Cash payments directly to individuals are a major component of most modern welfare states, alongside the provision of publicly provided services (throughout this chapter, we use the terms ‘transfers’, ‘benefits’ and ‘welfare payments’ interchangeably). The scale of their importance is easy to under-appreciate. The UK state spends more on cash transfers to those of working age (adults under state pension or retirement age) than on education, or defence and policing combined. At any point in time, more than a quarter of all working-age UK families are in receipt of means-tested benefits (Office for Budget Responsibility, 2018). And even that underplays the true reach of the system: at some point in their lives, most people will be in a household receiving a working-age means-tested benefit (Roantree and Shaw, 2018).

Executive summary

• Spending on cash transfers for those of working age – the focus of this chapter – has generally grown in the UK, both in real terms (from an average of £1,000 per working-age adult per year in the late 1970s to £2,500 just before the pandemic (in today’s prices)) and as a share of national income. But over the period of austerity between 2010 and the pandemic, the working-age benefits bill fell both relative to national income and per person.
• The targeting of support on different demographic groups has changed radically. Over the long term, the UK’s cash transfer system has increasingly oriented itself towards pensioners and those with children. The growing priority given to support for pensioners is an important part of the backdrop behind trends in the working-age system, especially for the tight squeeze on the working-age benefits budget since 2010. In 1990–91 the basic support for a single person with no other source of income was 32% higher for those just over pension age than for those just under, but that figure has now grown to 137%. Within the working-age population, too, there have been big shifts. In 1975–76 an out-of-work lone parent with two children would get just 12% more than a couple without children in otherwise-similar circumstances, but by the eve of the pandemic they would get almost double.
• Major policy reforms over the past 25 years have repeatedly followed a pattern of encouraging people into paid work (using both carrots and sticks) – especially if they do not live with another working adult. Such work is usually part-time, and often associated with very low earnings. The tax credit expansions of the early 2000s, which offered income top-ups for low-earning households, mostly expanded support for working 16 hours per week but often implied strong financial disincentives to go further. Imposing job-search requirements on an increasingly large fraction of lone parents on out-of-work benefits did push many into employment, but essentially all of it was part-time and on weekly earnings less than the 40^th percentile. The switch to universal credit – the current flagship reform of means-tested benefits in the UK – especially increases financial incentives to do so-called ‘mini-jobs’ at very low hours, and makes little difference to the incentive to shift from full- to part-time work.
• Much or all of the benefits system is a system of patches applied to problems that we have not found better ways of addressing, such as low pay, ill health and high housing costs. Hence, wider trends in the economy and society can and do radically change what is required of the benefits system. Housing trends are a leading example of factors that leave the transfer system with no easy answers. While rising rents and the shift towards private renting continue, policymakers have to either accept an ever-increasing housing benefits bill or leave a growing fraction of the low-income population highly exposed to high housing costs, or some combination. In reality, both have happened. Housing benefit spending per working-age person has risen by around 40% since the mid 1990s, and yet a growing fraction of the low-income privately renting population are spending large fractions of their income on housing.
• Transfer policy choices should in future factor in the longer-term effects to a greater extent than they have to date. In particular, recent research has shown that part-time work does much less than full-time work for career and wage progression. Hence, a drawback of incentivising some people to work part-time who would otherwise have worked full-time is that their future wages are likely to be lower than they would have been. We understand this better than we did when the UK’s tax credits system was introduced in the late 1990s, for example. The point is relevant for very live policy choices today. New research suggests that changing universal credit to incentivise employment in a way that further encourages part-time work has very different long-term impacts on wages, incomes and the government budget from doing it in a way that reduces the disincentive for full-time work.
• Compared with most developed nations, the UK’s benefit system provides little income protection against job loss. This is especially so for those on middle or high earnings, since those earnings typically buy them no additional support once they fall out of work, due to the UK’s reliance on means-tested, rather than earnings-related, payments. Families without children also have especially low earnings replacement rates, as their out-of-work benefit entitlements have barely changed in real terms for half a century while earnings have doubled. A single childless worker on average earnings in the UK can expect to receive 13% of their in-work income when they lose their job; across the OECD, the average is 55% (if they had been in work for a significant length of time). The growth of a significant in-work transfer system means that the system has shifted towards replacing lost income when a worker’s earnings decline (but they remain in work) and away from when they lose their job altogether.
• If the government wanted to strengthen the insurance it provides against job loss, there would be a number of options it could pursue without a wholesale move towards an earning-related benefits system. These options would include paying higher benefits early on in the jobless spell – perhaps by making them a function of past earnings for a limited period or by more closely linking initial entitlements to actual expenses (e.g. basing housing support on actual rent paid, and child-related support on the actual number of children in the family) – when pre-committed expenditures are especially hard to adjust.
• Imposing job-search conditions on claimants of out-of-work benefits (often known as ‘conditionality’) has become increasingly widespread. But the evidence suggests that the positive impacts of this, especially in the long term, are very arguable. Conditionality needs to be carefully justified with respect to clear goals, and carefully designed with those goals in mind. The extension of conditionality to many more single parents since 2008 has led many to move into paid work, but that work has been almost entirely part-time (fewer than 30 hours per week) and low-earning (in the bottom 40% of the overall earnings distribution). This is precisely the kind of work that tends to bring little or nothing in the way of longer-term benefits for skills, labour market attachment and wages. In combination with the fact that some lone parents have simply begun claims for health-related benefits instead (which come without the same conditions), this has meant that fiscal savings have been very minor. The jury is therefore still out on whether this kind of conditionality is achieving enough to be worth it, at least without effective schemes focused on human capital development running concurrently. Looking to the future, there is the additional issue that job-search requirements are focused on traditional employee work, and this may become increasingly outdated and hard to operationalise with continued increases in self-employment and the gig economy.
• Little is known about the impact of in-work transfers on wage levels – and so we do not know how many of the billions of pounds spent on them actually benefit the intended beneficiaries. It is entirely possible that these benefits, by encouraging people into work, allow employers to pay lower wages than they otherwise would. The available empirical evidence base on this is limited, but suggests that the effect might be significant. More evidence on this – and, crucially, on what other policies (such as the minimum wage) can help limit the unintended consequences for wages – would be extremely valuable. A very similar point applies to the impact of housing-related support on rent levels.
• Well over £10 billion of benefits goes unclaimed each year – but there is scope for changing this. Lack of information about benefits and the hassle or complexity associated with applying for them seem to be key reasons for non-take-up; the evidence on the role of stigma is thinner but what is available suggests that it is less important. Plenty of evidence suggests that simple interventions such as sending reminder letters to those who are likely to be eligible can be effective in boosting take-up, should a government want to do so. Moreover, the advent of ‘Real Time Information’ – where employers provide to HMRC frequent reports of employees’ earnings – could allow a greater role for ‘defaulting’ people into receiving benefits, or at least promptly informing them that they may be eligible. This is an area where experiments are feasible and likely to be fruitful – for example, by providing more information on the crucial issue of whether it is the neediest, or the least needy, that do not claim their entitlements, on which there is currently mixed evidence.

Cite this as:

Hoynes, H., Joyce, R. and Waters, T. (2023), ‘Benefits and tax credits’, IFS Deaton Review of Inequalities, https://ifs.org.uk/inequality/benefits-and-tax-credits