Picture 23 Kristian Niemietz is Poverty Research Fellow at the Institute of Economic Affairs, whose latest proposals are outlined in more detail in a major new report released today, A New Understanding of Poverty, which is available at the IEA website.

Imagine our government managed to enact policies that brought down the cost of essential goods and services in this country, resulting in a pronounced improvement in the living standards of the poorest. What do you think would happen to the national poverty rate? You’ve probably guessed wrong – because the real answer is nothing. Such is the madness of the current way that poverty is measured in this country.

The government could, for example, start by thoroughly liberalising the system of land use planning and building regulations, boosting the supply of housing. Artificially inflated housing costs hit the poor hardest, both directly and through their several knock-on effects.

At the European level, the government would aggressively push for an opening of agricultural markets, and for an abolition of quotas and price controls. It would be more concerned about the humble consumer than about the farmers’ lobby.

At the domestic level, there would be a clampdown on regressive taxes. On average, households in the bottom decile of the income distribution pay about £2,500 per year in ‘sin taxes’ and ‘green taxes’.

All of these moves would help bring down the cost of essential goods and services; but they would not help alleviate poverty because, when talking of poverty, governments over the years have been shackled to the idea of ‘relative poverty’.

The relative poverty line is set at 60% of median income, that is, 60% of the mid-point of the income distribution. But it contains no information on what this amount actually buys.

The government has inherited four different poverty targets – its child poverty target is even enshrined in law. All are based on slightly differing measurements of poverty, but all of them rely partially on nominal income. One of them measures ‘persistent relative poverty’, the share of households who fall below the relative poverty line for at least three out of four years. Again, this tells us nothing about what these families can or cannot afford. Another target is based on a measure of absolute poverty, where the relative poverty line of a base year is updated annually in line with the Consumer Price Index (CPI). This measure is not as bad as the two previous ones because it contains at least some information on price development. But the CPI reflects the consumption habits of average households – not of poor households, which can be very different.

Given the lack of logical wealth in poverty measurement, is it surprising that policy responses leave a lot to be desired? Instead of addressing poverty through supply-side reforms like the ones mentioned above, the previous government poured out billions of pounds in tax credits and other child-contingent benefits. In order to enrol ever larger numbers of recipients, the work requirements attached to tax credits have been continuously eroded. In the 1970s and 1980s, tax credit recipients had to work at least 24 hours per week to qualify at all. For most recipients today, 16 hours of work are sufficient to qualify for Working Tax Credit, while to qualify for Child Tax Credit, no work is required at all. This is hardly a sensible anti-poverty strategy in a country where 17% of all children live in households with nobody in work – easily the highest proportion in Europe. Fighting poverty through increasing transfer spending is like running up a down escalator.

As well as using supply-side reform to make goods and services cheaper, substantial changes to the welfare system are needed.

Iain Duncan Smith’s mission of breaking the trap of long-term dependency through the creation of a more integrated and straightforward benefit system represents a far more promising approach than the previous government’s, but simplifying the welfare system even further would be far more effective in tackling real poverty. This could be done by moving to a simple Negative Income Tax (NIT) where instead of paying income tax, low-earners would receive a tax transfer (so their tax liability would be negative) if their income fell below the tax-free allowance. As their income increased, their entitlement to NIT would gradually shrink, until eventually they would start paying ‘positive income tax’. This would be far more logical and efficient than the present system, in which low-earners pay taxes first, and then receive state transfers (tax credits, or ‘Universal Credit’ in the future). It would also mean an end to the couple penalty in the benefit system as the tax free allowance would be calculated by looking at households. Similarly, introducing workfare schemes, as the coalition is proposing, would be a good way of getting people back into work; but it will only be effective if the requirements for work are full-time for all able-bodied people on welfare.

The state-centric approach to poverty alleviation has reached its limits. We need a rethink of our anti-poverty strategy. But adequate policy responses require, first of all, that we define and measure poverty properly.