Winner of the New Statesman SPERI Prize in Political Economy 2016

Tuesday, 18 November 2014

Redistribution under the UK coalition government

In his party conference speech, David Cameron did mention inequality. He did not say, as Ed Miliband said recently (see postscript to this post): “This country is too unequal. And we need to change it.” Instead he said “Under Labour, inequality widened. With us, it’s narrowed.” So do the two quotes above mean that both major parties now aim to reduce inequality?

Here is the evolution of two aggregate measures of UK income inequality over time, as calculated by the IFS from this recent study.

The main change is the large increase in inequality that occurred under Mrs Thatcher from 1979 to 1990. There was then a small tendency for inequality to increase until around 2007, since when inequality has fallen. The main reason for this recent fall is the decline in real wages over this period, while benefits have remained more constant in real terms. The share of the top 1% also rose during the Thatcher period, but unlike the measure above continued to rise sharply until around 1997/8. It then remained relatively stable until around 2004, rose sharply until the financial crisis, when it fell back in 2010/11 to end 90s/early 00s levels. (For details, access the PSE database here.)

If the decline in real wages since the financial crisis has reduced overall inequality, what impact has government fiscal changes had? In a landmark report issued this week, Paola De Agostini, John Hills and Holly Sutherland analyse who has gained and who has lost as a result of the direct tax and transfer changes made by the coalition government. (Indirect taxes are excluded.) One of the things I liked about the analysis is that it attempted (with some success) to reconcile its own results with similar analysis undertaken by the UK Treasury and the IFS.

The headline result is shown in this chart.

The black dots track who has gained and who has lost as a result of the coalition’s changes to direct taxation and benefits, including pensions. The poorest have lost out, while the main gains have been in the middle of the top half of the income distribution. So while a decline in real wages may have reduced inequality in the years following the recession, government policy has attempted to move things in the opposite direction. So perhaps what the Prime Minister should have said is “Under Labour, inequality widened. With us, it’s narrowed, but we are doing what we can to change that.”

There are many other interesting results from the study, but let me mention just three here. The first is contained in the most right hand black dot. Over the period in which the coalition has been in power, changes in direct taxes and benefits have had no significant overall impact on incomes, compared to what would have happened if indexation had run its normal course. That means that the impact of benefit cuts in reducing the deficit has been almost exactly offset by tax cuts.

The second told me something I should have realised about the Treasury’s analysis of the distributional impact of budget measures. The Treasury’s analysis is similar, but with one important difference - the biggest losers in their figures are the top income decile. As the report shows, the main reason for this is straightforward - the Treasury analysis starts from January 2010, not (as in this report) from May 2010. Why does this make so much difference? Because the new higher 50p tax rate introduced by Labour actually started in April 2010. George Osborne subsequently reduced this to 45p. So the Treasury’s figures show the top decile losing as a result of the top tax rate going from 40p to 45p, while this study starts at the 50p the coalition inherited.

The third bit of the analysis I wanted to mention was how these numbers might change by 2019/20 under current plans. The broad picture remains similar, but with one large question mark for the lowest decile, concerning the introduction of the new Universal Credit (UC). One of the hopes for UC is that it will increase the uptake of benefits. The report calculates that if everyone who currently claims any one of the benefits UC replaces takes up UC, then UC will lead to large (+3%) overall gains for the bottom decile. Whether this will happen depends in part on the efficiency and manner in which it is introduced.


  1. Yes, but the trickle down effect will make sure those in the lower half/bottom of the distribution will benefit in due course! Or so someone said...

    1. There is perhaps a more interesting dimension to «trickle down effect will make sure those in the lower half/bottom» and it is the "divisive" issue that our blogger hopefully for brevity does not address, and it is the very different situation for the tory so-called Middle England and the North and celtic fringe areas.

      The graph above has a huge jump just around the time the government policy was to smash the industrial economy of the North etc. to smash the trade unions (which I agree had become a big problem). The North etc. have not recovered from that, and those areas have been in depression for 35 years, with their middle classing nearly erased and their working classes pauperized.

      Perhaps the very different trajectories of the economies of North etc. vs. so-called "Middle England" vs. London account for a large chunk of the jump in the aggregate Gini, especially as the government has recently handed out enormous sums of welfare to protect the salaries and jobs of bankers and other spivs in the "Middle England" and London areas that largely vote tory and provide very well paid low-effort directorships to retiring Tory politicians.

  2. It makes ugly reading when it was the shadow banking sector that set off the crisis in 2008.

    And even if you were to blame the Labour government and the opposition parties for never regulating (not unregulating) these banks, the conclusion that you hit the lowest half of 20 income groupings, getting steeper as the people get poorer, says a lot about the UK.

    1. Surely you're not suggesting that the 'wealth creators' - those who (unlike the bottom half of the income distribution) can afford to shoulder the bulk of the burden of the financial mess that they themselves caused - should actually take financial responsibility?? Privatise the gains/profits, socialise the losses old boy!

  3. Look at Figure 3.3 and you see what sort of country the UK is and what mainstream economics since 1978 has achieved.

    1. You can indeed. Inequality has hardly budged for 25 years and has fallen in recent years as wages have fallen.

      So, the lesson is that if we want inequality to decline, pray for a nice long recession.

    2. (Anonymous 18 November 2014 12:55) - This is change not really down to mainstream economics, although some economic ideas were used as cover for some very nasty political ones.

      SH - It depends on what measure of inequality you use, for the Gini coefficient this is true although there are some issues with this measure. The income of people at the very top (say the top 0.1% or even top 0.01%) has most definitely grown for most of the last 25 years.

  4. "Because the new higher 50p tax rate introduced by Labour actually started in April 2010. George Osborne subsequently reduced this to 45p. So the Treasury’s figures show the top decile losing as a result of the top tax rate going from 40p to 45p, while this study starts at the 50p the coalition inherited."

    Often said, but worth pointing out again, that we had 13 years of Labour with a top rate of 40p, only for them to put it up to 50p for the last month in office.

    If the Tories left a similar poison pill, oney. can imagine S W-L's (impartial) fur

    1. If the Tories left a similar poison pill, one, can imagine S W-L's (impartial) fury.

      I have no views on S W-L's fur.

    2. That's a very cynical view of things, a little too cynical I think. For most of those 13 years Blair was in charge and he was centrist to the very core of his being so just wouldn't have accepted it. Brown was more open, but for much of his premiership fiscal stimulus was a much higher priority.

    3. " Blair was in charge and he was centrist to the very core"

      Blair was just a brilliant politician. He understood the government machinery, the media and the electorate and how to get things through. His policies were merely the orthodoxy at the time. They were to maintain a light touch approach to financial (and labour and goods) markets, backed up by a lot of faith in the central bank, economic geniuses, algebra, econometrics and wizardry to keep a steady and dexterous hand over the levers. Any questions and it would be answered with "sophisticated" algebra and the rational expectations hypothesis.

      Had you given Blair a different set of policies to sell - the direct tackling of inequality, closer supervision of the financial sector and the separation of retail and wholesale banking, an eye on the housing sector and signs of liquidity gluts and direct policies that aimed at the long term native unemployed - and all this was the orthodoxy of the time - he would have got those things through as well.

      Blair's talents were wasted.

    4. He also fully believed in the policies that he was selling to the electorate. He makes it quite clear in his biography that his belief in those policies was genuine and not some show for the electorate.

  5. «Had you given Blair a different set of policies to sell [ ... ] Blair's talents were wasted.»
    «He makes it quite clear in his biography that his belief in those policies was genuine»

    You can both be right. Blair sincerely believed that the politics of "Blow you! I am all right Jack" were the right politics for winning over so-called Middle England. They also enabled a Labour government to introduce some social-democratic policies in an understated way to avoid the wrath of the same so-called Middle England.

    I'll repeat here the classic, and sincere (yet read between the lines) relevant part of Blair's pivotal speech:
    «I can vividly recall the exact moment that I knew the last election was lost. I was canvassing in the Midlands on an ordinary suburban estate. I met a man polishing his Ford Sierra, self-employed electrician, Dad always voted Labour. He used to vote Labour, he said, but he bought his own home, he had set up his own business, he was doing quite nicely, so he said I’ve become a Tory. He was not rich but he was doing better than he did, and as far as he was concerned, being better off meant being Tory too.
    In that moment the basis of our failure – the reason why a whole generation has grown up under the Tories – became plain to me. You see, people judge us on their instincts about what they believe our instincts to be. And that man polishing his car was clear: his instincts were to get on in life, and he thought our instincts were to stop him.»

    Note the euphemism «get on in life» for "milk the benefits of incumbency",
    What Blair understood very well is that the right mainline policy was to give "aspirational" voters an ongoing stream of the benefits of incumbency via higher house prices, because the "apiration" so-called Middle-England voters (especially middle aged and older property owning female ones) have is for massive tax-free effort-free windfall capital gains (cashed in via low rate remortgages), and Scottish oil revenues and exports made it possible to create a suitable financial environment to deliver them, which had been Thatcher's strategy too, as Blair himself summarized well in this article he wrote in 1987:
    «North Sea oil. The importance of this windfall to the Government’s political survival is incalculable. ... the balance-of-payments effect of oil. The economy has been growing under the impetus of a consumer boom that would have made Lord Barber blush. Bank lending has been growing at an annual rate of around 20 per cent (excluding borrowing to fund house purchases); credit-card debt has been increasing at a phenomenal rate; and these have combined to bring a retail-sales boom – which shows up dramatically in an increase in imported consumer goods. ... neither stable nor healthy in the long term: but in the short term it allows the living standards of the majority to rise rapidly, even though the industrial base, the ultimate foundation of a successful economy, is still only achieving the levels of output of 1979»

    After meeting "Sierra man" Blair realized that the winning thing to do was to pander to "Blow you! I am all right Jack" voters as much (or perhaps as little) as possible. I am sure he believed sincerely in that.

  6. I hope readers of comments can tolerate more of my usual quotes on the "Blow you! I am all right Jack" politics that have resulted in the Gini/MLD chart above.
    «The problem with Gordon,” a senior minister said to me recently, “is that he doesn’t understand why anyone would ever want to build a conservatory.”
    There is a growing concern in the Government that the Prime Minister is alienating the aspirational middle classes who put Labour into power in 1997 and have kept it there ever since.
    ... Although Mr Brown talks a lot about aspiration, he means it in the sense that people at the bottom of the pile should be able to get to the middle, rather than that those in the middle should aspire to get a little bit further towards the top.
    His preoccupations with child poverty, Africa and banning plastic bags are all very worthy – but they leave the conservatory-building classes thinking: what about us?
    ... With the cost of housing, energy, childcare and food going through the roof, people who are relatively well paid can no longer afford to live the way they did even a year ago. As the middle classes book holidays in Torquay rather than Tuscany, drink tap water instead of San Pellegrino and put the conservatory they had been planning to build on hold, they start to question the amount they have to pay to the Government.»
    «Flint, the shadow energy secretary, also holds a position as the party’s champion for the south-east. She writes: “We have to win votes from the Tories as well as from the Liberal Democrats. The collapse of the Liberal Democrat vote alone will not be enough to win in 2015. We have to continue to focus on those voters who supported Labour in 1997 but voted Conservative in 2010.”
    She adds: “We went into the last general election promising a ‘future fair for all’, but too often, when we thought we were talking about fairness, we were actually talking about need.” She claims that for many swing voters in the south-east “fairness is as much about exchange – taking out once you have put in – as it is about need. They want ‘fairness for my family as well.’»

  7. «mainline policy was to give "aspirational" voters an ongoing stream of the benefits of incumbency via higher house prices»

    As to this there is another very interesting article from a couple of days ago:

    The really amazing graph is the second one:

    That shows that between 1997 and 2013 house "wealth" has more than tripled, but other capital has increased very modestly or decreased,

    Of course that does not mean that between 1997 and 2013 the number of houses has more than tripled, but that the number has grown very little but their valuations have grown a lot. While house valuations have tripled, UK nominal inflation-adjusted estimated GDP has grown from £280b to £385b in the same period or 1.37 times, and a large part of that growth has been generated by the cashing in of house "wealth" capital gains via remortgages:
    «Under Thatcher, this exploded to over £250bn across her premiership – a staggering 104% of GDP growth. ... But Blair did his homework and let loose – as did Thatcher – a wave of cheap credit, financial deregulation, house price inflation and an equity withdrawal-led consumption boom. Withdrawals under Blair’s leadership totalled around £365bn, that’s a full 103% of GDP growth over the same period,»

    What seems amazing to me is that in the same period that "real" GDP rose by 37% non-housing wealth mostly decreased in "real" terms. Such are the consequences of "Blow you! I am allright Jack" politics.

    What is also amazing is that *average* UK "real" house "wealth" has tripled even if 1/3 to 1/2 of the country (North and celtic fringes, the areas that don't vote Tory) is still in a deep depression that has begun around 1980, and where house prices have been falling or not growing at all (except for a brief period of contagion during the weirdest parts of the debt-collateral spiral).

    1. What makes a plot of land (or identical house) in London more valuable than up north? It is location value, better schools, infrastructure provided by UK taxpayers. A land value tax would discourage land hoarding - people will either have to use land or sell onto someone who will and it has no deadweight loss as the land supply is fixed.
      Look it up - the UK desperately needs LVT to end property speculation and rebalance the economy away from London. Taxing location value (social wealth created by the community, try buying or selling land in a place without title deeds or high crime like Somalia!), allows reductions in taxes on privately created wealth (VAT, income tax, taxes on improvements e.g buildings.)
      The only people to lose out are massive landlords or not even that, people who passively hold land weighting as it increases in value!

  8. If you take into account the VAT raise and other indirect taxes it is likely to be even worse.


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