Government eyes end to benefits and inflation link

In September 2011 inflation came in at an unusually high 5.2%

The government is considering ending the automatic annual increase in benefits in line with inflation, sources have told BBC Newsnight.

If implemented, the move would see many benefits frozen for two years, then rising only in line with average pay.

In recent years inflation has risen at a far higher rate than average earnings - Whitehall officials say a switch since 2008/9 would have saved £14bn.

The government needs to find £10bn of extra savings in the welfare budget.

Sources stressed the detail of how to make these cuts had not yet been discussed. They would not be drawn on which policies were being looked at.

Newsnight understands that the new £14bn figure is entering into fractious government debate over how to make a further cut to the welfare budget - something occupying minds at the top of government.

Liberal Democrat resistance

The move, under which millions of claimants' benefits would eventually inch up at the same pace as average earnings, would affect a wide range of working-age benefits including jobseeker's allowance and housing benefit.

Chancellor George Osborne has told the Department for Work and Pensions (DWP) it must come up with the extra £10bn reduction to allow cuts to other government departments, due to begin in 2015, to stay at the level they are now, rather than go deeper.

Mr Osborne tried to refashion the link between benefits and inflation last September when inflation came in at an unusually high level - 5.2% - but he was beaten back by an alliance of the Liberal Democrats and the Work and Pensions Secretary Iain Duncan Smith.

Though he was unsuccessful then, the idea has resurfaced. One Whitehall source close to the process said: "A freeze [to benefits] for a couple of years would help us get to the £10bn."

Chancellor George Osborne has demanded a further £10bn welfare saving

Tory strategists believe they have polling evidence which would put significant numbers in support of an end to so-called benefits uprating.

But the possibility of freezing benefits will anger Liberal Democrat activists as they prepare to gather in Brighton this weekend for their annual conference.

Many in the party believe the coalition should find the further £10bn of cuts through tax rises such as wealth taxes and there should be no further cuts to welfare.

An increasing number believe the welfare budget is already straining to bring in its current £18bn of cuts.

Historically benefits have often risen by less than wages, with inflation not typically as high as in recent years, and it is already falling this year.

Despite this, coalition sources say it is not clear wage growth will recover to its former health for a while, which will require the examination of the relative increase in benefits versus that for wages.

Benefits freeze

One option now being weighed up inside government is the freezing of 90% of benefits - which officials estimate would make savings of £7bn in one year.

However, coalition sources suggest this is likely to be discounted as too harsh, since it would include disability benefits.

Instead, other options are being discussed which coalition sources believe would be "fairer".

Senior figures are proposing a two-step change to the payment of benefits. At first there would be a freeze to a wide range of working-age benefits to last for two years. After that a new link would be introduced between benefit payments and increases in wages.

Officials said they did not want a huge increase in benefits should wages start to climb very sharply, so work was being done on the exact linking mechanism.

The IPPR think tank has estimated that had benefits been linked to earnings, not inflation, over the last few years, jobseeker's allowance would be a weekly £66.81 rather than £71.

Sources said they were mindful of the risk of pushing benefit claimants into poverty, but that there was potential for massive savings.

"Benefits are rising faster than earnings; this does not encourage people to go to work. Benefits were never meant to be a salary replacement," one told the BBC.

"We are aware that there is the effect on poverty to be considered but we believe that benefits have risen by so much over the last few years that a freeze for a couple of years would help people deal with the transfer. When you see the savings possible, it is simply mind-boggling," the informant added.

Sources believe the change would not be implemented quickly, but could be in place by 2014, suggesting it is being eyed as pre-election challenge to Labour and the Lib Dems.

One benefit which will not be affected is the state pension. Pensions are now protected by a "triple lock" which means they will go up annually by either inflation, earnings, or 2.5%, whichever is higher.

Having introduced this measure, the coalition will not touch it. But all other benefits are not protected in this way.