We seem to have killed poverty, possibly a the cost of a slight rise in inequality. Credit, House of Commons Library, Crown Copyright

Or at least, we’ve got to be very careful when claiming that welfare is a subsidy to employers. For it is not true that the majority of the welfare system allows employers to pay lower wages. It is only – and even then only potentially – true of certain parts of that system. Further, the general overall effect of the system is to increase the wages that must be paid.

Thus this complaint doesn’t work:

Welfare was meant to help the poor, not subsidise exploitative employers
Kenan Malik

As welfare doesn’t subsidise employers then we don’t need to worry about this specific complaint, do we?

How did we get to the stage where many classed as needy are actually in work?

That one’s easy to answer. We started to define needy as being a higher income than that produced by going out to work. If we do that then quite obviously many of those we class as needy will be those in work. Shrug, no great secret to it, is there? And have a look at the image above to show that we have indeed changed our definition of needy.

But it’s this which is so profoundly wrong:

Tax credits may be essential for allowing many in work to keep their heads above water. They also expose the reality of the benefits system. Welfare is largely discussed from the perspective of the recipient. For most on the left, it’s a necessity for those who require social support. For many on the right, it is a reward for fecklessness and a means of establishing a “dependency culture”.

In reality, the welfare system is an acknowledgement and an indictment of the inadequacies of the market system. Nothing reveals this more forcefully than the existence of the working poor and the creation of a welfare system to support them. The state is, in effect, subsidising employers so as to allow them to get away with paying indecent wages and unacceptable benefits. When business leaders and Tory politicians insist that better pay or conditions mean fewer jobs, what they are demanding is the right to provide jobs that are insufficient to live on and for the state to pick up the tab. There’s the real culture of dependency.


Firstly, consider the logic used here. If we abolished all of those welfare payments then, given that they are a subsidy to employers, said employers will raise the wages they pay as a result of the absence of the subsidy. No?

Cool – so, let’s abolish the welfare state and watch, gape mouthed, as wages soar.

Ah, we don’t think that will happen then? So, therefore, those welfare payments aren’t a subsidy then, are they? Not to employers at least.

Fortunately, an actual economist has gone through this for us. All we need to know is that working tax credits are akin to the EITC in the US. Child tax credits are not, for a reason we’ll come to:

A final line of argument is that these public assistance programs have become de-facto subsidies for low-wage employers. For a program to be a subsidy for an employer, it needs to lower wages. Is this plausible for the public assistance programs considered? I think it is for the EITC, but not for other programs. Depending on where one is on the EITC schedule, that policy can increase work incentives. And there is a lot of empirical evidence showing EITC encourages labor force participation. An unintended consequence of that labor supply response, however, is that employers capture some of the tax subsidies. This can happen in a simple supply and demand framework, where an increased labor supply to the market drive wages down. This can also happen in a bargaining context where the size of the bilateral surplus expands from lower taxes, and employers capture some of this increased surplus. Work by UC Berkeley’s Jesse Rothstein suggests that for every $1 of transfer to workers using the EITC, post-tax income rises only by $0.73 because of employer capture.

But what about other programs like food stamps or housing assistance? These means tested public assistance programs are not tied to work, and we should not expect them to lower wages. Let’s take food stamps, which are available to eligible families whether or not a family member works or not. Indeed, when people are not working, they are more likely to be eligible for food stamps since their family incomes will be lower. Therefore, SNAP is likely to raise, and not lower a worker’s reservation wages—the fallback position if she loses her job. This will tend to contract labor supply (or improve a worker’s bargaining position), putting an upward pressure on the wage. Whether or not wages are increased is an empirical matter: there is evidence that the initial roll-out of the food stamps program across counties in the 1970s lowered work hours, consistent with an increase in the reservation wage. The key point is that it is difficult to imagine how food stamps would lower wages. And if they don’t lower wages, they can’t be thought of as subsidies to low wage employers. The same logic applies to other means tested programs like energy or housing assistance. Moreover, these conclusions hold in a wide array of models of the labor market, including ones that emphasize bargaining or efficiency wage concerns.

As a short hand, benefits you get because you’re poor don’t lower wages, therefore cannot be a subsidy to employers. Benefits you only get if you’re in work, because you’re in work, can indeed lower wages and thus be a subsidy to employers. And a reasonable guess is that about 30% of those only in work benefits is such a subsidy.

Child tax credits do not depend upon working status. Thus they’re not such an employer subsidy. Working tax credits are but only partially. And given that working tax credits are in fact designed as a subsidy to get employers to hire low skill labour, thus alleviating some of the welfare burden from the taxpayers’ shoulders, this seems reasonable enough.

Oh, and that Universal Credit? It stops paying working tax credits so we’ve already solved this whole problem anyway, no?

It does go further though. If you get some money for not working – you can afford a stale crust both today and tomorrow without working – then the amount of money an employer has to offer to get you to come into work rises, doesn’t it? If no-work provides £100 a week then work must provide £101 at least, no? There’s no point in making the effort unless a second crust can be had, after all.

So, we think that perhaps 30% of the working tax credit bill (no, I don’t know, but call it £20 billion a year maybe, thus £6 billion in subsidy?) is a subsidy to employers in that it lowers the wages that must be paid. And everything else we pay in that welfare state of ours, some £400 billion by the time we include the NHS, education, housing benefit and the lot, increases the wages that must be paid to get people to come into work.

We’re not exactly subsidising low wage employers, are we? But, you know, if you want to abolish all that so that wages rise then we’re willing to watch the experiment.