Are large benefit increases wise in a recession?

Benefit rates are set to rise substantially next month. State pensions will rise by 5%, while means-tested payments, such as Jobseeker’s Allowance, will rise by 6.3%. The new rates, based on the Retail Prices Index (RPI), were determined in September 2008, when inflation peaked, but now represent significant increases in real terms.

Higher welfare spending will push the public finances even further into the red. The prospect of yet more government borrowing and tax rises in the future could undermine economic confidence and deter investment in the UK.

Moreover, at a time when many workers are being made redundant and others are facing pay cuts, higher out-of-work benefits will reduce the financial incentives for jobless people to take employment, particularly since in many cases they will also be entitled to Housing Benefit, which pays their rent. Combined with the minimum wage and restrictive employment regulation, this is likely to make the surge in unemployment even worse and condemn many more people to a life of welfare dependency.

It could be said that “rules are rules” and it is just an unfortunate coincidence that benefit levels were set in a “freak” month for RPI. However, imagine inflation had fallen to -5% last September before rising to become positive again in April 2009. Is it credible that the government would have imposed benefit cuts?

12 March 2009, IEA Blog

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