11 Nov 2011

Will benefits rise more slowly now 50p tax rate is to stay?

Today’s remarks by both David Cameron and George Osborne that the Chancellor won’t abolish the 50p tax rate in his autumn statement at the end of this month (levied on incomes of more than £150,000) have an important knock-on effect. 

They surely make it a lot more likely that Osborne will announce that he won’t be uprating benefits by the full 5.2 per cent, as should be dictated by the September inflation rate (measured nowadays by the Consumer Prices Index – CPI).

The 5.2% CPI figure for September was an unfortunate peak in the inflation figures, and a full uprating of all benefits could prove exceedingly costly to the Treasury.

For weeks ministers have been debating whether to go ahead with a full 5.2 per cent rating, with intense discussions involving the Treasury and the Department and Work and Pensions (DWP).

It’s been presented in the media as a straight row between the DWP and the Treasury, though my understanding is that the argument is rather less heated than that, and rather more complicated.

The Welfare Secretary Iain Duncan Smith and his deputy Chris Grayling both sympathise with the Chancellor’s determination to reduce the deficit.  On the other hand ministers and officials in both departments fear that not uprating benefits in full may have wider adverse consequences. 

Income from benefits is ploughed almost immediately into consumer spending, so a lower than expected uprating might have a deflationary effect on a currently very fragile economy.

Ministers are considering several options to avoid a full uprating, though they are sticking with their commitment to increase pensions by the full 5.2 per cent.

But it would have been politically disastrous for George Osborne to announce in his autumn statement what would amount to cuts in real terms for the poor, whilst also cuts in tax for the reach.  Not least it could blow the coalition apart, since the Liberal Democrats have strong reservations about both policies. 

Cuts in the 50p rate have today been ruled out for the time being, pending next year’s HMRC report into how much money the new 50p rate raises.  So now some kind of cut in the benefits rating is much more feasible.

One option would be to freeze all benefits apart from pensions, but that would cause a huge row. 

Another option would be to uprate benefits in line with the rise in earnings to September, so that people on benefits would find their incomes rising in line with the rest of the population. 

A third alternative would be to raise benefits by an average of CPI over a certain period – the six months to September, say, which would mean an uprating of about 4.5 per cent.

Those involved in the benefit discussions in Whitehall are aware just how big a decision this is.  They know they have to think very carefully about the kind of messages whatever they decide might send about the government’s various commitments: to cutting the deficit; to protecting those worst off; and to growth.

Follow Michael Crick on Twitter: @MichaelLCrick