Income inequality in most high-income countries has increased considerably since the 1970s, creating interest in the drivers of this trend. One factor that has attracted intense interest is the role of tax and transfer policy. There have been longstanding trends among OECD countries toward less progressive income tax rates and more targeted welfare benefits. In the case of the United Kingdom, this targeting has treated some groups within the population substantively more favourably than others.
Our study uses a new empirical approach to quantify the evolution in the treatment of different types of families (for example, single adults without children, couples with children, age pensioners) by the tax and transfer system during the last half century. We quantify considerable improvements in the treatment of families with children and age pensioners, relative to the wider population.
Families with children and pensioners treated more favourably
Shedding light on how the welfare system treats families who are “welfare dependent”– meaning that the welfare system is their only source of income – we find that single parents with one child were receiving 30 to 40 per cent more in welfare payments, compared with childless single adults throughout the 1970s to the 1990s. The end period of our study is 2010-14. By that time, the gap in welfare payments had widened to 80 per cent, so that welfare dependent single parents with one child were receiving almost double the welfare payments typically received by childless single adults. This reflects a deliberate shift in policy in favour of low-income families with children, especially following the election of the Blair Labour Government in 1997.
The evolution of the welfare system is even more striking for age pensioners. Welfare dependent single age pensioners received roughly the same value of welfare payments as working-age single adults without children in the 1970s. In contrast, by 2010-14 they received roughly double the welfare payments of single childless adults. The relative rise in welfare benefits for age pensioner couples was more pronounced still, increasing from 50 per cent above the level for working-age singles in the 1970s, to triple that level by 2010-14. These shifts represent a profound reshaping of the UK tax and transfer system in favour of families with children and people above state pension age, largely driven by increases in generosity of targeted state benefits, relative to unemployment benefits.
Extending our analysis to middle-income families further demonstrates the relatively favourable treatment by the UK tax and transfer system enjoyed by families with children and age pensioners, relative to the wider population. To put our results in perspective, in the 1970s pensioner couples earning the equivalent of £900 per week in 2016 prices were subject to the same average effective tax rates (which account for both taxes and transfers) as single working aged adults without children earning £310 per week. By 2010-2014, those same pensioners were treated equivalently to single adults earning (only) £140 per week. These findings reflect the maturing of the state pension system, in addition to increases in the relative generosity of state retirement benefits relative to unemployment benefits.
Implications for UK income inequality
Contemporary analyses of income inequality typically use proportional income adjustments to account for differences in consumption needs associated with the number and age of household members. We explore how measures of income inequality are affected if the proportional adjustments for household need are specified to reflect the value judgements implicit in evolving UK tax and benefits policy.
We find that accounting for the evolution of value judgements discussed above exacerbates the rise in private income inequality that has been observed in the UK since the 1990s and depresses associated measures of redistribution. The result is a 6-percentage point increase in the Gini coefficient of (equivalised) disposable income inequality in the two decades to 2015. This finding is in sharp contrast to standard measures of inequality reported by the UK Office for National Statistics, which level off after sharp rises during the 1980s.
The reasoning that underlies these results is clear: although the UK transfer system during the last two decades has adjusted to shield some at-risk population groups from the rise in private income inequality, it has done so unevenly. Neutralising the distributional effects of changes in relative tax treatment associated with household demographic characteristics provides an alternative perspective of underlying trends in the tax-transfer system’s capacity to redistribute income and in market income inequality.
Further reading
van de Ven, J & Herault, N 2019, ‘The evolution of tax implicit value judgements, redistribution and income inequality in the UK: 1968 to 2015‘, Working Paper No. 6/19, Melbourne Institute: Applied Economic & Social Research, University of Melbourne, Melbourne.
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