Subtle change to wean workers off welfare benefits

London Briefing: Many economists of my generation have long given up on their chosen discipline: economics can be as fascinating as Sudoku puzzles, but just as irrelevant to the practical issues of the day

Peter Lynch, the investor who helped build Fidelity into the world's largest money manager, once said that 10 minutes was the maximum that anybody should ever devote to the study of the economy. Personally, I think that was a little harsh. You need at least 30 minutes to discern all that is useful from economics. There are some iron laws that should be intuitively obvious, but are all too often ignored.

Perhaps that is because policymakers end up thinking about the economy for more than 30 minutes and, bless them, end up hopelessly confused.

But incoming prime ministers who pride themselves on total ignorance of economics - like Tony Blair for instance - should be told two things. First, if you tax something there will, as a result, generally be less of it around. Second, if you subsidise something you will, as a result, generally get more of it.

Back in the 1960s, a brilliant Cambridge economist advised the then Labour government to impose something called selective employment tax (SET), which did exactly as its name suggested and taxed certain types of employment.

Imagine the consternation when certain types of employment collapsed.

The most obvious - and by now very tired - examples of subsidies that result in over- production are contained within the bowels of the Common Agricultural Policy (CAP).

Things are not quite so bad now that farmers are subsidised not to grow anything at all, but the earlier European wine lakes and beef mountains were drearily predictable consequences of subsidies.

Such egregious howlers are, in fact, quite rare. Taxes and subsidies often have distortionary effects that are as insidious as they are subtle. That's why most economists end up in favour of fiscal regimes that are simple and transparent.

The simpler the better, actually, which is why many economists are simply appalled by the complexities to the tax code introduced each year by Gordon Brown. All incoming finance ministers should be informed that the golden rule of public finance theory is "less is more".

So imagine our surprise when the government actually announces something that is soundly based in theory, has abundant empirical evidence backing it up and is politically unpopular, particularly within the parliamentary Labour party.

Governments have known for years that the system of long-term unemployment benefit acts as a subsidy to long-term unemployment. There are many aspects of the distortions present within the system but the most well-known problem relates to incapacity benefit. Far too many people are classified as permanently unable to work for health reasons.

Clearly, this is a potential minefield. It is important for any policymaker to acknowledge that some people are truly unable to work. But it is also well-known that a large proportion of people who claim to be sick are not necessarily people with disabilities.

Empirical studies have demonstrated this beyond a reasonable doubt. When GPs are asked why they sign off on so many sick notes that say "back pain", they rightly retort that doctors should not be the gatekeepers of an extremely flawed social welfare system.

And, lest anyone think this is just another rant against the laziness of certain sections of the former working population, it should be stated up front that it is not the really the fault of the welfare claimants. Blame has to be laid at the door of the benefit payment system. If that system provides financial incentives to behave in a certain way, then it is rational for individuals to do so. Over the past 20 years, employment has risen by 2.3 million, but the number of people claiming invalidity benefits has risen by around 2-2.7 million. Invalidity benefit is relatively easy to obtain, amounts to more money than unemployment benefit and goes up the longer you stay on it.

The first thing that the government is going to do is to change the question. Rather than checking on qualifications for incapacity benefit - that sick note - people will be asked if they are capable of any kind of work at all. Subtle but effective. Ultimately, the authorities have a 10-year plan to get a million people back to work at a saving to the taxpayer of £7 billion (€10.25 billion) a year. Essentially, it's about not subsidising unemployment. Brilliant.

Chris Johns is an investment strategist with Collins Stewart. All opinions are personal.