Saving for Retirement

This is a podcast, showing the effects of taxes and benefits on income inequality. For a transcript email info@ons.gov.uk . To begin with we will look at what makes up household income. Our starting point is original income, which is income before taxes and benefits. This is made up of wages and salaries, self-employment, private pensions and investments. Adding cash benefits, for example, the state pension or those related to unemployment, gives us gross income. Subtracting direct taxes, for example, income tax and council tax, gives disposable income. Taking off indirect taxes, which are those paid when spending, such as VAT, leaves us with post tax income. We calculate household incomes for these four stages to show how incomes are affected by taxes and benefits. We can also use these estimates to look at how incomes vary between the richest and the poorest households, which is known as the level of income inequality. We can measure inequality on a scale of 0 to 100. To explain this, consider an example where there are five households in a street. If we give the street a total income of £100,000 and allocate each household an income of £20,000, this means that the total income for the street is equally distributed. Therefore the level of income inequality is zero per cent. Or in other words, there is no inequality of income. Now, let's take the same street, with the same five households and the same total income of £100,000. If one household received all of the income, and the other households have no income, then income inequality is 100 per cent, and there is complete inequality of income. We will now look at the level of income inequality from 1980 to 2009, and the effect that taxes and benefits have on these figures. This first line shows original income and in 1980, original income inequality stood at 44 per cent. Over the past 30 years it has increased and in 2009 it stood at 52 per cent. All of the increase in inequality happened during the 1980s and early 1990s. This increase was mainly caused by faster growth in wages and salaries for the richest households compared with the poorest. Since the early 1990s through to the latest period, the level of inequality of original income has remained quite stable. When cash benefits are included they reduce the level of income inequality. This is because very little cash benefits go to the richest households. Looking at the level of income inequality for gross income, which is income after adding in cash benefits, we see the fall in income inequality. In 1980 the inequality for gross income stood at 31 per cent, 14 percentage points lower than for original income. While income inequality increased over the period, to 37 per cent for gross income in 2009, cash benefits had a slightly bigger impact on reducing inequality, reducing it by 15 percentage points. Like cash benefits, direct taxes also reduce the level of income inequality. This is because richer households tend to pay more of their income in direct taxes than poorer households do. However, the reduction in inequality caused by direct taxes is smaller than the reduction caused by cash benefits. In 1980 direct taxes reduced income inequality by 3 percentage points, and in 2009 the reduction was 4 percentage points. The last stage is the effect that indirect taxes have on the level of inequality. Indirect taxes increase the level of income inequality, because poorer households tend to pay more indirect taxes as a proportion of their income than richer household, even though richer households pay more indirect taxes. We can see this as income inequality for post tax income is above that for disposable income. In 1980 indirect taxes increased inequality by 2 percentage points and from the mid-1980s onwards by around 4 percentage points. So we see that overall, taxes make little difference to income inequality. This is because direct taxes reduce inequality and indirect taxes increase inequality by roughly the same amounts. The information comes from the Living Costs and Food Survey, which is a survey of around 5,000 households across UK. The survey asks about the things that people spend their money on and the income they receive. This allows us to estimate the level of income inequality and how it is affected by taxes and benefits. Further information can be found in 'The effects of taxes and benefits on income inequality, available at the link here. For any queries about this podcast, please email hie@ons.gov.uk