Yahoo Finance What Truss could save by linking benefits to pay instead of soaring inflation
Just days after escaping one rebellion by Tory MPs, Liz Truss was facing another brewing mutiny in the corridors of Birmingham’s ICC this week.
Truss bowed to a revolt over abolishing the top rate of income tax on the eve of her party’s annual conference but her hand could be forced again on the issue of benefits.
In a bid to reassure markets in the wake of the chaotic mini-Budget, Truss is considering whether she can tighten the purse strings by increasing benefit payments by average earnings rather than inflation. Such a move should help to soothe the concerns of international investors by helping to balance the books on the recent fiscal statement.
Increasing welfare payments by the lower rate of average earnings, rather than inflation, could save the Exchequer £11bn next year.
However, it also risks exploding tensions in her party.
Cabinet ministers are already breaking rank as Truss mulls the decision. House of Commons leader Penny Mordaunt said linking the Universal Credit increase to inflation - currently at a budget-squeezing 9.9pc - “makes sense” while Wales Secretary Sir Robert Buckland has also signalled his opposition to a stark real terms cut for benefit claimants.
“We want to make sure that people are looked after and that people can pay their bills,” said Mordaunt.
The Treasury is hunting for savings in the wake of Kwasi Kwarteng’s £43bn of unfunded tax cuts, which spooked markets with its plans to borrow more for the giveaways.
A fiscal plan to reassure investors is being drawn up by the Chancellor but economists warn “Osborne-levels” of spending cuts will be needed to help balance the books.
Analysts warn there is little fat left to trim off department budgets following the austerity era, meaning the axe may need to fall on benefits to find the estimated £37bn needed in order to have debt declining by 2026-27.
Rishi Sunak pledged to uprate benefits in line with inflation earlier this year when he ran the country’s finances but the new Chancellor has far less room to manoeuvre. Currently earnings growth including bonuses is almost half the inflation rate, at 5.5pc, meaning big savings could be made by tweaking the benefits pledge.
The Resolution Foundation estimates that increasing benefits by earnings growth rather than inflation would save the Exchequer £11bn in one year and £20bn over two. Alone, it is not enough to offset the tax giveaways but it could go some way to assuaging worries that the Chancellor has rolled the dice with the country’s finances.
Allan Monks, economist at JPMorgan, says the sustainability of the public finances “will likely require confirmation of spending restraint, and that is where the battleground between the administration, MPs and the media is now shifting.
“The Conservative leadership has repeatedly refused to rule out allowing inflation to produce real terms spending cuts, and in particular capping benefit increases below the rate of inflation. Policy in that regard is yet to be made explicit, and there will be clear political consequences as it is.”
It would save the Government billions of pounds but it may come at a heavy political price.
Tom Waters, economist at the Institute for Fiscal Studies, says: “Between 2015 and 2019, most working age benefits were frozen… but really going back quite a long way, there's been a policy of uprating by inflation.
“Taking in the round, the suite of tax cuts plus reductions in the benefit system is trying to do less redistribution than was done previously.”
Linking the increase in benefits to pay points to a large real term cut to the incomes of the poorest households and even many workers who receive state help.
The worst-off households are already feeling the effects of 40-year-high inflation hardest as they spend a higher proportion of their incomes on energy and food than richer households.
A squeeze on benefit payments would cost a single adult £391 in 2024-25 while a couple with two children would face a £1,061 hit, according to the Resolution Foundation.
Due to the lag between when the uprating is set and its introduction, these households have already felt a real terms squeeze on their incomes. Benefits rose 3.1pc in April 2022 but the rate of inflation had already accelerated to 9pc by that point.
A move to limit benefits would likely spark revolt within the Tory party, underscoring the fragility of the Truss administration. Former work and pensions secretary Iain Duncan Smith is one of a number of MPs to signal his concern.
He said at a fringe event at the Conservative Party conference: “I do see what will be gained by making sure that they have enough money through the winter. Because, as I say, that money will flow back into the economy at the very time that we need the economy to be growing.”
However, some in the party could back a move to curb welfare payments as it may encourage recipients to find work that will boost incomes.
Waters says: “Looking both in the UK and internationally it is the case that people respond to financial incentives around work so cutting out of work benefits does tend to push people into work.”
He adds that this incentivising effect is “real” but difficult to quantify and “more of a political judgement”
Cutting payouts in the middle of a cost of living crisis could also harm the party’s polling at a time when Labour is already on course to win a huge majority at the next election. YouGov’s polling indicates a 33-point lead for Labour over the Conservatives even before any potentially politically damaging spending restraints are announced.
“The uprate across benefits has huge implications for people’s wellbeing as well as their ability to meet their basic needs,” says Hannah Webster, head of research at the RSA.
“The value of benefits has steadily been in decline and is currently amongst the lowest in OECD countries. This latest announcement [would] push those most in need of an income increase into deeper insecurity.”
Truss’s decision on benefits could prove crucial to the longevity of her premiership as she tries to assure the electorate and investors. She could ultimately face a choice of who she can afford to anger: markets or voters.
