Under plausible assumptions, average UK living standards could improve substantially over the coming decade – with one exception: the poorest sections of society. If we want a more prosperous future for all, Mike Brewer and Lalitha Try write, then social security benefits should keep pace with wage growth and rising housing costs. Common objections to these reforms, they argue, turn out to be unfounded.
After 15 years of stagnant productivity and relative decline, Britain desperately needs economic growth. Without it, it will be impossible to raise the living standards of our country’s worst-off households – who are currently a fifth poorer than their counterparts in France – and achieve a truly shared prosperity.
But growth alone is not enough. In Ending Stagnation, the final report of the Economy 2030 Inquiry project, we show that if the living standards of all are to be raised then the UK must implement a policy agenda focussed not just on growth but also on measures for predistribution and redistribution. The first of these involves sharing the rewards of the labour market more evenly. It’s the second set of measures – redistribution – that is the focus of this post. In particular, we propose two key reforms to the current benefits system: raising social security benefits in line with wages, rather than prices, and ensuring that benefits keep pace with rising housing costs.
Implementing these reforms would be a big challenge, but doing so is essential if we want a more prosperous future for all sections of society. Worsening inequality is a choice, not an unstoppable force. If we take steps to tackle it now, we can halt and reverse its path.
Large numbers of people cannot rely on earnings when it comes to income growth
Pay and wages are important, but the UK contains 10.9 million individuals in working-age households – around a fifth of the country in total – who live in households in which income from the labour market makes up less than half the total income of the household (see chart below). People in this situation cannot rely on a booming labour market for future income growth.
Chart 1: Proportion of income by source for non-pensioner households by income quintile: 2019-20, UK
This number might sound large. However, almost 5 million of these individuals live in households where someone is in paid work, but where earnings are less than half of the total income of the household. Of the 6 million people in households where no-one is in paid work, 3.6 million are in households with someone who is long-term sick or disabled, 1.2 million in households with dependent children, and 400,000 are students.
Single parents (63 per cent of whom receive less than half their income from the labour market), people of Bangladeshi origin (47 per cent) and people with a disability (40 per cent) are also disproportionally likely to be in this situation.
It is essential that when economic growth is achieved, these sections of our society are not excluded from the gains. But this won’t happen without substantial reform.
Social security benefits should keep pace with earnings and housing costs – not prices
Recent Resolution Foundation research showed what we can expect to happen if the UK manages a full decade of earnings growth. Under plausible assumptions, average wages would increase by 16 per cent – and median income by 12 per cent – in real terms.
But rather than being shared evenly across the income distribution, those in the top quintile would see income rises of 14 per cent, while the incomes of people at the bottom of the income distribution would see average growth of just 2 per cent. This is what happens when productivity improvements feed through to earnings growth, but not to growth in other sources of income.
To achieve truly shared prosperity, we must ensure that the other key source of household income – social security benefits and tax credits – also keeps up with broader economic growth.
Currently, most working-age benefits are uprated each April using the previous September’s rate of CPI inflation. This means that basic benefit support is today at the same level in real terms as it was in 1992, despite a 51 per cent growth in GDP per capita. Should we continue with the current system we would see the Universal Credit (UC) standard allowance fall from 14 per cent of average earnings in 2025-26, to 12 per cent in 2035-36, and just 10 per cent in 2045-46 – down from 17 per cent in 2000-01.
We also know that, when the economy and average incomes grow, housing costs also grow – especially for those who are renting. Should housing costs continue to broadly follow income growth trends over the coming decade, our analysis suggests that further growth is likely to lead to housing costs rising in line with incomes for the top half, but outpacing income growth at the bottom.
This is because of the current system’s approach to Local Housing Allowance (LHA), which is used to calculate how much people in receipt of benefits who are renting from a private landlord can claim in Housing Benefit or Universal Credit. LHA is being increased back to the 20th percentile of local rents in April 2024, but is still set to be frozen in future years: a situation which is clearly unsustainable.
Crucially, even if governments decided to increase LHA in line with inflation, the higher long-term increases in housing costs would eat up all the gains from income growth at the bottom of the income distribution – meaning that households in the bottom income quintile could see a living standards decline of 4 percentage points over 10 years. To prevent this happening, we need LHA rates to keep up not only with inflation, but with growth in housing costs.
This fundamental disconnect between the living standards of society’s poorest, and the living standards of the rest of the UK, must not be allowed to continue. Instead, the value of social security benefits for working-age households should keep pace with earnings growth – through this, we can ensure that households that are unable to work, or where earnings make up a minority of their income, are not left behind.
Countering objections to the proposed reforms to redistribution policies
Objection 1: Uprating benefits in line with earnings would disincentivise work
One criticism of the reforms outlined above is that, if benefits were increased in line with average wages, financial incentives to work would be removed – discouraging people who might otherwise be able to do so from from seeking out paid employment.
However, this criticism ignores the fact that raising benefits in line with average wages while the minimum wage is rising at least as fast would do nothing to weaken work incentives from where they have been in recent years – years in which employment has reached record highs. If someone is five times as well off in work today compared to not working, then they would still be five times as well off in work in a decade’s time if benefits and earnings increase at the same rate.
Objection 2: The proposed benefit reforms are unaffordable
The changes outlined here would be significant. Uprating benefits in line with wages, and uprating LHA in line with housing costs, would cause governments to spend more than if they permanently linked them to prices. But the Office for Budget Responsibility (OBR) currently projects that welfare spending directed at working-age households would fall as a proportion of GDP even if these policies were enacted, with spending in 2041-42 predicted to be 0.4 percentage points lower than in 2026-27, due to favourable demographic trends.
We also have form in uprating benefits in line with earnings via the Triple Lock on the State Pension, which uprates by the higher of earnings, prices or 2 per cent. If we equalised the treatment of benefits uprating across working-age and pensioner households then this would further reduce the long-term cost of the policy, reducing future spending by around 0.5 per cent of GDP by 2041-42, and offsetting over half (52 per cent) of the long-term costs of earnings-uprating working-age benefits.
Chart 2: Working-age and pensioner welfare spending as a proportion of GDP: UK
Of course, focussing here on benefits uprating does not mean that other parts of the social security system do not also need to change. We have tried to show, however, that while shared prosperity as a result of boosted economic growth is very possible, it won’t happen without bold policy changes. Making these changes should therefore be just as much a priority for current and future governments as boosting economic growth itself.
All articles posted on this blog give the views of the author(s). They do not represent the position of LSE Inequalities, nor of the London School of Economics and Political Science.
Image credits: Main image by Jason Batterham via Shutterstock. Both charts © The Economy 2030 Inquiry.
What is unaffordable is the extra money that needs to be spent on the NHS, social care and the justice system as a result of poverty. That is just the cash – Look at the lives that are blighted because poverty trashes thier life chances (If you live in a series of hotel rooms and never have enough to eat – are you really going to pass exams ond go to University). Add in the costs of the Doctors, Nurses, Socail Workers, Police etc who burn out and/or leave because they have to spend all thier time fighting poverty rather than doing what they went into the job to do. Has anyone ever looked at the knock on effects of low benefits and austerity?