In this fourth article on Coalition Economics, Robert Joyce and Luke Sibieta (Institute of Fiscal Studies) consider the effects of the Coalition’s policies on inequality and poverty. They discuss the impact of the recession, which tended to reduce inequality, and then of government tax and benefits policies, which have tended to increase it, and the rising incidence of child poverty. Sibieta and Joyce’s earlier assessment of income inequallity under the Labour government, 1997-2010, is included in the special journal edition which is free to download until the election.
The coalition government came to power just after the Great Recession and during the associated fall in real earnings. One cannot properly understand the coalition’s record on inequality and poverty without considering that context. The Great Recession led to large falls in workers’ real pay between 2009 and 2011, which led to bigger falls in incomes further up the income distribution. However, the coalition government also had to implement a large fiscal consolidation in response to a hole in the public finances that had opened up or revealed itself due to the recession.
Decisions on how to implement this consolidation have had further important implications for inequality, with cuts to working-age benefits leading to reductions in income primarily towards the bottom of the income distribution and some net tax rises primarily hitting a smaller group towards the top.
Hence, falling real pay meant that incomes initially fell more towards the top of the distribution – partly at the end of Labour’s reign and partly at the start of the coalition’s - but the fiscal consolidation probably means that incomes are falling at the bottom of the distribution towards the end of the current parliament.
- Changes in household income during the Great Recession
The coalition came to power right in the middle of a period of large falls in workers’ pay. Between 2009 and 2011 – a period which neatly sandwiched the May 2010 election – median weekly earnings fell by 7% in real terms (http://www.ifs.org.uk/uploads/gb/gb2015/ch2_gb2015.pdf). Because earnings are a larger source of household income, on average, further up the income distribution, this acted to reduce income inequality. This came on the back of a reduction in inequality during the recession itself, as the real value of benefits and tax credits had been boosted by falling inflation and some discretionary increases, meaning that the bottom had been catching up with the middle. These patterns are shown in Figure 1.
The precise timing of this fall in real earnings was not entirely independent of policy choices. The Labour government’s temporary VAT reduction between 1 December 2008 and 31 December 2009, as a fiscal stimulus measure, had kept inflation very low and hence real earnings did not fall during this period. But ultimately the fall in earnings was an inevitable, if somewhat delayed, impact of the severe economic contraction.
Had the election happened a year earlier this would all have happened under the coalition; had it taken place a year later it would have been largely on Labour’s watch. In truth it would be economically arbitrary to attribute trends in the income distribution since May 2010 to the coalition and anything before that to the previous government. The large fall in income inequality between 2009 and 2011 was driven by the large scale of the recession and the historically unusual nature of the labour market shock that came with it – namely widespread falls in workers’ pay, rather than sharp rises in unemployment.
Figure 1. Real changes in real household income from 2007–08 to 2012–13, by percentile point Notes: Percentiles 1-4 and 96 to 99 are excluded due to high levels of statistical and modelling uncertainty. Incomes are deflated using the RPIJ index.
Source: Cribb et al (2015); http://election2015.ifs.org.uk/article/living-standards-recent-trends-and-future-challenges.
- Role of tax and benefit policy
It is more instructive to think about the coalition’s record on inequality and poverty by looking at what it has done since coming to power in response to the hole in the public finances. One obvious thing to look at, which affects inequality via direct policy levers, is tax and benefit policy. Considering all tax and benefit changes between January 2010 and May 2015 together, this group of measures have had the largest impact on a small group at the very top of the income distribution. This is mainly due to the implementation of tax measures pre-announced by the previous Labour government (such as the introduction of a 50% income tax rate, subsequently reduced by the coalition to 45%), which had their biggest effects just before or early in the coalition’s period in government.
The coalition government has chosen to implement a package of cuts to benefits and tax credits totalling £16.7 billion per year by 2015–16, and a net tax rise of £16.3 billion (all in 2015–16 prices). Figure 2 below (taken from Browne and Elming, 2015) shows the net impact of these changes on the incomes of different groups. Households are divided into ten equally sized deciles depending on their household income, but also different demographic groups within each decile (pensioners, working-age adults without children and working-age adults with children).
These measures (such as the increase in VAT and cuts to benefits and tax credits) have had the largest impact on approximately the bottom third of the income distribution but have been focused on those of working age. Low-income pensioners seem to have been largely protected from these cuts. Individuals in the middle and upper-middle parts of the income distribution have actually gained on average from tax and benefit changes under the coalition (such as increases in the personal allowance), though they had been more affected by cuts in earnings during and immediately after the Great Recession. In sum this probably means that inequality has risen in the latter half of the parliament, at least across much of the distribution.
Figure 2. Impact of tax and benefit reforms introduced between May 2010 and May 2015 by income decile and household type
- Overall changes in inequality during recession and recovery
Figure 3 brings these stories together by showing expected changes in income across the income distribution between 2007-08 and 2014-15 (using simulation techniques beyond 2012–13 – the latest household income data – accounting for changes to taxes and benefits and trends in employment and earnings), covering the whole period of recession and coalition government. Perhaps contrary to popular perception, inequality will in fact still be lower in 2014–15 than in 2007–08. This is due in no small part to the nature of the labour market shock, which caused widespread falls in real pay rather than the kinds of rises in unemployment – concentrated on the low skilled – seen in previous recessions. Cuts to social security as part of the post-recession fiscal tightening have so far unwound only some of that sharp prior fall in inequality. This highlights the important point that, whilst the fiscal consolidation measures – which increase inequality across much of the income distribution – are the result of direct choices made by the coalition, these choices were of course made in a context where inequality had just fallen substantially and earnings levels had fallen relative to benefits.
There is a twist to this story though. Inflation has been hitting the poor harder over this period (primarily between 2007–08 and 2009–10), because they are less likely to have benefitted from plummeting mortgage interest rates and more likely to spend large shares of their budgets on food and energy, which have risen in relative price. The black line on Figure 3 shows that accounting for this does make an important difference. Nevertheless, even having done so there is no rise in inequality between 2007–08 and 2014–15.
Figure 3. Change in real household income from 2007–08 to 2014–15, by percentile point Notes: Percentiles 1-4 and 96 to 99 are excluded due to high levels of statistical and modelling uncertainty. Incomes are deflated using the RPIJ index.
Source: Cribb et al (2015); http://election2015.ifs.org.uk/article/living-standards-recent-trends-and-future-challenges
When it comes to poverty, trends and policy have been somewhat more confusing. Measures of relative poverty – such as the proportion of individuals with incomes below 60% of the contemporary median – have fallen significantly since the start of the Great Recession and over the period of coalition government (from 18% in 2007-08 to 16% in 2010-11 and 15% in 2012-13). However, this is mostly because falls in median income have reduced the poverty line, rather than because of rises in the living standards of low-income households. Absolute poverty (defined as household incomes less than the 2010-11 median) has risen since household incomes began to fall (rising from 15% in 2009-10 to 17% in 2012-13) and is likely to have increased further as a result of cuts to benefits and tax credits taking effect from 2013-14 onwards.
However, there has been a distinct lack of clarity over what the coalition government goals really are with respect to poverty. There is currently a legally-binding target to ‘abolish’ child poverty by 2020, defined as reducing relative child poverty to below 10% as well as targets across a number of other domains. The coalition government initially announced rises in the Child Tax Credit alongside other benefit cuts in order to ensure no net impact on child poverty; but swiftly abandoned this practice (and cancelled the second planned CTC rise). Child poverty stood at 17% in 2012-13 and is expected to increase to 21% by 2020 (http://www.ifs.org.uk/uploads/publications/bns/BN154.pdf ), clearly way off the legally-binding target. The coalition government has expressed some dissatisfaction with the current measure of child poverty and has consulted on a new measure of child poverty (https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/228829/8483.pdf), though this has led to nothing as of yet. We are therefore left in an odd situation whereby there is a legally-binding target to reduce child poverty by 2020 and no credible plan to meet that target.
The coalition government has outlined a number of strategies to reduce child poverty in the long-run (https://www.gov.uk/government/publications/child-poverty-strategy-2014-to-2017). For instance, it has emphasised improving work incentives, which have indeed been strengthened for most groups over the past five years (http://election2015.ifs.org.uk/article/the-effect-of-the-coalition-s-tax-and-benefit-changes-on-household-incomes-and-work-incentives). Improving work incentives and reducing complexity have been important motivations for the introduction of Universal Credit. However, the implementation of this has been fraught with delays and is unlikely to be fully implemented until at least 2020 on current plans (http://election2015.ifs.org.uk/article/benefit-spending-and-reforms-the-coalition-government-s-record).
The coalition has also emphasised improvements in education outcomes, which are likely to be crucial determinants of later-life earnings capacity. The introduction of the disadvantaged pupil premium was a major plank of policy to improve the educational performance of disadvantaged children. However, there were already very significant amounts of funding targeted at poorer pupils before the coalition came to power (http://www.ifs.org.uk/bns/bn123.pdf) and there is no evidence to suggest that this led to a larger reduction in the attainment gap. Moreover, any such improvements in educational outcomes are likely to feed through into the labour market in the long-run.
Looking to the future, an important challenge for the next government will be to set out a clear set of objectives in the area of child poverty alongside measures to meet those objectives, whatever they may be. For instance, are they still committed to the 2020 target and, if so, how are they going to meet it?