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…

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