trojan and disaster politics. They contend that Obama has deliberately contrived this so-called crisis to ‘discipline’ the Democrats into voting for cuts in securicare, medicare and other privatisations, in return for Republican concessions on higher tax rates for top income brackets.  In the words of Michael Hudson, ‘There is no crisis at all’. Obama has to repay his Wall Street donors with ‘Romney-lite’ austerity cuts.

The possibility of a fiscal cliff was set in motion over the past two years as a way to force action on mounting government debt.

Now, legislators risk looking politically cynical by seeking to weaken the measures enacted to try to force them to confront tough questions regarding deficit reduction, such as changes to government programs like Social Security, Medicare and Medicaid…

Obama’s latest offer set $400,000 as the income threshold for a tax rate increase, up from his original plan of $250,000. It also had a new formula for the consumer price index — called chained CPI… and would result in smaller benefit increases…..

..the change would mean Social Security recipients would get $6,000 less in benefits over the first 15 years of chained CPI. Liberal groups have openly challenged the plan, calling it a betrayal of senior citizens who contributed all their lives for their benefits.

http://edition.cnn.com/2012/12/28/politics/fiscal-cliff/index.html

 

Fiscal Cliff Trojan November 25, 2012

Michael Hudson: Fiscal cliff was manufactured to shift more of the burden of the crisis onto ordinary people.  (Full transcript at http://michael-hudson.com/2012/11/fiscal-cliff-trojan/)

Why the Fiscal Cliff is a Scam – Published on Nov 29, 2012  TheRealNews

James K. Galbraith: Is there a looming crisis of debt or deficits such that sacrifices in general are necessary?

Black: Too Big to Prosecute and It’s Obama’s Fiscal Cliff

Published on Dec 22, 2012

Bill Black – ‘Its Obama’s Fiscal Cliff’ starts at 5.00 mins (after the scandals of HSBC and UBS, banks which are too big to prosecute.)

Hat-tip http://www.scoop.it/t/monetary-reform

How can pay rise be unfair when mega-rich get tax cut?

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In reaction to a letter in the local press, COUN JIM GRUNDY (Lab),  Hucknall member of Ashfield District Council replied:

I was saddened, if not surprised, by Mr P’s response last week, to the news that Ashfield District Council had signed up to the Living Wage (a promise to ensure that all employees receive at least £7.45 per hour, around £275 per week or £14,300 p.a.).

He argued that this was unfair since other workers, particularly in the private sector, won’t receive it too. Perhaps Mr P doesn’t know that public sector workers are in the third year of having received no pay rise whatsoever, meaning that they’ve seen their incomes cut in real terms. Has that made anyone else feel happier about their lot? Thought not.

It is sad, indeed, when the classic divide and rule tactics employed by the Tories and the Lib Dems gain any traction. But what it does best is to betray a certain lack of imagination in this kind of thinking, that there is no alternative than to accept that low pay is inevitable, whilst having nothing to say about the £107,500 p.a. tax cut handed to 8,000 multi-millionaires by George Osborne.

If anyone can explain to me what’s fair about VAT being raised to 20% and pay being held down for everyone else to fund a tax cut the size of which the rest of us could hardly dream of ever receiving as a salary, let alone as a tax bill, then I’ll think paying people enough simply to get by is unfair.

Low pay is hardly a badge of honour for those unlucky enough to be included in that bracket.  And if someone manages to secure a fair — if still modest — pay settlement then how is the unfair treatment of others a sensible reason to oppose it?

A commitment to the Living Wage shows what can be done, beyond a race to the bottom that will do nothing for anyone struggling now or in the future.

Applying the same ‘logic’, if you’re with a friend and they’re attacked and mugged, the only fair thing to do would be not to help your friend fight off the mugger, but to insist that you hand over your own wallet too. And, I suppose, if someone’s seriously ill, don’t try and cure them because you’ll only make the dead jealous.

There is a wider practical purpose to this move. Putting more money in the hands of low paid workers makes perfect economic sense. Where will this money be spent? It will be spent in local shops and that can only help to maintain the viability of our town centres. Or, since gas prices have risen 31% in the past three years, it might be spent on luxuries like keeping warm.

Where will the lucky 8,000 multi-millionaires spend their extra £107,500? It’s just a hunch I have but I’m guessing it won’t be in any shop in Hucknall.

Even at the level of their new ‘unfair’ salary, council staff would have to work for seven and half years merely to earn the same amount that is being given away as an unearned tax cut each year to people who are hardly struggling. We are not all in it together, are we?

We all have to ask ourselves who’s side we are truly on? Low paid workers or millionaires? I know where I, Hucknall’s other district councillors and those who will contest the Notts County Council elections for Labour next May stand.

Can Mr P tell us who he stands by?

Why does the Structural Deficit remind me of LIBOR?

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(I know this might sound rather boring but the facts are actually a bit incredible…)

The London Interbank Offered Rate (LIBOR) is a benchmark interest rate used broadly all over the world and affects trillions of dollars of loans worldwide – mortgage loans, small-business loans, personal loans. ‘The Libor is not based on an objective measure of the interest for bank-to-bank loans. It is the average of a daily poll of the Association’s member banks, who give an estimate of the interest rate they think they would pay if they sought to borrow from another bank. It is supposed to be the way the financial system assesses the overall health of the financial system.It has now been discovered that a substantial number of banks were manipulating their estimates of the interest rate to their own advantage.

Rep. Denis Kucinich, U.S. Representative from Ohio’s 10th District on the LIBOR-participating banks:  “We don’t know just how deep this scandal goes. But the fact is that if a fundamental component of our financial system has been or is being manipulated, we have the right to know about it.”

In May 2010, the coalition decided to place the structural budget deficit at the heart of its fiscal policy, and George Osborne’s argument for his ‘austerity’ programme depends largely on his assertion that it is necessary to completely eliminate it.  Initially, clearing the deficit was projected to occur within the course of one parliament but the time-span has been extended repeatedly, and estimates currently seem to be somewhere between 2017 and 2020.

So given its central importance for the coalition’s policies, we need to know what is a structural deficit?  How is it calculated?  And is it a valid measure justifying the coalition’s draconian austerity programme?

structural deficit

A budget deficit that results from a fundamental imbalance in government receipts and expenditures, as opposed to one based on one-off or short-term factors. [1]

A government budget deficit occurs when a government spends more than it receives in tax revenue.  It is called a structural deficit when the ‘spending-exceeding-income’ state persists for a period of time.  This causes concern to mainstream economists because they argue that if the deficit is actually over and above the ability of the country to repay, then a government can only clear it by cutting spending, defaulting, or by deflating the debt through engineering a high inflation rate.

Clearly these last two options alarm lenders, and since in a neoliberal world, governments can only borrow from the markets, governments worry that if there is a crisis of confidence, the bond markets will impose very high interest rates or yields ….  which in turn, will increase the structural deficit still further!  This is what is supposed to have happened in Greece and Spain.

At its simplest, the Structural deficit is calculated by finding the difference between government spending and the amount it receives in the form of tax … but nothing about economics is ever that straightforward.  The important thing to take on board is that if tax revenue falls, as it did in the 2007 recession, there will be an increase in the budget deficit without there having, to have been any increase, or change, in government spending.  Nevertheless, since job losses occur in a recession, government spending will inevitably rise because of paying out in unemployment benefits.

Budget Balance = Revenue – Spending.

Budget Balance = (Tax Revenue + Other Revenue) – (Welfare Payments + Other Spending)

We know that Tax Revenue and Welfare Payments move inversely with respect to each other, with the latter rising when GDP growth falls and the former rises with GDP growth. These components of the Budget Balance are the so-called automatic stabilizers (2)

 

Furthermore, the ability to pay off the deficit is assessed by a country’s deficit relative to its GDP. Therefore, without any change in absolute size, the deficit becomes a proportionately bigger percentage of GDP when the economy is contracting (as in a recession) and proportionately smaller when the economy is growing.  Hence:

‘Before the financial markets went into meltdown in the summer of 2007, it was assumed the structural deficit was about 2-3% of GDP; Osborne’s plans are based on estimates from the Office for Budget Responsibility that the structural deficit is actually more like 5-6% of national output.’ (3)

In other words, the structural deficit grew as a percentage of GDP because the economy contracted in the summer of 2007, but in addition, it also actually increased because of falling tax receipts and increased welfare spending.

‘…. the drastic nature of the government’s deficit-reduction plan is explained by the belief that the economy suffered severe permanent loss to its productive potential as a result of skills being lost, capital being scrapped and the closing down of entire bits of the financial system. According to this view of the world, the fact that inflation has been well above its target for the past 18 months suggests that there is little or no spare capacity in the economy despite the severity of the recession.’ (3)

The words, ‘productive potential’ and ‘inflation’, are the nub of complications in calculating the revenue part of the structural deficit.

The ‘productive potential’ is an estimate of what the tax revenues would be if there were ‘full employment’.  In fact, the structural deficit used to be called the Full Employment or High Employment Budget. Professor Bill Mitchell says “The change in nomenclature is very telling because it occurred over the period that neo-liberal governments began to abandon their commitments to maintaining full employment and instead decided to use unemployment as a policy tool to discipline inflation.”(2)

The puzzle is, that in a neoliberal world, ‘full employment’ is not what you think … For most of us, full employment’ is ‘an economy that delivers as many jobs as there are people wanting them and hours of work consistent with the desired hours of the workers.’  But in the neoliberal world of OECD, the IMF et al, ‘conceptions of full capacity are ideologically-loaded by the NAIRU concept and are frankly … a total joke. (2)

 From the 1970s, the concept of the Non-Accelerating Inflation Rate of Unemployment (the NAIRU) became a central plank in the front-line attack on the use of discretionary fiscal policy by governments. ‘It was argued, erroneously … that full employment occurred when the unemployment rate was at the level where inflation was stable.’(2) Estimates of NAIRU are just that… ‘estimates’… and the standard errors of these estimates can vary between 3 and 13 percent in some studies.  Clearly, such a large range for error means that an estimate of the structural deficit based on the NAIRU, or some derivation of it, is highly questionable.

Nevertheless, these estimates are used to compute the tax and spending that would occur at the so-called ‘full employment’ point. But, according to Bill Mitchell, because it ignores 5% (usually) of the working-age population ‘it severely underestimates the tax revenue and overestimates the spending and thus concludes the structural balance is more in deficit (less in surplus) than it actually is.(2)

The significance of the statement, the fact that inflation has been well above its target for the past 18 months suggests that there is little or no spare capacity in the economy despite the severity of the recession’ (3), is that… given full employment is defined as that point where inflation is stable,… there is an assumption that the current tax revenue is more or less at full capacity.  (Madness or what?)

In June 2012, the official unemployment rate was 8.2% of the economically active population. This means that there were 2.61 million unemployed people, but there was also another 9.23 million economically inactive people aged from 16 to 64.  (4)

It seems that government ‘believes’ that this is the new ‘full employment’ because the economy is supposed to have ‘suffered severe permanent loss to its productive potential as a result of skills being lost, capital being scrapped and the closing down of entire bits of the financial system.(3)

This is turning common sense on its head.  In an economy that is designed for the whole population, and not just the wealth of the 0.014%, there are a multitude of jobs that need doing, a ‘green revolution is required… and if there is still not enough employment, cut back the number of hours that each person works and reduce the pension age.  This would pump demand back into the system, balance the economy and potentially mitigate the looming energy disaster.

I can almost hear the cries of  ‘we can’t afford it, there’s no money left’.  But quite apart from the obvious course of increasing taxes on the wealthy and corporations and the shutting down of tax havens, £31 billion is currently sitting unused in HMT’s Debt Management Office; £1 billion from TV licenses paid 6m in advance and so on… not to mention the fact that Quantitative Easing has poured 375bn into the banks and that may well be increased to 500bn in the future (5).  And to complete the heresy…. there is no reason why governments cannot afford to run a bigger debt and structural deficit, than we currently enjoy, in order to create real full employment.

But to get back to the structural deficit – tax revenue is not only derived from individual employment, there are also taxes paid by companies and corporations.  So what has George Osborne done?  He has cut corporation tax from 28% in 2010 to 23% in 2012, with the aim of eventually reducing it to 20% or less.  He has made it easier to put wealth into tax havens and removed the requirement on UK companies to pay tax to British authorities on overseas earnings.  Furthermore, he has cut the top tax rate for individuals from 50% to 45%, on the basis of the improbable Laffer curve.

The Office for National Statistics said the data for July 2012 heightens concerns that the government will miss its deficit reduction target.

The ONS said the total deficit since April had reached £47.2bn – up £11.6bn on 2011 – excluding financial interventions and a one-off boost after assets from the Royal Mail’s pension fund were transferred to the Treasury… At this rate, borrowing for 2012/13 overall will massively overshoot the Office for Budget Responsibility‘s forecast of £120bn, excluding Royal Mail effects, by over £35bn…”we think that the government will struggle to cut borrowing at all next year.”  Government spending, meanwhile, grew 5.1% on the previous year, mostly on welfare payments….  (6)

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Richard Murphy suggests that George Osborne should take the blame for July’s dramatic fall in tax receipts:

‘… this loss can simply in part be due to a deliberate government give away at a time when it could not be afforded… some companies may now be anticipating the impact of new controlled foreign company rules in their payments on account. The Treasury said in Budget 2011 that these would cost £210 million in lost revenue this yearand I have always thought this a massive underestimate. This encouragement for companies to abuse tax havens to hide their profits may already be costing us dear. (7)

Putting it simply, George Osborne says one thing and has done the opposite in many instances.  He has reduced the amount of money coming into government by the loss of tax caused by cutting jobs, tax cuts for the wealthy and corporations, including through tax haven legislation. He has increased the spending on welfare payments by 5.1% because of the increased unemployment resulting from his austerity programme.  And this is notwithstanding either the extra expenditure on the reorganization of the NHS, education, the courts and so on, or the cuts in expenditure on benefits which came into force in April.

Budget Balance = (Tax Revenue + Other Revenue) – (Welfare Payments + Other Spending)

And now, on the basis that the deficit is rising not falling, there is talk of more cuts being introduced in the November Spending Review … more cuts on top of those already scheduled.  For example an additional 10bn from the Welfare budget.

Chris Dillow wrote in November 2011 after the last Spending review:

. Forecasts of the structural deficit rest upon two huge uncertainties – and it’s not clear that they offset each other: an uncertain estimate of the output gap (and sensitivities of spending and revenues thereto); and  the usual uncertainties surrounding any fiscal forecast. I’m with Simon Ward on this: “it is troubling that the fiscal framework pivots on a concept subject to huge empirical uncertainty.”

I suspect that the notion of a structural deficit is playing an ideological role… (8)

 

Chris Giles of blogs.ft.com (9) agrees that the use of the ‘structural budget’ as a fiscal target leaves a lot of room for games. And as an example, Simon Ward reported that:

The Chancellor and the Office for Budget Responsibility (OBR) have, in effect, traded assumptions. The OBR has cut its guess about potential output, implying that a larger proportion of the current deficit is structural. The Chancellor has retaliated by assuming that he will be able to cut public spending by 0.9% a year in real terms in 2015-16 and 2016-17, thereby putting the structural budget position back on track. (10)

To be frank, all of George Osborne’s approaches are consistent with, and have striking parallels, with the last 30 years of disastrous Republican ‘neoliberal’ or plutonomic economic strategy  ‘Has George Osborne been taking Trans-Atlantic lessons from Jude Wanniski and the Republicans?’

So to sum up as to why the Structural Deficit reminds me of Libor:

The Libor is a fundamental component of our financial system, and the structural deficit is a fundamental component of the coalition government’s programme.

‘‘The Libor is not based on an objective measure of the interest’ and the structural deficit is not based on an objective measure of potential tax revenue… both are more or less ‘guess-timates’.  Yet Libor is ‘supposed to be the way the financial system assesses the overall health of the financial system’ and the structural deficit is used by the coalition government to assess the health of the UK economy.  Both the Libor and the structural deficit ‘guess-timates’ have a direct impact on the lives of millions of ordinary people.

It has been admitted that the Libor was manipulated in the interests of the banks, and the structural deficit is clearly open to being used to justify the unjustifiable… for example, in terms of dismantling/privatizing the welfare state, and cutting benefits to those who are disabled, unable to work, unemployed, low waged or suffering from high rents.

As Denis Kucinich says ‘If a fundamental component of our financial system has been or is being manipulated, we have the right to know about it.’  The same holds for government economic strategy.  Bill Mitchell calls Structural deficits – the great con job! 

 

Addendum:

The structural deficit is ‘the problem’ in the neoliberal ideological construct of the world.   But in the ‘real’ world, the problem is the lack of demand, a global ‘out of control’ banking system, and the level of private sector debt.  According to Michael Meacher:

‘…. the first forecasts of the newly formed OBR in 2010, the government was expecting the level of private household debt, already £1.57 trillion, to rise to a staggering £2.13 trillion by 2014-5.   It should be emphasised that this was not something they feared would happen or were simply allowing to happen, but rather it was a deliberate aim of monetary policy that it should happen.   The plan was that the deficit provided the perfect excuse to squeeze the public sector, shrink the Welfare State, but ever-increasing private household debt would provide the extra demand to maintain at least some modestly decent growth.   The opposite has happened.

In the private corporate sector deleveraging (i.e. paying off debt) has gathered pace because the corporates are sitting on mountains of cash (at least £70bn) but not investing because demand is being squeezed.   Equally in the private domestic sector households are being forced to pay down their debts and cut their consumption as rapidly as they can as the only way to get by.   The effect is massive private debt deflation, which is the real cause of the slump. (11)

 

Related posts:

‘Has George Osborne been taking Trans-Atlantic lessons from Jude Wanniski and the Republicans?’

Thom Hartmann describes Osborne’s vision for the UK

Simon says: QE is the biggest confidence trick of all time.

A Modern Jubilee: How to End the Recession 

What is George Osborne playing at?

(1) http://lexicon.ft.com/Term?term=structural-deficit

(2)  Structural deficits – the great con job!   http://bilbo.economicoutlook.net/blog/?p=2326

(3)  http://www.guardian.co.uk/business/2011/jul/17/economics-osborne-uk-structural-deficit

(4)  http://www.ons.gov.uk/ons/rel/lms/labour-market-statistics/june-2012/index.html

(5)  https://think-left.org/2012/07/27/simon-says-qe-is-the-biggest-confidence-trick-of-all-time/

(6)  http://www.guardian.co.uk/business/2012/aug/21/uk-public-finances-deficit-borrowing

(7)  http://www.taxresearch.org.uk/Blog/2012/08/21/why-have-corporation-tax-receipts-fallen-by-20-start-by-blaming-george-osborne-as-its-all-his-fault/

(8)  http://stumblingandmumbling.typepad.com/stumbling_and_mumbling/2011/11/structural-deficit-doubts.html

(9)  http://blogs.ft.com/money-supply/2010/05/17/the-obrs-flaws-and-benefits/#ixzz24Jk6COTe

(10)  http://moneymovesmarkets.com/journal/2011/11/29/uk-autumn-statement-much-ado-about-nothing.html

(11)  http://www.michaelmeacher.info/weblog/?s=household+debt