VAT increases income inequality, ONS analysis shows

Council tax and indirect taxes such as VAT are the most regressive taxes because they increase income inequality but pension credits, housing benefit and income support have been identified as the most progressive in 2014/15, in that they were the benefits most targeted towards reducing inequality, analysis from the Office for National Statistics shows

The conclusions follows analysis from the ONS of the effects of taxes and benefits on income inequality.

According to the ONS, data measured by the Gini coefficient – the most commonly used measure of inequality, is a measure of statistical dispersion intended to represent the income distribution of a nation’s residents - has changed between 1977 and 2014/5, with income tax emerging as the tax that was most targeted towards reducing inequality in 2014/15.

Cash benefits have become less progressive since the late 1990s.

The ONS adds however that since the average amount households receive in benefits as a proportion of their income increased for much of this time, between 2001/2 and 2011/12 their overall effect on reducing inequality increased slightly.

Since 2007/08, there has been a slight decrease in overall income inequality, though from a longer-term perspective it is above levels seen in the early 1980s.

While there was little change in overall levels of inequality during the 1990s and early 2000s, unofficial estimates suggest the income share of the richest 1% (and 0.1%) increased steadily over this time. However, since the economic downturn their income share has fallen sharply.

Direct tax

Direct taxes – comprising income tax, national insurance contributions and council tax – have reduced income inequality, reducing the Gini coefficient by a further 3.2% 2014/15.

Since 1977, the average proportion of income households pay in direct taxes has generally fallen, most recently going from 21.4% of gross income in 2007/08 to 18.8% in 2014/15.

At the same time, despite a number of fluctuations, direct taxes have generally been becoming more progressive.

‘Both these factors, operating in opposite directions, have led to the overall impact of direct taxes on inequality remaining at a similar level for most of the time since 1977,’ the ONS report states.

Indirect taxes

Since 1977, indirect taxes have become more regressive, with most of that change happening during the 1980s.

‘Unlike cash benefits and direct taxes, indirect taxes are regressive, meaning that they have the effect of increasing income inequality, leading to a 3.5% increase in the Gini coefficient in 2013/14,’ the ONS says.

Income inequality in the UK

The ONS has tracked income across four categories - original income (income before any taxes and benefits), gross income (after cash benefits are added), disposable income (after cash benefits are added and direct taxes subtracted) and post -tax income (after cash benefits are added and both direct and indirect taxes are subtracted).

In the early 2000s, income inequality fell. This was in part owing to faster growth in income from earnings and self-employment at the bottom end of the income distribution. Policy changes, such as increases in the national minimum wage, tax credit payments and NI contributions in 2003/04, are also likely to have had an impact.

The most recent peak in income inequality was in 2006/07 or 2007/08, depending on the measure used. Since then the broad trend has been one of gradual decline in levels of inequality on each of the measures.

Across the EU

The data indicate that, before any taxes and benefits, the UK had one of the highest levels of income inequality in the EU.

‘However, the UK’s tax and benefits system appears to be more redistributive than that of many other countries with relatively high inequality of original income, bringing the UK close to the overall EU average for disposable income inequality,’ the ONS says.

Across the EU, the countries with the lowest levels of income inequality in 2013, based on the Gini coefficient for disposable income, included Slovakia (24.2%), Slovenia (24.4%) and the Czech Republic (24.6%). The highest levels of income inequality were observed in Bulgaria (35.4%), Latvia (35.2%) and Lithuania (34.6%).

The full ‘The Effects of Taxes & Benefits on Income Inequality: 1977 to financial year ending 2015’ article is available here

Penny Sukhraj |Content editor, Accountancy - (up to 2016)

Penny Sukhraj, former content editor and writer for Accountancy and Accountancy Live, responsible for commissioning and editing news...

View profile and articles

Be the first to vote

Rate this article

Related Articles