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Instead of cutting tax credits, the government should replace major means-tested benefits - including tax credits and Jobseeker’s Allowance - with a single, individualised ‘Negative Income Tax’ payment that is withdrawn as earnings rise.

This would guarantee a minimum income floor and top up low-paid workers’ wages while still ensuring that everyone has a strong incentive to work.

The government should merge this into the tax system and abolish the Department for Work and Pensions to save up to £6bn in administrative costs.

The government should replace tax credits, Jobseeker’s Allowance, the Universal Credit, and most other major welfare payments with a single Negative Income Tax, according to a new report from the Adam Smith Institute, Free Market Welfare: The case for a Negative Income Tax. This Negative Income Tax (NIT) would act as a minimum income guarantee for all British citizens and be tapered away as people’s earnings rise through work.

Britain’s existing welfare programmes are costly to administer, complicated to navigate, and designed for a postwar-style labour market that no longer exists, the paper argues.

Under a Negative Income Tax, if a citizen earns nothing then the automatic NIT payment will be their entire income. As the individual earns more through work, the payment is gradually withdrawn until the citizen begins paying tax. The payment scheme is structured so that the claimant is always better off working more hours or taking higher wages than in their current position. These payments would be automatic for workers within the PAYE system.

The report says that the biggest welfare challenge future governments are likely to face is chronic in-work poverty, as globalisation and technological change lead to lower productivity and pay growth for some bottom and middle earners. This means that Britain’s current welfare system is outmoded and must be restructured to support low-wage workers throughout sustained periods of low-paid work, not just when they are out of employment altogether.

Systems like tax credits and the Universal Credit aim towards this goal, but are still too complex. Instead of a complicated web of different payments, the government should make just one, the report’s author Michael Story argues. Recipients would decide themselves how to spend their benefit, and as they earn more in wages, the benefit would be withdrawn at a rate that guarantees work always pays.

A simpler welfare mechanism like the Negative Income Tax could be integrated into the tax system, allowing the government to shut down the Department for Work and Pensions, take many of its 34,000 staff off the payrolls and save up to £6bn in administration costs.

The report’s author, Michael Story, said:

The UK’s current welfare system was built after the Second World War for a fundamentally different labour market, and it shows. It’s time to rethink the whole benefits structure, with emphasis on radical simplification, to give the UK workforce a steady footing for the new challenges of the 21st Century. In-work poverty is the key problem facing Britons and its prevalence and importance will only increase. We cannot tackle it with our current tools: Universal Credit is complicated, incredibly costly to administer, and still not fully operational, and minimum wages can only go so high before they start to create unemployment. The solution is a simple, single payment, that still provides an incentive to work. The Negative Income Tax is an idea with a long, impressive pedigree and its time has come.

Sam Bowman, the Adam Smith Institute’s Deputy Director, added:

The government shouldn’t cut tax credits, it should reform them. Topping up the wages of low-paid workers is the best way to improve their standard of living. It makes labour markets more flexible and does not cause involuntary unemployment, as minimum wages do. But the current welfare system is not fit for purpose: it is complex, outdated and wasteful. A Negative Income Tax that replaced most benefits and tax credits would radically simplify the welfare state and guarantee that everybody is better off in work. This was the promise of the Universal Credit but, as the report shows, the UC’s incrementalist approach has not delivered. We need a wholesale replacement of the existing system, and this report gives a compelling model of how to do it.

Notes to Editors:

Download ASI report Free Market Welfare: The case for a Negative Income Tax.

The Adam Smith Institute is a free market, libertarian think tank based in London. It advocates classically liberal public policies to create a richer, freer world.