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Tax to equalise Reshaping Labour

Whilst poverty declined under New Labour inequality did not. Paul Teasdale argues Labour has to bite the bullet and fight for progressive taxation to remedy this.

Inequality has fallen out of political discussion since the creation of New Labour. Labour ministers stated that they were very comfortable about people becoming very rich, several showed their desire to join them. The New Labour years saw growing inequality but, almost by stealth, progress was made in reducing poverty. Gordon Brown focused particularly on reducing the proportion of children living in poverty, although the government's target was missed, considerable progress was made, reducing the number by a third. This was the result of steady economic growth and rising employment, combined with minimum wage legislation and tax credits for those in work. The onset of recession might be expected to reverse this and to widen inequality. Figures published by the Department of Work and Pensions (DWP) earlier this year showed that the initial effect has been to narrow inequality; nobody appears to have been cheered by this fact.

The key indicator of poverty is the proportion living in a household with income below 60% of the median – the median being the point with half above and half below. The EU describes these as being at risk of being in poverty. The figures are published each year by the DWP in its report Households Below Average Income. The Institute for Fiscal Studies has estimated that the proportion was around 12-15% in the sixties and reached a low of 10% in 1977. It then increased steadily in the eighties reaching a peak of 21% in 1992, and then fell to around 18% where it has stayed from the mid-nineties. The UK figure is among the highest in the EU.

The figures released by the DWP earlier this year showed that the proportion in poverty (before housing costs) had fallen to 16% (and to 18% for children). Politicians who might have welcomed such an improvement tended to be quiet because the change was mainly due to a fall in the median income rather than to increased incomes at the bottom. This prompted Conservative politicians to restate their arguments against the use of a relative measure of poverty.

Rather more interesting was what the figures showed about changes in the distribution of income.

Comparisons with two years earlier show that people at the upper end of the income distribution had fared worst. While the median was lower by 3% in real terms (i.e. after adjusting for inflation), the income at the 90th percentile was lower by 6%, and at the 10th percentile household income was at the same level as two years earlier. The result of this is a narrowing of inequality on a variety of measures. Using perhaps the simplest measure the ratio of the 90th percentile to the 10th the gap is lower than at any time since the early nineties. This has been achieved by a narrowing of the gap between the bottom and the middle, and the gap between the middle and the top. The share of income going to the top ten per cent fell to the level it was when Labour came into office.

The gap between the rich and the super-rich may have widened but that has no effect on these statistics. Only 300,000 people are in the 50% tax band. However, their economic effects are not insignificant, and can be seen, for instance, in the distortions to the housing market in the south east.

The main factors behind the slight reduction in inequality are the peculiar response of the labour market in the current recession, and the benefit regime providing support to those on low incomes.

In previous recessions inequality has widened as the loss fell heavily on the unemployed. But this recession has seen surprisingly little job loss compared with the drop in output. The impact of the downturn has been seen in reductions in hours worked, lower real wages and lower productivity, rather than in unemployment - with the result that the impact has been more widely spread across the income distribution than in previous recessions. This is reinforced by the second factor. While wages have been rising more slowly than prices for the first time in decades, benefits are linked to inflation so have risen faster than wages. That has helped those on lower incomes. Tax credits have many faults but they appear to have helped in this respect.

With little sign that the recession will change course in the next two years there is little reason to expect the progress in the latest inequality figures to be reversed. There is little sign of wages picking up so it is likely that incomes in the upper part of the distribution will fall further in real terms while those with some benefit component will have some protection. Tory backbenchers have been used by the government to float the idea of removing the link between benefits and inflation: ‘why should the unemployed have their living standards protected when hard working families are struggling'? But so far there are no definite proposals. This argument fails to recognise that most benefit recipients are not unemployed.

The Labour Party appears rather ambiguous on the subject of inequality. The new figures show that Ed Miliband was right when he spoke of ‘the squeezed middle' – but his impact was rather weakened when he was vague about where the middle is. This is not surprising as the media regularly give the impression that typical wages and incomes are higher than they are. (See box for the actual figures for 2010/11).

If Labour wishes to avoid a repeat of the increase in inequality, seen in the New Labour years, high employment and benefits will not be enough. Labour needs to have policies that are explicitly designed to reduce inequality, not hope that growth will benefit all. However, that would require adopting some unpopular policies.

The only really effective step would be to make the tax system more progressive – and that would mean more tax on Miliband's squeezed middle. First, it would require raising the basic rate of tax. Of the 25 million people paying income tax only 3.4 million pay the higher (40%) rate so raising the upper rate would have little effect on the distribution of income. The threshold for the higher rate of tax needs to be lowered (it is currently sixty per cent higher than the median wage). But a more significant step would be to raise the basic rate of tax for all tax payers. Over the past thirty years the level of basic tax has been falling. In 1980 a single man on the average wage paid 32% of his income in tax and National Insurance Contributions. By 2012 that had fallen to 25%.

A possible measure would be to link all benefits (not just pensions) to earnings when earnings are rising above inflation. But perhaps the main requirement is to engineer a cultural change. Tax and earnings should be more transparent. There have been calls to expose the tax wheezes of the rich and the earnings of politicians and people in public sector jobs (now including bankers). But it would be unjust to be so selective about this. We could consider the disclosure of tax records for everyone - along the lines already adopted in Sweden and Norway. Thirty years ago most workers had a reasonable idea what their colleagues earned – with collective bargaining and agreed pay scales. The widening of differences in pay has gone hand in hand with increasing secrecy. (One consequence has been the difficulty of exposing sex discrimination in pay.) A public better informed about real earnings might be more able to support a more equitable distribution.