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July 19, 2021

Stimulus spending can’t go on forever – but cutting Universal Credit too early risks derailing the economic recovery just as it gets going

It is clear that the Universal Credit (UC) uplift of £20 per week has improved the living standards of the UK’s worst-off households since it was implemented in March 2020, helping many to stay above the poverty line. Cebr’s Income Tracker research – conducted with ASDA – confirms this, showing that the increased value of social security has been a key driver of higher discretionary income amongst the poorest 40% of households. In one of several examples of the diverging impacts of the pandemic on different demographics, the increase to discretionary income amongst poorer households has been less marked than for those at the other end of the income scale. The pockets of richer households have benefitted from curtailed social opportunities, cutting back on more ‘luxury’ spending, enabling an even greater proportion of their income to be saved.

It is therefore unsurprising that the Government has raised the alarm bells of the opposition when it was announced that the uplift would be phased out at the end of September. The Chancellor became one of the best liked politicians during the crisis and it is probably fair to say that his role propping up the economy by spending vast sums of money has been conducive to this. However, with the economic recovery underway, the Chancellor may have to prepare for plummeting approval ratings if the taps are turned off too soon.

The standard arguments around the correct level of benefits are well known. The state needs to balance economic incentives for people to find work with its mandate to care for its citizens and provide a social safety net. In the context of the ongoing Covid-19 pandemic, arguments can be found for both sides.

The argument that higher benefit payments disincentive work is strengthened when considering other recent policy changes. The decision to freeze the personal allowance on income tax stands out here, which will be held at its current level of £12,570 until at least April 2026. This will have multiple effects, including increasing the size of the income tax paying base, as earnings grow. Importantly, the real value of the allowance will reduce over this period, being eroded by inflation. The impact of this will be particularly stark amongst those at the lower end of the income scale, given that the personal allowance makes up a greater proportion of their total income. Coupling this with a higher value welfare offering could have reinforcing effects, encouraging certain people out of the labour market.

There is also the argument that the uplift should be withdrawn as a step towards cutting the deficit. Public debt has spiralled as a consequence of the Government’s reaction to the crisis and fiscal hawks will want to see a return to balanced budgets sooner rather than later. However, the risk is that dialling down fiscal spending too quickly will hurt the prospects of the economic recovery, which of course also has a cost in the form of lower tax revenues. There is also the question of societal fairness and whether it should really be the least well-off who are among the first to shoulder the cost of fiscal retrenchment. This is especially pertinent given the unequal impacts of the pandemic so far. The fact that job losses amidst the pandemic have been heavily concentrated amongst lower-paid occupations, while richer households have seen their wealth enhanced through inflated asset prices represent just two sources of such divergence.

A further case against the planned withdrawal of the uplift concerns the outlook for the labour market. An increase in joblessness is anticipated upon the full termination of the furlough scheme at the end of September, with Cebr forecasts pointing to a peak unemployment rate of 5.8% in Q4. The rise in unemployment will be a drag on the economic recovery and aggregate demand. This could be further exacerbated by a UC cutback, by reducing consumption levels amongst claimants and potentially encouraging non-claimants to spend less, in the face of heightened uncertainty and a weaker fallback position.

Ultimately, the crux of this argument centres around the need to support the most vulnerable individuals, while acknowledging the potential consequences to the wider economy. They are not always opposing factors. Especially in the current context, it seems that a premature cut to UC would lower the spending power of millions of claimants just when the economy is emerging from the most severe recession in recent history. Nevertheless, it is unlikely that such heightened government spending can go on forever. To balance these competing requirements, one option would be to keep the uplift in place for slightly longer, supporting livelihoods amidst the ongoing uncertainty, while also supporting the wider economic recovery through increased consumption levels. A tapered withdrawal once the impacts of the furlough scheme termination have weakened would then go some way to avoiding adverse longer-term impacts on the labour market.

For more information please contact:

Sam Miley, Economist smiley@cebr.comphone: 07710 083652

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