Why do we subsidise firms that keep workers in poverty?

At the other end of the pay scale, it was announced that the minimum wage is rising by 12p an hour for adults to £6.31 an hour. So someone putting in a 40-hour week would earn £252.40 – although many reliant on such wages while serving in shops and slaving away in fields endure piecemeal and part-time work, so do not even make these pathetic sums. Forget about Iain Duncan Smith surviving on £53 a week; could you live on this?

These two stories illustrate the widening global inequality, as a small cluster of self-serving plutocrats plunder the world’s wealth while millions of their fellow human beings struggle to survive in a chilly economic climate. So the Government deserves credit for resisting calls to freeze the minimum wage, even over-ruling the Low Pay Commission on apprentice pay. Yet we need to ask a profound question: why should the state encourage firms that refuse to pay decent wages?

This question was brought home to me earlier this month while talking to people about welfare in Wythenshawe, a sprawling suburb of Manchester. Quite rightly, those in jobs took a tough line on neighbours who could work but chose to coast through life on benefits, at other people’s expense; they thought the Coalition far too wimpish on such claimants, and were amazed that the £26,000 benefit cap introduced yesterday was so high.

Few earned such sums; they worked for self-pride, sometimes to the derision of friends. One woman who rose daily before dawn for a part-time job that brought in less than if she were on the dole bemoaned a 50p rise in her daily bus fare; while talking to her, I thought guiltily how little I would suffer from such an increase. This underlines the flip side of the benefit crackdown: that work has to pay, and pay properly. Yet all too often the rewards on offer are pitiful.

Many companies are sitting out the economic storm by piling up cash, some paying staff peanuts while the bosses hand themselves bigger pay and better perks. The gap between rich and poor is widening – while the greed of some fat cats is sickening, especially those slick sycophants who slide into top jobs without the slightest understanding of entrepreneurship, risk or innovation. These people – often at the helm of cosy corporate cartels – underline the need for more disruptive capitalism, not less.

While it is delusional to think that inequality can be eliminated, there is something very wrong when a heavily indebted nation takes taxes from hard-pressed families to effectively subsidise firms that underpay their workforces. But this is precisely what is happening with the complex, bureaucratic and backfiring means-tested tax credits system used to top up the pay of poorer people.

As so often, the fault lies with Gordon Brown, who took a sensible scheme introduced by Ted Heath and inflated it to such an insane level it defies logic, and disincentivises work. There were 734,000 people on this support mechanism when he became Chancellor; by the time he left Downing Street, their numbers had soared close to sevenfold. His legacy is all those firms paying too little to care staff, farm workers, office cleaners and shop assistants, knowing that the state will ensure they do not starve and have roofs over their heads.

One solution is simple: to ramp up the minimum wage towards ‘Living Wage’ levels, which would be about £1 an hour higher – and more in London, where inequality is at its most extreme. This would be a move of sound political sense for the Tories, something David Cameron came close to backing in opposition. It would show they cared about ordinary people while cutting the ground from beneath Labour leader Ed Miliband and repairing damage done by trimming the top rate of tax. And we have moved on from the days of Margaret Thatcher; even her former policy adviser Ferdinand Mount now worries about inequality and calls for responsible capitalism.

There would be protests, just as when the minimum wage was introduced in 1999, but studies show the long-term economic effect would be surprisingly negligible or even mildly positive. Better pay reduces expensive staff turnover and raises productivity; it also ensures that extra money swirls around the economy. Already, many bigger companies pay the Living Wage, with low wages most commonly found in sectors that cannot move abroad such as catering, hotels and retail – although some small firms might suffer.

The first retail boss to guarantee the Living Wage in London was Mark Constantine, founder of the Lush cosmetics chain. It cost £300,000 a year – but he was inspired by staff telling him that they had to take other jobs to ensure they could live and afford childcare in the capital. “You are not lifting people into some nirvana,” he told me. “You are just taking them out of misery.” This is not just a better business model, smart politics and more sensible for the nation – it is also morally right.