Welfare payments to be linked to inflation: Varadkar

http://www.irishtimes.com/news/ireland/irish-news/social-welfare-to-be-linked-to-inflation-under-varadkar-plan-1.2729649

Minister for Social Protection Leo Varadkar has said he intends to link social welfare rates to the cost of living or average earning to ensure that people dependent on the payments do not see their standard of living fall in the future.

Most fair-minded people will read this and think 'that's a good idea'. After all, if welfare payment rates remain constant during a period of inflation, household income will fall in real terms. A mechanism to keep welfare payments constant in real terms would be broadly welcomed.

But I'm not convinced this is a good idea.

First of all, working-age income supports are supposed to be temporary measures, and we should start looking at disability payments in a similar vein. The focus ought to be on accommodating as many people as is reasonably possible in the workforce. Healthy people of working age. and disabled people who can do some work, shouldn't be remaining on income support long enough to notice a substantial cut in real income.

If they are, we have a bigger problem, which is where our focus ought to be.

Secondly, I'm wary of linking welfare payments to indices like the CPI, or a similar index, since they are slow to respond to changes in consumer behaviour, or do not respond at all. For example, if I lose my job tomorrow, I'll stop buying my typical shampoos and aftershaves. I'll shop more frequently in Aldi or Lidl. I might sell my car and cycle more regularly. My life probably won't change very much, but I'll achieve a similar level of utility through lower spending.

Thirdly, Ireland has already lost enough control of its fiscal policy without adding indexation of current spending. We spent about €18 billion euro on (ongoing) welfare payments in 2014.

A increase in welfare transfers in the amount of 2% would be an automatic increase of €360 million in government expenditure, even if the economy didn't grow that much, and even if it were not matched by a corresponding tax take.

This is why I believe indexation of welfare payments is unwise. At a time when other governments are pulling-back on indexation of welfare payments, I would argue the Government should desist from pursuing it altogether.

This government is increasingly resembling the Fianna Fail of the old days.

Iftheyshutmeup

Funny how house price inflation is never included...

So what happens if we move into a period of deflation (which we seem to be in my opinion)...Will he publicly lower welfare just to keep it in check with deflation?

K-9

Aye, as long as rates are reduced during periods of deflation I'm not against it. Long term unemployment is a big issue but I don't think it is necessarily linked to indexation, we should have schemes targeting it anyway whether we have it or not.

Welfare rates were cut by €10 a week in 09 IIRC, about a 5% cut to the standard rate so maybe reductions would be accepted grudgingly!

Suryavarman

I believe policy would be a bad idea. Being able to reduce real incomes through inflation can be a very helpful tool to have. It's a lot easier to reduce the real value of welfare payments than the nominal value. This is important when fiscal adjustments need to be made.

Iftheyshutmeup wrote: »

Funny how house price inflation is never included...

So what happens if we move into a period of deflation (which we seem to be in my opinion)...Will he publicly lower welfare just to keep it in check with deflation?

House price inflation is included in the CPI as part of division 04.

Should house price inflation be included when considering welfare payments?

Iftheyshutmeup

Iftheyshutmeup wrote: »

So what happens if we move into a period of deflation (which we seem to be in my opinion)...Will he publicly lower welfare just to keep it in check with deflation?

K-9 wrote: »

Aye, as long as rates are reduced during periods of deflation I'm not against it.

I'm open to correction, but I don't believe this is how it works in the U.K. Automatic inflation adjustments are upward only.

Although I'm against this proposal overall, if it does go ahead, I can see the logic in upward-only adjustment.

Very often, the last thing you want in a time of deflation is for people to curtail their household spending.

andrew

A Tyrant Named Miltiades! wrote: »

First of all, working-age income supports are supposed to be temporary measures, and we should start looking at disability payments in a similar vein. The focus ought to be on accommodating as many people as is reasonably possible in the workforce. Healthy people of working age. and disabled people who can do some work, shouldn't be remaining on income support long enough to notice a substantial cut in real income.

I don't see how indexing them implies that the measures aren't meant to be temporary?

Secondly, I'm wary of linking welfare payments to indices like the CPI, or a similar index, since they are slow to respond to changes in consumer behaviour, or do not respond at all. For example, if I lose my job tomorrow, I'll stop buying my typical shampoos and aftershaves. I'll shop more frequently in Aldi or Lidl. I might sell my car and cycle more regularly. My life probably won't change very much, but I'll achieve a similar level of utility through lower spending.

The CPI incorporates a huge variety of prices. If inflation over the past 10 years has been 10%, chances are most of the stuff you buy, be it from lidl or elsewhere, has gone up by a similar amount.

Thirdly, Ireland has already lost enough control of its fiscal policy without adding indexation of current spending. We spent about €18 billion euro on (ongoing) welfare payments in 2014.

A increase in welfare transfers in the amount of 2% would be an automatic increase of €360 million in government expenditure, even if the economy didn't grow that much, and even if it were not matched by a corresponding tax take.

It would be always be matched by an increase in the tax take though, since the tax take is a function of nominal prices; nominal prices rise --> taxes rise.


The whole point is that when we set a benefits at a certain level today, we're implicitly saying 'people on benefits should be able to purchase x.' If you don't index them to inflation, then it means that in 5-10 years time, people on benefits won't be able to purchase X, but a fraction of it. What gives? We already decided they should be able to buy X, so why not ensure they'll always be able to do so?

andrew

andrew wrote: »

I don't see how indexing them implies that the measures aren't meant to be temporary?

What I'm referring to here is the Minister's statement that he never wants to see a person on welfare see the value of their welfare eroded.

Now, in my view, nobody ought to be on work-related welfare benefits long enough to see a noticeable decrease in the real value of their income. If they are, there's probably something wrong.

By all means, we ought return to welfare rates on a regular basis and have a national discussion about how welfare rates ought to reflect recent macroeconomic changes, the price index, economic forecasts, and public values. But I'm opposed to most forms of automatism that curtails the Exchequer.

The CPI incorporates a huge variety of prices. If inflation over the past 10 years has been 10%, chances are most of the stuff you buy, be it from lidl or elsewhere, has gone up by a similar amount.

Sorry, but no; low-income and high-income households experience different rates of price inflation. A big increase in inflation of luxury products and houses can have a major effect on the price index, and will not automatically reflect the prices paid for a basket of goods in a poor household.

It would be always be matched by an increase in the tax take though, since the tax take is a function of nominal prices

No, if CPI rises by 2%, the tax take absolutely can fall. This might be reasonably unusual but it's been known to happen. Prices can rise but VAT will still fall if demand drops. If the price of grain rises by 10% this year, and demand falls by 20%, the VAT return will diminish, output will fall, and the tax take will diminish. It absolutely is not true to suggest that a rise in CPI guarantees an increased tax return.

The whole point is that when we set a benefits at a certain level today, we're implicitly saying 'people on benefits should be able to purchase x.' If you don't index them to inflation, then it means that in 5-10 years time, people on benefits won't be able to purchase X, but a fraction of it. What gives?

I'm simply saying that we should adjust the welfare budget based on an informed and rational discussion, not be bound by automatism.

Let me also point out, although it is scarcely relevant to the facts, that I'm not approaching this from some neoliberal, anti-Welfare perspective. I believe that an ongoing discussion about public expenditure needs to be deliberative, as well as any discussion about welfare transfers, and, for example, why it is that workers are not paid living wages.

Consigning welfare rates to faceless indexation is to make background noise of a very important public conversation.

andrew

A Tyrant Named Miltiades! wrote: »

What I'm referring to here is the Minister's statement that he never wants to see a person on welfare see the value of their welfare eroded.

Now, in my view, nobody ought to be on work-related welfare benefits long enough to see a noticeable decrease in the real value of their income. If they are, there's probably something wrong.

We probably just disagree on this point, but I feel like that there are lots of long term unemployed people or disabled people who are in that situation unwillingly. Even if there aren't a lot, and there are just a large minority, I feel like those people shouldn't see their standard of living decline due to inflation.

Sorry, but no; low-income and high-income households experience different rates of price inflation. A big increase in inflation of luxury products and houses can have a major effect on the price index, and will not automatically reflect the prices paid for a basket of goods in a poor household.

Regarding that bolded bit, no it can't. Do you know how the HICP is constructed? It takes various consumer types and shops into account. See here.

No, if CPI rises by 2%, the tax take absolutely can fall. This might be reasonably unusual but it's been known to happen. Prices can rise but VAT will still fall if demand drops. If the price of grain rises by 10% this year, and demand falls by 20%, the VAT return will diminish, output will fall, and the tax take will diminish. It absolutely is not true to suggest that a rise in CPI guarantees an increased tax return.

Inflation without output growth is very rare. See this chart for example for the USA, but it's true in most places. Output growth and inflation generally go hand in hand, not least because central banks contrive to make it so. The example you've constructed is also wrong, since you're first reasoning from a price change (as in, is the price of grain rising due to increased demand or decreased supply? Why would output fall just because prices rise? Just saying the price has gone up and then saying people will buy less is getting the order in which things happen wrong and doesn't make much sense). Second, inflation is a general increase in the price level, not a single good, so it doesn't make sense to talk about just grain in this context.

I'm simply saying that we should adjust the welfare budget based on an informed and rational discussion, not be bound by automatism.

Let me also point out, although it is scarcely relevant to the facts, that I'm not approaching this from some neoliberal, anti-Welfare perspective. I believe that an ongoing discussion about public expenditure needs to be deliberative, as well as any discussion about welfare transfers, and, for example, why it is that workers are not paid living wages.

Consigning welfare rates to faceless indexation is to make background noise of a very important public conversation.

The point of indexation is to make sure that the welfare budget remains constant and isn't adjusted arbitrarily by inflation. As it currently stands, we're reducing the real welfare budget every year by the amount of inflation without any informed and rational discussion whatsoever. The status quo is the situation you fear! If we index it, we can actually have a meaningful discussion about what kind of living standards we want people on welfare to have instead of obfuscating the discussion by having to manually take into account inflation every couple of years. Indexation gets you exactly the kind of conversation you want!

andrew

andrew wrote: »

Sorry, but no; low-income and high-income households experience different rates of price inflation. A big increase in inflation of luxury products and houses can have a major effect on the price index, and will not automatically reflect the prices paid for a basket of goods in a poor household.

Regarding that bolded bit, no it can't.

Incorrect. If the higher-spec products across a commodity group rise sharply, and the lower quality goods in the commodity group remain static, or fall very slightly, the average price level in that commodity group will rise.

As the price of the high-quality goods rises, poor people will substitute those goods with cheaper goods. This is referred to, as I hope you know, as substitution bias. This is Inflation 101.

Different households experience different rates of inflation depending on their economic status. This has been researched and demonstrated by the E.S.R.I
https://www.esri.ie/news/new-research-note-examines-changes-in-inflation-rates-across-income-groups/

Another major problem in price indices is that of quality-adjustment bias. I rarely use a P.C., preferring to use a phone or ipad. But statisticians still record price level of near-obsolete technology, or that which is slowly fading from popularity. VHS recorders were only recently removed from the basket of goods in the U.K. In an increasingly innovative society, CPI is becoming clunky and less reliable.

See the Boskin Commission report for a more indepth critique of how badly the CPI measures inflation.

Inflation without output growth is very rare

That's true. However, you said the price rise would "always be matched". lets move briefly from the realm of economics to economic history. From 1983 to 1989, when Nigel Lawson was Chancellor of the Exchequer, inflation was frequently rising twice the rate of economic growth, going as high as 11% in 1990,at which point the economy promptly tanked, resulting in a serious current account deficit and a painful recession.

Here's the lesson: not only does inflation fail to move in line with economic growth and government revenue, any automated system that we might introduce whereby welfare transfers are linked to inflation, is itself inflationary.

I have already linked to an E.S.R.I. research which shows that poor households experienced less price inflation than the headline rate of inflation throughout the Celtic Tiger period. Imagine we had automatic inflation-linked welfare spending at that time. Not only would we have experienced higher average inflation through higher welfare spending, the increases would not have been justified, and there would have been uproar if any Minister had attempted to curtail those increases. I daresay the current account deficit would have been a lot worse, and welfare cuts would have been a whole lot deeper.

Just saying the price has gone up and then saying people will buy less is getting the order in which things happen wrong and doesn't make much sense).

Prices rise for all sorts of reasons, especially so in a global market. I really don't think this needs elaboration to a mod of the Economics forum. Of course prices can rise and demand can fall when that product is substituted or simply abandoned.

If there is a global tea shortage and the price of Lyons' Tea rises by 50%, Paddy will drink coffee, or he may stop drinking tea altogether.

The point of indexation is to make sure that the welfare budget remains constant and isn't adjusted arbitrarily by inflation.

Knowing what we know about the shortcomings of inflation measurements, I wonder which is more arbitrary. Any major change in government spending must be carefully considered having regard to the economic outlook, the price index (and in particular, how it applies to poorer households), and economic growth. We are only now recovering from a serious economic catastrophe, and we must not return again to driving this economy into the ground by failing to look around us.

andrew

A Tyrant Named Miltiades! wrote: »

Incorrect. If the higher-spec products across a commodity group rise sharply, and the lower quality goods in the commodity group remain static, or fall very slightly, the average price level in that commodity group will rise.

As the price of the high-quality goods rises, poor people will substitute those goods with cheaper goods. This is referred to, as I hope you know, as substitution bias. This is Inflation 101.

Different households experience different rates of inflation depending on their economic status. This has been researched and demonstrated by the E.S.R.I
https://www.esri.ie/news/new-research-note-examines-changes-in-inflation-rates-across-income-groups/

Another major problem in price indices is that of quality-adjustment bias. I rarely use a P.C., preferring to use a phone or ipad. But statisticians still record price level of near-obsolete technology, or that which is slowly fading from popularity. VHS recorders were only recently removed from the basket of goods in the U.K. In an increasingly innovative society, CPI is becoming clunky and less reliable.

See the Boskin Commission report for a more indepth critique of how badly the CPI measures inflation.

First, that ESRI paper finds no difference in inflation over the full time period under consideration. They find differences when you split the time periods into two, but it evens out in the end. Second, the differences the ESRI find are attributable to housing costs because lower incomes tend to rent, not generally different consumption patterns as you suggest. So if it really was that big an issue, the government could use an adjusted CPI with which to index payments; I think the UK does this. In any case, looking at figure 5 from that paper, the difference doesn't seem to be that huge as to make the policy worthwhile.

Regarding quality adjustment, yeah this is a notoriously hard thing to capture in inflation figures, though a lot of work goes into adjusting for quality. Just because the CPI isn't perfect doesn't mean it's utterly useless for indexing welfare payments though, and as I note below, it can be altered to suit its use.

That's true. However, you said the price rise would "always be matched". lets move briefly from the realm of economics to economic history. From 1983 to 1989, when Nigel Lawson was Chancellor of the Exchequer, inflation was frequently rising twice the rate of economic growth, going as high as 11% in 1990,at which point the economy promptly tanked, resulting in a serious current account deficit and a painful recession.

Here's the lesson: not only does inflation fail to move in line with economic growth and government revenue, any automated system that we might introduce whereby welfare transfers are linked to inflation, is itself inflationary.

OK, not always be matched then; almost always matched. I don't think a situation which happens as rarely as stagflation is a very strong basis for a policy decision, especially given the advances in monetary policy over the past 30 years and anchoring of inflation expectations, which have made high inflation pretty unlikely. Also, my limited reading suggests that not even wage indexation increases inflation, so I doubt welfare payment indexation would. The welfare payment are reacting to inflation, not causing it; and if inflation were to get absurdly high, the ECB sorts that out.

I have already linked to an E.S.R.I. research which shows that poor households experienced less price inflation than the headline rate of inflation throughout the Celtic Tiger period. Imagine we had automatic inflation-linked welfare spending at that time. Not only would we have experienced higher average inflation through higher welfare spending, the increases would not have been justified, and there would have been uproar if any Minister had attempted to curtail those increases. I daresay the current account deficit would have been a lot worse, and welfare cuts would have been a whole lot deeper.

Inflation wouldn't have been much higher, because there's not much evidence indexation causes it. Not only that, but the number of people on welfare at that time was relatively low. Even if the CPI overstates inflation for poorer people, it's still true that those people were seeing the value of their welfare fall for no good reason, and they were entitled to some sort of increase.

Prices rise for all sorts of reasons, especially so in a global market. I really don't think this needs elaboration to a mod of the Economics forum. Of course prices can rise and demand can fall when that product is substituted or simply abandoned.

If there is a global tea shortage and the price of Lyons' Tea rises by 50%, Paddy will drink coffee, or he may stop drinking tea altogether.

My point was just that you can't make an argument on the outcome arising from a price change without knowing what has caused that price change. If there's a global tea shortage, the supply curve shifts left. Prices rise and the quantity demanded falls. If people suddenly demand more tea in general for whatever reason, the demand curve shifts right; the quantity demanded increases, as does the price. You can't reason from a price change.

Knowing what we know about the shortcomings of inflation measurements, I wonder which is more arbitrary. Any major change in government spending must be carefully considered having regard to the economic outlook, the price index (and in particular, how it applies to poorer households), and economic growth. We are only now recovering from a serious economic catastrophe, and we must not return again to driving this economy into the ground by failing to look around us.

I think it's pretty safe to say not using some sort of price index, is more arbitrary than using a price index. Use a price index which excludes the stuff rich people buy if you have to. The recent economic catastrophe had nothing to do with giving poor people too much money.

Geuze

Suryavarman wrote: »

House price inflation is included in the CPI as part of division 04.

They are not.

Division 4 refers to the costs of running a house:

rents
mortgage interest
repairs
water supply
elec, gas, other fuels

House prices are asset prices, these are not part of the CPI, and should not be part of the CPI.

House prices are tracked in another index:

http://www.cso.ie/en/releasesandpublications/er/rppi/residentialpropertypriceindexjune2016/

andrew

andrew wrote: »

First, that ESRI paper finds no difference in inflation over the full time period under consideration

I'm finding it increasingly difficult to keep track of your goalpost-shifting. You started out by defending the CPI, and dismissing the possibility of different rates of inflation between high and low-income groups.

Now, you appear to accept that it happens, but your new argument appears to be that it has balanced out over one randomly selected time-period?

We're talking about welfare transfers here. I have been specifically addressing work-related welfare transfers. Very few people have been on work-related benefits for eleven years.

Most people stay on these particular benefits for a few months, so they shouldn't notice much change in their real income on welfare. Pensioners would notice a difference on a multi-annual basis, but that could be addressed 'manually', as it always has been (and our pensioners are very well looked after by European standards).

But when you spend €18.7bn per annum on welfare transfers, as we in this country do, a 1% error translates to a €187 million error in a single year (excluding administration and salaries). Even half that amount would be a shocking waste of public money.

The CPI is simply too blunt an instrument to use when dealing with these colossal figures.

OK, not always be matched then; almost always matched. I don't think a situation which happens as rarely as stagflation is a very strong basis for a policy decision

We don't even have to be as dramatic as stagflation.

Imagine a small, open economy called Siliconia, whose economy is growing at a slow and steady pace of around 2-3%, and where unemployment is low; but where inflation is running at 5-6%, because of unit-wage inflation and/or global factors (higher oil prices); and/ or fiscal/ monetary considerations (internal devaluation or currency depreciation), presuming that the price elasticity of demand is relatively inelastic (Siliconia has a weak manufacturing base, and its economy is based heavily on tourism, I.T., and financial services; productive capacity cannot keep pace with aggrregate demand)

One could further complicate that scenario by positing that Siliconia has a very low corporation tax rate as well as a very malleable tax law, which allows a lot of MNCs to shunt their profits into offshore havens. Therefore the GDP of Siliconia, and its tax receipts, do not reflect headline economic activity.

Of course, if you really want a contemporary example of the disparity between economic growth, Exchequer receipts and inflation just look to Ireland in 2015.

The economy grew by 26% (lol), Exchequer receipts grew by 10.5%, and CPI fell by 0.3%!

Presumably you'd be cutting pensions, illness benefits, and the dole this year, if you were in power?

After all, I'm not coming at this problem from some sort of ideological opposition to welfare benefits. I don't think I've ever been accused of being remotely right-wing. This policy can hurt the poor as much as it can benefit them. It's a lottery.

But it's fundamentally an unreliable system, is replete with unfairness, and is liable to waste public resources.

Varadkar is pushing this populist nonsense because he wants to be the next Taoiseach of Ireland. There is no sensible economic basis for implementing this policy in Ireland.

andrew

A Tyrant Named Miltiades! wrote: »

I'm finding it increasingly difficult to keep track of your goalpost-shifting. You started out by defending the CPI, and dismissing the possibility of different rates of inflation between high and low-income groups.

Now, you appear to accept that it happens, but your new argument appears to be that it has balanced out over one randomly selected time-period?

Well yeah, if the data says it happens I'm going to say it happens. I'm not wedded to the idea of being right. But I think it's valid to point out that that paper doesn't show much of a difference on aggregate.

We're talking about welfare transfers here. I have been specifically addressing work-related welfare transfers. Very few people have been on work-related benefits for eleven years.



Most people stay on these particular benefits for a few months, so they shouldn't notice much change in their real income on welfare. Pensioners would notice a difference on a multi-annual basis, but that could be addressed 'manually', as it always has been (and our pensioners are very well looked after by European standards).

I'm not understanding why it matters how long people stay on these benefits. We/I want people in general to have the same standard of living over time. That might apply to an individual, or equally to person 1 at time x and person 2 at time y; those people should get the same level of benefits.

But when you spend €18.7bn per annum on welfare transfers, as we in this country do, a 1% error translates to a €187 million error in a single year (excluding administration and salaries). Even half that amount would be a shocking waste of public money.

The CPI is simply too blunt an instrument to use when dealing with these colossal figures.

But the status quo is that we definitely are making those kind of errors every year by not adjusting it, except those errors mean people get less money so people don't mind! I'd rather erroneously pay people too much than too little.

We don't even have to be as dramatic as stagflation.

Imagine a small, open economy called Siliconia, whose economy is growing at a slow and steady pace of around 2-3%, and where unemployment is low; but where inflation is running at 5-6%, because of unit-wage inflation and/or global factors (higher oil prices); and/ or fiscal/ monetary considerations (internal devaluation or currency depreciation), presuming that the price elasticity of demand is relatively inelastic (Siliconia has a weak manufacturing base, and its economy is based heavily on tourism, I.T., and financial services; productive capacity cannot keep pace with aggrregate demand)

One could further complicate that scenario by positing that Siliconia has a very low corporation tax rate as well as a very malleable tax law, which allows a lot of MNCs to shunt their profits into offshore havens. Therefore the GDP of Siliconia, and its tax receipts, do not reflect headline economic activity.

Of course, if you really want a contemporary example of the disparity between economic growth, Exchequer receipts and inflation just look to Ireland in 2015.

The economy grew by 26% (lol), Exchequer receipts grew by 10.5%, and CPI fell by 0.3%!

Presumably you'd be cutting pensions, illness benefits, and the dole this year, if you were in power?

All that stuff about Ireland; I'm failing to see how it's relevant. Yes there are different types of inflation, and you can make up scenarios where somehow inflation is detached from economic growth, but does that happen particularly often?

I don't think the CPI actually fell in 2015? (going by here) anyway. But yeah I'd cut benefits if there was deflation.

After all, I'm not coming at this problem from some sort of ideological opposition to welfare benefits. I don't think I've ever been accused of being remotely right-wing. This policy can hurt the poor as much as it can benefit them. It's a lottery.

But it's fundamentally an unreliable system, is replete with unfairness, and is liable to waste public resources.

Varadkar is pushing this populist nonsense because he wants to be the next Taoiseach of Ireland. There is no sensible economic basis for implementing this policy in Ireland.

How exactly does this policy hurt the poor? For someone who hasn't been accused of being right wing, you are currently being right wing I think!