Incapacity benefit vs the banking crisis

How much could we save by reforming incapacity benefit? George Osborne is hinting at big numbers. He claims that “Incapacity Benefit and Employment Support Allowance is a very large budget“: the media are talking of £12.5bn.However, DWP figures show that, in 2009-10, incapacity benefit and ESA (which replaced IB for new claimants in 2008) put together cost just £6.7bn. That’s less than half a percent of GDP. That £12.5bn, I suspect, is obtained by adding in income support. But that exaggerates the potential saving to be made from changing IB and ESA, because moving someone off these and onto Jobseekers Allowance might not, in itself, reduce that income support.Let’s do a simple sum. The long-term basic rate of IB is £91.40 a week. Moving someone off IB and onto Jobseekers Allowance, which pays £65.45 a week would therefore save the tax-payer just under £26 a week. This means that even if a million people were to make the move, we’d save just under £1.4bn a year.You might object that they wouldn’t move onto JSA, but into work. There are two possibilities here.First, the IB claimant might somehow find work at the expense of a JSA claimant. If so, my calculation stands. Alternatively, the increased supply of labour as people come off IB might be met by an increased demand for labour, so overall employment expands. But this can only happen if the greater supply bids wages down. In the presence of the NMW, there’s a limit to how far this is likely. Insofar as this limit bites, employment won’t rise. But what if it doesn’t bite? Even then, the economic gains are mitigated by two factors. First, low-wage workers face lower wages, which offsets the taxes they save from not having to subsidize “scroungers“. And second, these lower wages cause an increase in tax credit payments.The gains from reforming IB, then, are small.This is especially so compared to the cost of the banking crisis. Michael Dicks of Barclays Wealth, working with the IFS, says:By 2015, we estimate that potential output will be 9% of GDP (£132 billion in today’smoney) lower than it would have been in the absence of the crisis (see Figure 1.11).In other words, the banking crisis costs us 100 times as much as we could save by reforming IB.More, in fact. This cost of the banking crisis - lower GDP (not, note the sums involved in bailing out the banks) - is a pure loss. But savings on IB spending are a mere transfer - they enrich tax-payers but impoverish benefit claimants.This raises the question. How can people be reasonably relaxed (by now) about the massive cost of the banking crisis, and yet so concerned about the much smaller costs of the IB/ESA system?The rational possibility is that the banking crisis is a sunk cost - we can do nothing about it - whereas the benefit system isn’t. But is this really the whole story?