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A Proposal to Fix Welfare and Fight Intergenerational Unfairness

21 May 2018

Diego Zuluaga

The Resolution Foundation recently proposed to introduce a
“citizen’s inheritance” of £10,000 in order
to offset the growing wealth gap between generations.

Free-market advocates did not welcome the report with open arms, and for good reason:
its authors seem to want to address what is at root a problem of
constrained housing supply and low productivity growth with redistribution.
Transfers may improve well-being among those made better off by the
grant, but it will not meaningfully lower house prices nor increase
the economy’s long-run growth potential.

Yet the authors are on to something with a proposal that
approaches a direct cash transfer early on in life. Perhaps
unwittingly, they have pointed to a more honest and rational way to
structure the welfare state.

At present, governments in rich countries provide tax-funded
benefits in complex and inefficient ways. Universities are
state-owned or heavily subsidised. Pensions nominally operate under
the contributory principle, even though pension payments are funded
by current expenditure, not the pensioners’ earlier
contributions.

Here’s a way to make the
welfare state freer, fairer and more transparent.

On their own, these programmes cause many distortions. The true
scale of the pensions commitment to future generations is hidden
from public sight by questionable accounting that wouldn’t
pass muster among regulators if attempted by a private firm.
More transparent analyses have estimated that
the UK would need to set aside 12 per cent of all future GDP in
order to meet its pension and other welfare commitments. For the
United States, the figure is 9 per cent.

Meanwhile, state-sponsored education lures many people into
spending time and money, often borrowed, pursuing degrees that do
little to boost their future earning potential. Student loan
liabilities in the US just passed $1.5 trillion. In Britain, they are
£100 billion and increasing rapidly.
Those who argue that higher education is a signal of ability rather
than a way to gain valuable skills even view public funding as a
net waste of resources, since easier access to
university only serves to blunt that signal without any real
productivity impact.

Some might say that the flaws of existing programmes provide
reason enough to abolish them altogether. But consider, as an
intermediate measure, taking the funds presently spent on old-age
pensions and giving them to people as they enter their adult lives.
It could be stipulated that the money may only be spent on
education, job training (such as internships, whether paid or
unpaid), retirement saving or, more questionably, a home purchase.
Alternatively, people could be left free to decide how to use the
funds.

A direct cash grant in replacement of pay-as-you-go pensions
offers many benefits relative. First, it is fairer than the present
system, which pays out to people according to how long they live
rather than how much they contributed. This system would enable
accrued wealth to pass to one’s heirs in the event of premature
death.

Second, an upfront payment would bring into the reach of all the
benefits that the welfare state aims to make available, without the
paternalism associated with present arrangements. Unlike current
policy, what to do with the money would be for the recipient to
decide, within the limits defined by the programme.

Third, the reform would bring the welfare state into the
government’s annual budget, forcing elected officials to grapple
with the need to finance any increase in cash outlays. No longer
could politicians pay for today’s votes with the taxes of
tomorrow’s voters. In one fell swoop, the policy would make the
welfare state fairer, freer and more transparent. What’s not to
like?

One might object that such a programme would be far too costly
to be implemented at a time of budgetary restraint. But the figures
don’t look quite so daunting when one runs the numbers: assuming a
retirement age of 67 and a life expectancy of 87, real growth -
after inflation - of the basic state pension of 1.5 per cent, and
the Resolution Foundation’s own conservative estimate of 3.6 per
cent real asset growth, the average lifetime pensioner payments
amount to £36,250.

In other words, given the above assumptions, the Treasury would
need to transfer £36,250 to each individual in order to
assure him or her of an amount equal to pension receipts over an
average lifetime.

How much would that amount to in aggregate? The Office for National Statistics estimates that
between 700,000 and 800,000 people will turn 25 each year in the
coming two decades. This yields an annual outlay of £27.2
billion, which sounds like a lot until we put it in context. It
would amount to 10 per cent of the government’s current social
protection budget. It would be less than annual expenditure on
housing or transport policy.

The programme would still account for 3 to 4 per cent of the
budget, but remember that it would replace other schemes, such as
the state pension and much public support for higher education. In
a context of chronically underfunded long-term welfare commitments,
this reform would probably save money.

It would doubtless pose short-term challenges. The most salient
among them is the transition from the current system, in which
people expect future payments in exchange for today’s
contributions, and what to do with the over-25s who are far from
retirement.

One option is to compensate them in proportion to their age and
the contributions made so far. However, if the idea is to increase
intergenerational equity in a context in which older people have
benefited from a constrained housing supply, handing them cash in
addition to their home equity growth defeats the purpose.

Another challenge is to ensure that the proposal is a
replacement, not a supplement, to the current pension system. It
would certainly be undesirable to find ourselves with an additional
expenditure item at a time of high effective marginal tax rates and
high spending, without phasing out other costly and distortionary
policies.

Yet, even with these hazards, a reform that increases choice,
distributes benefits more fairly and forces greater fiscal prudence
on politicians will go some way to address the glaring deficiencies
of the welfare state.

Diego
Zuluaga
is a policy analyst at the Cato Institute’s Center for
Monetary and Financial Alternatives.

Click here to view the full article which appeared in CATO Journal