I am going to focus my talk on the research we do at the Institute for Fiscal Studies. What I want to discuss is work on reforming the tax and benefit system. This is an important area of work at the Institute and I want to look at this work in the light of recent reforms in the U.K., U.S.A. and Canada. Of course, there have been lots of reforms to the tax and benefit system. I want to concentrate my discussion on the concerns that people have about the welfare system as it affects those who are not in employment, and the issue of how best to get those types of individuals, or welfare recipients, into the labour market. It is the most important issue, in some sense, in the design of welfare systems and it is a red hot policy issue.
The problem with systems designed to relieve poverty among particular target groups of families - in particular, single parents - is that as these individuals start to earn, then there is typically an implicit tax rate of close to 100% in most welfare systems. Effectively, there is a dollar for dollar loss on the welfare benefit as earnings rise. In addition, in-kind transfers like free medical services, free dental care, free medical prescriptions, and subsidised housing are often lost with a move into employment.
What I want to focus on then, in light of these concerns, is the move in the policy debate towards the use of in-work benefits. This is a topic that has been of interest on both sides of the Atlantic, and especially in the U.S. and the U.K. Coincidentally, there is a big debate going on in Canada right this minute and I'll try to refer to Canadian evidence as I am discussing this topic. The idea is to make work pay for individuals who are welfare recipients. The difficulty in the design of welfare reforms that attempt to achieve that goal is to avoid too large a reduction in the income of individuals who either can't find work or are not able to work.
Before I discuss the types of reform, I want to put these reforms within the context of the 1990s. Quite important things have been changing in the economic environment, especially in the labour market. And it is only within the characteristics of this environment that you can begin to understand how this kind of welfare reform is going to operate. One characteristic we are familiar with is the shift in demographic patterns. There are now more retired people and more single parents. In addition, there is a remarkable shift in returns to education and skill; in particular, declining real wages for individuals who are less educated or less skilled. For example, in the U.S. even median real earnings have fallen yearly since the late 1970s. And the lower deciles have fallen yearly since around 1974 or 1975. That characteristic is quite exaggerated in the U.S., but it is nonetheless common to most developed countries and those with low skills are exactly the type of people you find in the welfare system. Welfare recipients have found a continuously falling return to being in employment, certainly over the last 15 years.
In addition to that, we have seen an increase in income uncertainty, with higher chances for people to have repeat low income spells. On top of this, there are certain factors that bear on the cost of living for these individuals. In particular, one thing I'll focus on with regard to the U.K. - but I am sure it is true in Vancouver and lots of other North American cities - is increasing housing costs, especially among low income households. Typically in welfare programmes, some housing assistance is given, and so one can find individuals in cities, such as London, with quite high welfare benefits covering, to a large extent, their housing costs. With a lowering of the real returns for individuals who are less skilled - exactly the group on welfare - there is a dual problem of a falling return from employment and an increasing level of benefit through welfare …