In this note we consider the scale of income and wealth inequalities in the UK. Why does inequality happen? And what government policies have been applied to affect the final distribution of income?

Income and Wealth

It is important to make a clear distinction between income and wealth:

• Income is a flow of factor incomes such as wages and earnings from work; rent from the ownership of land and interest & dividends from savings and the ownership of shares
• Wealth is a stock of financial and real assets such as property, savings in bank and building society accounts, ownership of land and rights to private pensions, equities, bonds etc

 

Sources of income

Sources of gross income by quintile groups of disposable income, 2005
Values (£ per year)	Bottom	2nd	3rd	4th	Top	Overall
Cash benefits	6 409	6 213	4 773	2 799	1 381	4 315
Investment income	1 132	2 185	3 074	3 860	6 221	3 295
Earned income	3 144	9 011	18 501	30 604	60 111	24 274
Earned income includes wages and salaries, income from self-employment and income from "fringe benefits". Investment income includes occupational pension income

For the poorest households in the UK, cash benefits from the state are more than twice as important as a source of income as income earned from working. Poorer families have little access to investment income. Income from assets earns five times as much income for the richest 20 per cent of households than it does for those at the bottom of the income ladder.

Measuring inequality – the Lorenz Curve and the Gini Coefficient

We can measure the distribution of income and wealth by using concepts such as the Lorenz Curve and the Gini Coefficient. A diagram showing the Lorenz Curve is given below.

The further the Lorenz curve lies below the line of equality, the more unequal is the distribution of income. There are problems with the Lorenz curve – particular if we are inaccurate in our measure of incomes across the distribution of households in a country

The Gini Coefficient is derived from the same information used to create a Lorenz Curve. The Gini Coefficient can take values from 0 to 100 per cent where a value of zero would indicate that each household had an equal share of income, while higher values indicate greater inequality.

The chart below shows the trend in the Gini Coefficient for original and disposable incomes of UK households since the late 1970s. Inequality of disposable income was fairly stable in the first half of the 1980s then increased during the second half of the 1980s. Inequality was relatively flat in the 1990s but with some indications of a slight fall in the first half of the 1990s. The Gini-coefficient for all types of income including original income and post-tax income has indeed fallen since 1998 providing evidence of a reduction in the overall inequality of incomes in the UK

Gini-coefficients for UK households	1993	1998	2005
Original income	53.5	52.7	50.6
Gross income	37.5	37.5	36.1
Disposable income	34.5	34.1	32.3
Post-tax income	38.5	38.0	36.1
Source: Office for National Statistics

The distribution of wealth

The distribution of wealth is more unequal than the distribution of income. This is shown in the chart below. In 2001, over 90% of marketable wealth was in the hands of just half the population and over a fifth of wealth was highly concentrated among the richest one per cent of households.

Distribution of marketable wealth in the UK
				Percentages
	1991	1996	2001	2002
Percentage of wealth owned by:
Most wealthy 1%	17	20	22	23
Most wealthy 25%	71	74	72	74
Most wealthy 50%	92	93	94	94
Total marketable wealth (£ billion)	1,711	2,092	3,477	3,464
Source: HM Revenue and Customs

 

Distribution of real disposable household income
	£ per week at 2003/04 prices
	10th		90th	Ratio of 90th to 10th percentile
	percentile	Median	percentile
1971	103.4	188.0	328.0	3.2
1979	124.7	217.2	372.8	3.0
1989	130.7	268.9	526.9	4.0
1999	147.1	292.5	604.6	4.1
2004	171.1	335.7	673.9	3.9

Proportion of people whose income is below various fractions of median household disposable income
	Below
	60 per cent	Below half
	of median	of median
	income	income
1961	12.8	7.4
1971	13.6	6.3
1981	12.1	4.5
1991	20.1	11.7
2001	17.0	9.7
2004	16.8	9.4
Source: Social Trends 36

Another way of measuring relative poverty and inequality is the proportion of the population whose income falls below some pre-defined threshold. In the table above we see two measures of relative poverty. If income falls below 60 per cent of median income, this takes a family below the European Union’s official “poverty line” or “poverty threshold”. There was a huge rise in inequality between 1981 and 1991 but since then the figure has fallen from 20% of the population to just under 17 per cent (although this figure is still much higher than that seen in the 1960s and 1970s). Nearly ten per cent of households live on an income of less than half median income.

Explaining the scale of income and wealth inequality in the UK

There are numerous explanations both for the existence and persistence of a huge divide in incomes and wealth within the UK. Most of them are directly economic in origin, but some are linked to social change. A summary is provided below:

(1) Differences in pay in different jobs and industries

High growth industries have enjoyed above average increases in pay and earnings. These include financial and business services and information technology. Jobs where labour demand is high and there are persistent shortages of skilled labour tend to offer more generous pay packages for employees. In contrast, public sector service jobs have seen a decline in relative pay levels because pay in private sector jobs has tended to out-strip earnings growth.

Many of the worst paid jobs are still found in low-skill service sector industries – often there is little trade union protection and job insecurity is endemic. Income inequality tends to rise during periods of rapid wage growth because the poorest households are the most likely to contain non-working individuals.

(2) Falling relative incomes of people dependent on state benefits

State welfare benefits normally rise in line with prices (they are index-linked) rather than with earnings. Therefore, households dependent on welfare assistance see their relative incomes fall over time. This is a particular problem for many thousands of pensioner households – the issue of pension poverty has become a major political challenge for the government.

(3) The effects of unemployment

Unemployment is a key cause of relative poverty (i.e. an increase in income inequality). For example, a serious problem is the increase in the number of households where no one is in paid employment and where a family is dependent on state welfare aid.

(4) Changes to the tax and benefit system

Changes to direct and indirect taxes have contributed to an increase in relative poverty. Income tax rates have fallen over the last two decades. The top marginal rate of tax fell from 83% in 1979 to 40% in 1988 where it has remained. The basic rate has come down from 33% in 1979 to 22% today. These tax reductions allow people in work to keep a higher proportion of their earned income. The benefits from lower taxes have flowed disproportionately to people on above-average incomes because of a fall in the progressive nature of the UK’s direct tax system.

There has been a switch towards indirect taxes in recent years including higher rates of value added tax and higher excise duties on petrol, alcohol and cigarettes. Some of these indirect taxes have a regressive effect on the distribution of income.

Suggestions for wider reading and research

• Child Poverty Action Group
• Fuel poverty
• Institute for Fiscal Studies see also IFS Background
• Joseph Rowntree Foundation – see also background on Joseph Rowntree Trusts
• Oxfam - UK campaign on child poverty
• Poverty rate may have risen under Labour (BBC news – March 2006)
• Voices from the poverty front line (BBC)
• Where do you fit into the UK income distribution? (IFS interactive web site)