Unpacking the government welfare bill climbdown

The backbench revolt against the proposed welfare bill and the climbdown leaves Sir Keir Starmer’s government at a crossroads just a year since it won a landslide majority. The coming months will determine its trajectory, and the outlook is not promising.

The Labour Manifesto promised a ‘mission-driven government’ but was short on details about how the different elements would be reconciled. There was a mismatch between the ambitions and the realities of funding the manifesto. The green prosperity plan was abandoned by the end of 2024 and more U-turns followed. With the PM confessing that he avoids political debates and big ideas, it appears that the Chancellor and the Treasury are setting the agenda, focused on investment-led growth and self-imposed fiscal rules. These are intertwined and facing headwinds.

The fiscal rules adopted by Chancellor Rachel Reeves go much further in restricting the flexibility of fiscal policy compared to previous governments. The budget must be balanced or in surplus by 2029/30, and net financial debt must decline as a share of GDP. These rules restrict increases in social security spending, including unemployment benefits, and must be met within a three-year horizon — shorter than the previous five years. This explains the government's excessive focus on ‘fiscal headroom.’

Are fiscal rules a good idea? My research shows they can discipline fiscal policy if loosely enforced. But if binding year-on-year, they risk triggering market instability through self-fulfilling beliefs or ‘animal spirits’ (the non-rational, emotional factors that can influence economic behaviour and decision-making). This now seems to be the case in UK.

One way to meet deficit and debt targets is through growth. Excluding capital investment from debt calculations offers some space, but the UK does not have a particularly good record of meeting either targets or proposed budgets. Productivity has stagnated at least since the 2008 financial crisis. The relatively high growth in 2021-2022 comes after the sharp fall in the Covid years.

Research shows that human capital is key to growth – i.e. the education and health of the workers. While investment in infrastructure, technology, and physical capital are key drivers for economic growth, without a healthier workforce, returns will be limited and slow to materialise. This is missing from the government’s current strategy.

The welfare reform bill aimed to curb rising spending, capped by fiscal rules. Since the Covid-19 pandemic, there has been a significant increase in the number of people receiving long-term illness allowances and PIP allowances, with further increases projected. However, instead of addressing the fundamental causes of these trends, the policy was designed only to meet fiscal targets and make savings. It became clear that the policy would increase hardship and poverty of those affected without a plan to consult them.

It did not address the fundamental issue of why an increasing share of the population is receiving these benefits: is it the case that increased illness payments are substituting for one of the least generous unemployment benefits amongst comparators; does it reflect the aging population who become disabled before they are eligible for National Insurance; are they a reflection of the mental and physical costs of Covid; or are they a reflection of the declining health outcomes in the UK population relative to G7 countries?

Research shows that poor nutrition and health (both physical and mental health, not only of children but also their mothers) translate to poorer educational and health outcomes over the life cycle. A study in the Netherlands, which also has a universal national health system, shows that health inequalities between the richer and the poorer sections of the population appear early in life and increase with age. Given the well-documented disparities in health outcomes in the UK, not addressing the fundamental causes will perpetuate these inequalities and increase fiscal burdens in the future.

The proposed changes to disability benefits, such as PIP, were poorly considered in terms of social welfare and the economy, as well as on political grounds. The cuts would fall hardest in the Labour heartlands, making future electoral success challenging.

In order to win the vote, the government had to scale back the cuts, shelving plans to change PIP. The watered-down welfare bill has two consequences. First, it means either larger tax increases in the next budget or dropping the strict fiscal rules. Second, combined with the winter fuel U-turn and a retreat from the ‘island of strangers’ speech, it has weakened the government’s agenda.

Starmer now faces pressure not just from the Reform Party but also from the Greens and Liberal Democrats, alongside internal dissent. Governments can weather many storms — but credibility is hard to recover.