Fun with numbers: the optimum marginal withdrawal rate for welfare payments

HMRC publish a useful table showing the number of taxpayers by each band of income and type of income (Table 3.4 from here).

You can knock out all the pensioners and add on another 13.5 million working age people with an assumed income of nil to bring it up to 39.2 million working age people (aged 18 to 64).

Then, assuming no changes in behaviour and that you want to stick to the current total annual welfare spending bill (incl. Housing & Council Tax Benefit plus value of the personal allowance for this age group) of £160-billion a year (figures from the Citizen's Income Trust booklet from here), there's a trade-off between how much the basic welfare payment is and what sort of marginal withdrawal rate you need.

For example, you could simply give every adult £4,100 as a combined tax rebate-sum-welfare payment and have done with it. Or you can have a higher base amount but then to keep spending down you have to have some sort of income-based withdrawal rate, which acts like a second layer of income tax as far as work incentives are concerned.

By trial and error, we arrive at the following figures:

£4,100 - no withdrawal required
£5,000 - 5% withdrawal rate
£6,000 - 12%
£7,000 - 20%
£8,000 - 30%
£9,000 - 45%
£10,000 - 65%
£11,000 - 100% (for every £1 you earn, you lose £1 in welfare)

Clearly, in terms of cold-hearted incentives, the flat rate £4,100 is best. Very few people will be able to/be paid to sit round doing nothing and there is no disincentive to working and earning more. But a lot of people (possibly most people) who are out of work aren't really to blame and you can't let people starve either, even if they are. Ho hum.

The £10,000 with a 65% withdrawal rate is pretty much how our welfare system is set up (the £10,000 includes e.g. income support + Housing and Council Tax Benefit) and clearly this is a piss-poor way of doing things. The Housing Benefit just goes straight to landlords as higher rents, it creates a poverty trap, disincentives work and erodes social cohesion.

So for a start, we could get rid of the ear-marked benefits like Housing and Council Tax Benefit and have a single welfare payment (aka Universal Credit), if some or most of it goes on rent, then so be it.

Now, the reason why means-testing is so particularly damaging is because it is on top of income tax. If we had no income tax (or NIC or VAT) at all (and everything were funded out of Land Value Tax, fuel duty, bank asset tax etc) then I can see the argument for having a higher basic welfare payment and means testing.

As a fair sort of compromise, we could go for £7,500 a year (£150 a week, same as the Pensions Credit rate, thus eliminating another set of complications) and a 25% withdrawal rate, so if you claim it, then you have 25% income tax deducted at source from your wages etc. If you don't claim it (out of principle or because you earn so much that you wouldn't get anything anyway), you just get paid out gross.

I guess this ought to keep the proper Red Socialists happy (those who want to "focus welfare spending on the most vulnerable") and also keep the Blue Socialists happy (the Home-Owner-Ists), because assuming two people sharing a home and a full-on LVT-only tax system, their combined £15,000 welfare payment would be enough to pay the LVT on about two-thirds of all homes. They might choose to use up their whole welfare entitlement on a detached house in a cheap area, a terraced house in a nice area, a semi-detached in a very nice area or a flat in an expensive area, that's their decision. If they have little earnings capacity, they can move to a small flat in a cheap area and have enough money left over to pay for basic living costs.

Just sayin', is all.