In this note we consider the options available to the government if it wishes to achieve a greater degree of equity in the distribution of income and wealth. 

Policy options to change the distribution of income and wealth

There are many policy options available to a government if it wants to change the final distribution of income and wealth in a country. The main strategies that the Labour government has chosen to reduce poverty since it was elected in May 1997.

• The introduction of a National Minimum Wage and a series of increases in its value
• The launch of the Working Tax Credit and Child Tax Credit – designed to boost work incentives for low-income households who opt to work full-time or part-time
• Provision of a Minimum Income Guarantee for Pensioners and increases in the real value of Winter Fuel Payments – designed to alleviate “fuel poverty” among old people
• Active employment policies such as the introduction of New Deals for young people, the long-term unemployed, lone parents and disabled people – a long-term strategy designed to increase employment opportunities

In addition the government already has in place a progressive system of income tax and welfare benefits that helps to reduce the huge differences between original and final disposable incomes between different groups of the population.

Income redistribution through the tax and benefit system

The effects of taxes and benefits by quintile groups on households, 2005
	Quintile groups of all households						Ratio Top/Bottom quintile
						All
	Bottom	2nd	3rd	4th	Top	households
(£ per year)
Original income	4 280	11 200	21 580	34 460	66 330	27 570	15.5
plus cash benefits	6 410	6 210	4 770	2 800	1 380	4 310
Gross income	10 690	17 410	26 350	37 260	67 710	31 880	6.33
less direct taxes	1 030	2 270	4 650	7 910	16 760	6 520
Disposable income	9 660	15 140	21 690	29 360	50 960	25 360	5.28
less indirect taxes	2 860	3 410	4 570	5 510	7 330	4 730
Post-tax income	6 800	11 730	17 130	23 850	43 630	20 630	6.4
plus benefits in kind	6 460	5 780	5 420	4 470	3 780	5 180
Final income	13 250	17 520	22 550	28 320	47 410	25 810	3.59

What are the effects of the tax and benefit system on the final distribution of income in the UK? This summary table is published each year by the Government and gives us an idea of the progressiveness of the tax and benefits system for households in different income bands.

Original income comes from wages and salaries in work, self-employment income, investment incomes et al. To which we add entitlements to welfare benefits in cash – not that the lowest income households are those most entitled to these benefits, some of which are means-tested. The ratio of the original income of the richest fifth of households to the poorest fifth is nearly 16. By the time that government welfare benefits have been included, that ratio falls to less than 7.1.

Then we include the effects of direct taxation – mainly income tax and national insurance – which acts as a progressive form of taxation – a higher income group pays a higher % of their incomes in tax. This gives us disposable income - the ratio of the disposable income of the richest fifth of households to the poorest fifth is 5.3.

Our final transfer is to include the effects of indirect taxes and estimated benefits in kind from state provision of education, the NHS and housing subsidies to give a figure for final income. The final result is that our ratio between richest and poorest quintiles falls further to 3.6.

Main benefits in kind

• Health services
• Education
• Travel subsidies
• Housing subsidies
• School meals and welfare milk

Indirect taxes fall most heavily on poorest households. In 2001-02, they accounted for 34% of disposable income whereas for the highest income quintile, the percentage was just 14%. This suggests that indirect taxation overall has a regressive effect on the distribution of income in the UK.

Percentage shares of household income and Gini coefficients, 2005
	Percentage shares of equivalised income for all households
	Original	Gross	Disposable	Post-tax
	income	income	income	income
Quintile group
Bottom	3	7	8	7
2nd	8	11	13	12
3rd	15	16	17	16
4th	24	23	22	22
Top	50	43	41	43
All households	100	100	100	100
Decile group
Bottom	1	3	3	2
Top	32	27	26	27
Gini coefficient for the UK	51	36	32	36

The government has focused its’ policies in the following areas

• Promoting higher levels of employment through increased spending on labour market training and subsidies for businesses who take on people through the New Deal programme.
• Attempting to reduce the skills gap existing in the labour market – workers with low grade skills are suffering badly in today’s ever-changing labour market.
• Switching towards means-tested benefits rather than universal benefits.
• Offering specific financial help to certain groups.
• Improving work incentives for the low paid.
• Attempts to reduce child poverty e.g. by increasing the value of child benefit.

There has been some limited progress in attacking some of the causes of poverty. For example the number of children living in poor households fell by 200,000 in 2002-03. But the latest official figures for the UK show that, for the year 2002-03, income inequality remains greater under Labour than under the 1979-97 Conservative governments of Margaret Thatcher and John Major.

The main sources of income for different groups in 2003

Percentage of Gross Income	Bottom	Second	Middle	Fourth	Top	Overall
	Quintile	Quintile	Quintile	Quintile	Quintile
Source of Income
Earnings from work	35	55	74	84	87	77
Investments	3	2	2	3	6	4
Occupational pensions	4	5	6	5	4	5
Miscellaneous	3	3	2	2	1	2
Welfare Benefits and Tax Credits	55	35	16	7	2	13

The reality is that there are powerful forces at work in the British economy (and specifically within our labour market) that are increasing the gap between rich and poor. In particular the incomes of the most affluent households have raced ahead of relatively poorer families. Thus one can argue that the government has through its redistribution policies to run simply to stand still. Without Labour’s commitment to redistribution, the level of income inequality would be even higher than it is now.

Which policies are most effective in reducing poverty?

A government truly committed to making a serious dent in relative poverty would

• Invest more resources in skills training and life-long education for all households – particularly those of low income families in a bid to make a real effect on child poverty
• Making the tax system more progressive – for example raising the higher rate of tax from 40% for the top-earning households
• Analysing carefully the effects of changes in indirect taxes such as VAT and excise duty in case they have a regressive effect on the overall distribution of income
• Focus more on targeting benefits by means-testing them according to financial need
• Increase the value of welfare benefits / tax credits in line with the annual percentage growth in median earnings so that the relative value of these benefits does not decline

Income tax payable: by annual income, in 2005/06
	Number of taxpayers (millions)	Total tax liability (£ million)	Average rate of tax (percentages)	Average amount of tax (£)
£4,895–£4,999	0.1	1	0.1	5
£5,000–£7,499	2.9	369	2.0	126
£7,500–£9,999	3.5	1,580	5.1	445
£10,000–£14,999	6.1	7,560	9.8	1,220
£15,000–£19,999	5.1	11,500	13.0	2,260
£20,000–£29,999	6.4	24,000	15.4	3,760
£30,000–£49,999	4.3	28,900	17.9	6,690
£50,000–£99,999	1.5	25,900	25.7	17,000
£100,000 and over	0.5	34,200	33.4	71,100
All incomes	30.5	134,000	18.2	4,390

Taking the long view

Percentage shares of original and post tax income in the UK
	1993-94	2004-05
Original income
Bottom	2	3
2nd	6	8
3rd	14	15
4th	25	24
Top	52	50
Post-tax income
Bottom	7	7
2nd	11	12
3rd	16	16
4th	22	22
Top	44	43

No policies to relieve poverty are risk free. Many are highly expensive and their effects often take many years to show through properly. The consensus among the leading academic researchers is that high employment, and a commitment to raise the skills and potential earnings of people towards the bottom of the pay ladder are the most effective and sustainable policies in the long term.