The progressivity of UK taxes and transfers
Last year, we produced some analysis of ONS data which showed just how progressive the UK welfare state is. Remember, we can only really judge this by looking at all functions of ‘the welfare state’, which was envisaged not just to provide a safety net for the poorest in terms of cash out-of-work benefits, but also health and education provision and other benefits in kind.
Helpfully, the Office for National Statistics produces a great piece of work each year called ‘The effects of taxes and benefits on household income’ which orders households by disposable income, and produces data on what the average household in each fifth of this disposable income scale receives/pays in:
- Original income, i.e. earned income such as wages etc
- Direct taxes
- Cash benefits
- Indirect taxes
- Benefits in kind, i.e. health spending, housing subsidies, rail and bus subsidies and education.
They also strip this analysis down into examination of retired and non-retired households (which is useful, because then we can check whether any trends are due to the effects of an ageing population).
This allows us to calculate a whole manner of different interesting statistics on the share of income different groups pay in tax, net contributions to government and effective tax rates given all inflows and outflows from the state. Though it excludes state spending on defence, law and order and many of the liberal functions of government, this data gives a clear indication of the affordability of, and the net contributors/recipients of, the welfare functions of the state. A good statistic which we found last year, for example, but which will take a bit of work to replicate, is that the proportion of households receiving more in cash benefits and benefits-in-kind than they paid in taxes had risen from 43.8% of GDP in 2000/01 to 53.4% in 2010/11 – that’s an increase of 3 million households on just ten years earlier.
So, what does this year’s data show?
The data shows that when all benefits, benefits in kind and taxes are considered, the UK welfare state is highly progressive. The table below shows the effective tax rate on original income, calculated as total taxes paid minus the value of all benefits and benefits in kind received, as a proportion of original income. It also shows the absolute levels of the average original (i.e. market) income by quintile and the average final income (original income – direct taxes + cash benefits – indirect taxes + benefits in kind).
Unsurprisingly, the figures show that households at the bottom end of the income scale have highly negative effective tax rates, whilst those at the top end have positive. So, for example, on average, for every £ of income earned by a household in the middle quintile, it received an additional 20p in net government transfers (benefits minus taxes). Similarly, on average, for every £1 earned by those in the lowest quintile an additional £1.90 was received in net transfers. The bottom 60 per cent of households are then, on average, net recipients of the state while the top two quintiles are net contributors.
- The lowest quintile household: received £10,387 more in benefits (incl. in kind) than paid in taxes.
- The second quintile household: received £9,560 more in benefits than paid in taxes.
- The middle quintile household: received £4,580 more in benefits than paid in taxes.
- The fourth quintile household: paid £4,469 more in taxes than received in benefits.
- The highest quintile household: paid £20,958 more in taxes than received in benefits.
The welfare state is therefore, unsurprisingly, very progressive, and to a large degree, this is what we would expect. After all, those in the bottom quintiles are likely to be those on low incomes, the unemployed or retired households. What is more interesting then is to examine how these trends have changed over time.
Tables 2 and 3 below are instructive. The first uses the deflator provided by the ONS to work out how the average net contributions by quintile have changed over the last three decades in real terms.
It’s noticeable that over the past year the real net contribution of all incomes has increased. The effective tax rates have remained much the same. But the key trend over the last thirty years has been that middle-income households have moved from being significant net contributors to significant net recipients (this trend is moving in the same direction for those in the 2nd and 4th quintiles). In 1990, the middle quintile of households had a net effective tax rate of 7% - now it’s minus 20%. This means that the average household in the middle quintile has gone from a real net contribution of £1,083 in 1990 to net receipt of £4,580 in 2011/12.
Perhaps this trend is due to an ageing population, with retired households more likely to be net recipients? So, it’s worth examining the data for non-retired households as well.
This shows that, on average, for every £1 of income earned by each household in the middle quintile of non-retired households, it made a net contribution of 3p. For every £1 earned by those in the bottom quintile an additional £1.32 was received in net transfers.
- The lowest quintile household: received £10,281 more in benefits (incl. in kind) than paid in taxes.
- The second quintile household: received £6,337 more in benefits than paid in taxes.
- The middle quintile household: paid £827 more in taxes than received in benefits.
- The fourth quintile household: paid £9,871 more in taxes than received in benefits.
- The highest quintile household: paid £25,389 more in taxes than received in benefits.
And as we can see from the Table below, the trends in terms of real contribution show are very similar to those of the whole population, especially in terms of the real net contribution of the middle income quintile having fallen significantly.
As we can see, though the real net contributions have increased for all income groups in the past year (not least because of the measures required to repair the public finances), the structure of net contributions and net receipts from the state has changed hugely in the last decade following a huge expansion in state spending and the after-effects of the financial crisis.
In further blogs on this data, I’ll try to ascertain what is driving these results, and will be investigating whether the proportion of total households who are net recipients of the state has changed significantly.