Inequality in the UK: the paradox under Labour

January 25, 2010

Alastair Murid B0133P 0248-Ali Muriel is a Senior Research Economist at the Institute for Fiscal Studies. The views expressed are his own.-

Start with two (apparently contradictory) facts about income inequality in the UK:

1. Since coming to power in 1997, Labour has changed the tax and benefit system to make poor people better off, and rich people worse off.

2. The gap between rich and poor is now larger than when Labour came to power.

So Labour has acted to reduce inequality – and yet inequality has gone up. This presents us with something of a puzzle. Your first thought might be that one of the facts above simply isn’t true – that either Labour hasn’t redistributed as much as they claim, or the gap between rich and poor has been exaggerated – but we can illustrate both facts with simple charts.

Beginning with Fact 1, the graph below shows how much better off people at the bottom of the income distribution are, and how much worse off are those at the top, compared to a world in which Labour had simply ‘left the tax and benefit system alone’ when they came to power. Dividing the population into ten equality sized groups (‘deciles’), from poorest to richest, we can see that Labour really has been a latter-day Robin Hood, taking from the rich to give to the poor. The bottom tenth of the population are on average 12 percent better off under today’s system, compared with the system Labour inherited, while the richest tenth of the population are over 5 percnet worse off.

Gain/loss under the 2008 tax & benefit system*, compared with the one Labour inherited

Chart 1

Source: IFS calculations using the 2006–07 Family Resources Survey.

* This chart shows the 2008 tax and benefit system, the latest for which the IFS has conducted these calculations. These figures will be updated by IFS in the coming months.

And yet the second chart, below, shows that income inequality (measured using the well-known Gini coefficient) is higher than at any point since (at least) the 1970’s. It’s true that we haven’t seen a repeat of the extremely rapid rise in inequality under Margaret Thatcher – but nor has that increase been reversed, and the overall trend under Labour has been upwards.

The Gini coefficient, 1979 to 2007–08 (Great Britain)

Chart 2

How can we explain this rise in inequality, even as the government redistributes like never before?

One possibility is that the government has been ‘swimming against a rising tide’ – that pre-tax incomes have become more unequal faster than the government could equalise them. But this doesn’t appear to be the case – IFS research looking at gross (pre-tax) incomes has shown that they’re becoming more unequal at roughly the same rate as net (after-tax) incomes.

So what’s going on? One explanation (though this remains speculation) is that the nature of inequality in the UK has changed. Remember that a tax and benefit system dampens inequality in two ways:

1. By lifting incomes at the bottom, and -

2. By dragging down incomes at the top

Now the tax and benefit system in the UK does rather more of (1) than of (2). Our top rates of tax remain relatively low by European standards (though certainly high by American ones), which means that redistribution to the poor tends to be paid for ‘by everyone’, not just by the rich. And yet less of the UK’s inequality is caused by stagnating incomes at the bottom than in the past – gross incomes at the bottom of the distribution have grown quite strongly under Labour (at least until the recession hit).

More of our inequality is instead caused by top incomes ‘racing away’ from everyone else – with incomes at the very top of the distribution growing much faster than those in the middle under Labour. And yet this ‘top tail’ inequality is precisely the sort which the government claims not to be overly concerned about, and which our tax and benefit system does little to dampen. As Peter Mandelson famously said in 1998, “we (Labour) are intensely relaxed about people getting filthy rich.”

This, then, is a possible solution to the ‘paradox’ of inequality under Labour. Even as the government was making our system more redistributive, the economy was changing in ways which undermined this effort – making a given tax and benefit system less redistributive. Labour really were running to (not-quite) stand still – just not in the way most people think.

However, the credit crunch (and ensuing collapse in the public finances) appears to have changed the political calculus somewhat. Suddenly bashing the rich (and in particular, bashing the bankers) is no longer politically unthinkable. Already our top rate of income tax has risen to 50 percent, and a windfall tax on bankers bonuses has been announced. For inequality-watchers in the UK, the next few years look set to be interesting times indeed…

Comments

Wealth re-distribution by Labour (or any other well meaning champagne socialists) can only ever be a form of unnatural manipulation on the natural flow of markets, economy and society. While life on a low income is hardly worth celebrating, being wealthy isn’t something to be envied either – wealth can also be whittled away. Wealth distribution is a natural flow: those who work for true wealth, will get it. There will always be poor, rich, and the middle class to pay for it all.

 

These arguments are over-complicated. The explanation is really very simple. Take two people, one on £20,000 and the other on £100,000. Assume zero taxation for present purposes. They both get a 10% pay rise. The result is that the gap between their gross incomes has increased from £80,000 to £88,000. In order for the gap between their incomes to have decreased, to £79,500 for the sake of argument, the pay increase of the person on £100,000 would have to be taxed at 85%. Simple arithmetic. If the person on £100,000 was already taxed at 40% on all his income, the gap between the net income of the two would increase from £40,000 to £44,000 after the pay rise. In order for that gap to decrease after the pay rise, say to £39,500, the second person would still have to be taxed at 85% on the top £10,000 of his income!

It just ain’t gonna happen – thank god.

Posted by Matthew | Report as abusive
 

The answer really isn’t difficult – as Matthew above hints, Labour haven’t taken from the rich, but from middle-class Middle England. It is those on reasonable but not huge incomes that have felt the chill wind. He has caned those that have worked hard to better themselves, that have saved for a rainy day, and now find themselves being punished for their thrift and prudence (oh how it sticks in the craw to hear the thieving weasel Brown hypocritically trying to hug these values to his stone-hearted breast).

Hopefully he will reap the whirlwind, and before too ,long become an unemployment statistic himself, though I doubt he will be heading for the soup kitchen – his cronies in banking and global industry will fall over themselves to line his pockets.

If only there were the prospect of anything better to come…

Posted by John | Report as abusive
 

Nice article. It is good to see a breakdown of why incomes are racing away whilst we are told of the policies aiding the low income groups.

Posted by Kim | Report as abusive
 

I spent 9 months researching this topic for my dissertation, and I found that even the most respected economists in their field were dibvided as to the increase. Global trade reducing low skilled wages, and technolgical advances incerasing the most skilled ability to increase their productivity. The governmnet should create a level playng field, but not tax success!

 

Some points noted here: There are many reasons why there are so many rich people regardless of who the government is. Its just so happened that Labour came to term. Government has the responsibility to redistribute the wealths within the country, this certain doesn’t mean poor should get pay for doing nothing and rich get ripped off. Rich people are willing to help if they see real improvement, otherwise there are all sorts of way they can go. Poor should be helped by giving opportunities, but before we talk about giving opportunities, we should talk about how to better prepare them for opportunity. Education is the foundation and protection of the state, this can/should not be compromise. Elite people should be made happy to stay in UK so, inevitably, there would be difference between low and high skilled workers. No high skill people want to stay if they are treated marginally better than the low skilled. The world is full of bright British, keep them and utilize their knowledge.

Posted by Chris | Report as abusive
 

Simon
There was wealth re-distribution when all our moneys went to underpinning the banks, so that there wouldn’t be civil disorder if the whole thing had collapsed.
What you call the “natural flow of markets” wasn’t allowed to flow naturally then or was it? We are not naturally good creatures, otherwise there wouldn’t be a need for Government and everybody would have the wisdom EITHER to live in a sustainable way or at least have the decency not to add children into this world because in a few years time living with or without money will not be an enviable state. The best thing to avoid poverty is to get a grip on our collective breeding…

Posted by Esther Phillips | Report as abusive
 

@Matthew – I’m afraid your simple argument is simply wrong.
The Gini coefficient measure of inequality is ‘scale independent’, meaning that if you multiply everyone’s incomes by a fixed constant (as you did in your example, increasing everyone’s income by 10%), the Gini remains unchanged.
In other words, statisticians and economists have long been aware of the problem you cite – and solved it.

(You can read about this here: http://en.wikipedia.org/wiki/Income_ineq uality_metrics#Properties_of_inequality_ metrics)

So the Gini isn’t going up because everyone’s getting better off at the same rate. It’s going up because some people are getting better off faster than others. How you feel about that is a different matter – but it’s not just a statistical artifact.

Posted by Denzel | Report as abusive
 

I agree totally with John – the rich have been able to get richer (especially the bankers seemingly contributing huge amounts of tax from their bonuses for being so amazingly clever when actually they were just lending vast sums of money to people who shouldn’t have been lent it in the first place) the “poor” have been helped up financially but not in other ways and the middle incomes clobbered especially those who have payed down debt and saved and want to leave something for their children. Brown/Blair/Mandelson will all become “rich” and probably buy a country estate (to avoid inheritance tax) – what disgusting hypocrites they are…

Posted by Clare | Report as abusive
 
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