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Poverty and income inequality Jonathan Cribb Public Economics Lectures, Institute for Fiscal Studies 17 th December 2012

Overview The standard of living in the UK Income Inequality The UK income distribution Measuring income inequality Explaining changes in income inequality Poverty Measuring income poverty Effect of government policy on poverty Material deprivation Summary and conclusions

How do you measure living standards? Clothing Consumption Health Education Nutrition Employment Income Housing Crime Status Political voice/power

Measurement of income Income as measured by government in Households Below Average Income (HBAI) Income is measured net of direct taxes and benefits Measured at the household level (implicitly assumes income sharing) Adjusted for household size (equivalised) Adjusted for inflation Based on Family Resources Survey (from 1994-5 onwards) 25,000 households across the UK Subject to sampling error

Comparing HBAI income to GDP per capita 120 Quarter 2 2002 = 100 115 110 105 100 95 90 GDP per capita Mean income Median income Source: ONS series IHXW and Family Resources Survey, various years

Income Inequality

The UK income distribution in 2010-11 Net household income ( per week) 2,500 2,000 1,500 1,000 500 0 Equivalent income for a childless couple 50th percentile: 419 Corresponds to 279 for one-person household or 587 for couple with 2 children 10 20 30 40 50 60 70 80 90 Percentile point Source: Author s calculation using the Family Resources Survey 2010-11

The UK income distribution in 2010-11 2,500 Household income ( per week) 2,000 1,500 1,000 500 0 10th percentile: 216 50th percentile: 419 90th percentile: 846 10 20 30 40 50 60 70 80 90 Percentile point Source: Author s calculation using the Family Resources Survey 2010-11

Where do you fit in? Single person with starting pay of 30k A. 20 th percentile B. 50 th percentile C. 70 th percentile D. 78 th percentile Couple no children, with joint pay of 80k A. 64 th percentile B. 74 th percentile C. 84 th percentile D. 94 th percentile http://www.ifs.org.uk/wheredoyoufitin Source: IFS calculations using TAXBEN and Where do you fit in?

How do we measure income inequality? Typically, inequality refers to the gap between rich and poor But we may also be interested in the gap between rich and middle or poor and middle. Therefore we can look at the difference in income at different points in the income distribution Or we can use a measure which summarises the whole distribution in one number.

Measures of inequality: Gini coefficient Share of total income (%) 100 90 80 70 60 50 40 30 20 10 0 Gini = A A + B Perfect equality 0 10 20 30 40 50 60 70 80 90 100 Percentage of population, ranked by income A B UK Lorenz curve in 2010-11: Gini = 0.34

Gini coefficient since 1979 0.40 1979 to 1990 Gini increased from 0.25 to 0.34 1996-97 to 2009-10 Gini rose from 0.33 to 0.36 Gini coefficient 0.35 0.30 0.25 1979 1982 1984 1986 1988 1990 1992 1994 95 1996 97 1998 99 2000 01 2002 03 2004 05 2006 07 2008 09 2010 11 Source: Figure 3.7 of Cribb, Joyce and Phillips 2012

Gini masks changes in different types of inequality 2.9 2.7 2.5 Ratio 2.3 2.1 1.9 1.7 1.5 Year 50/10 ratio 90/50 ratio 99/90 ratio

Why has income inequality risen? Skills-biased technological changes [see Acemoglu (2002), Machin (2001) and Goldin and Katz (2008)]

Rising college premium Wage premium (Skilled / unskilled wage) Supply P 2011 P 1979 Demand 2011 Demand 1979 Q 1979 Q 2011 Skilled / unskilled employment

Real earnings growth: increasing inequality? UK (1980-2005) Sweden (1980-2005) Avg annual earnings growth 3.0 2.5 2.0 1.5 1.0 0.5 0.0-0.5-1.0 Avg annual earnings growth 3.0 2.5 2.0 1.5 1.0 0.5 0.0-0.5-1.0 Avg annual earnings growth 3.0 2.5 2.0 1.5 1.0 0.5 0.0-0.5-1.0 USA (1980-2005) Source: OECD. Notes: Full-time male workers only

Why has income inequality risen? Skills-biased technological changes [see Acemoglu (2002), Machin (2001) and Goldin and Katz (2008)] International trade and globalisation (Stolper-Samuelson theorem) Labour market institutions: weaker trade unions and a decline of collective bargaining (Goodman and Shephard 2002) Changes in the tax and benefit system

Effect on income inequality of replacing tax/benefit system with those from previous years (UK) Increase in Gini relative to 2009-10 0.05 0.04 0.03 0.02 0.01 0.00 Regressive tax and benefit changes in late 1980s correlate with rise in inequality But inequality has not fallen since, despite inequality-reducing tax/benefit changes 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Source: Adam and Browne (2010). Note: Tax and benefit systems from previous years have been uprated in line with the Retail Prices Index. Years up to and including 1992 are calendar years; thereafter, years refer to financial years.

Other reasons for changes in inequality More inequality in employment status across households (Gregg and Wadsworth, 2008) Is there also an increase in transitory shocks to income? Inequality observed from cross-sectional income distributions may be higher than inequality in life-time incomes Transitory income shocks affect the former more Strong growth in permanent shocks in early 80s; but strong growth in transitory shocks in late 80s; and slower growth in both in the 90s (Blundell and Etheridge 2009) What about top income inequality? Superstar effects and globalisation (OECD 2012) but difficult to measure and understand

Decomposing reasons for rising earnings inequality Percentage contributions to changes in household earnings inequality, OECD average, mid-1980s to mid-2000s Women's employment Men's earnings disparity Men's employment Assortative mating Household structure Residual -19% 42% 17% 11% 11% 39% -40% -20% 0% 20% 40% 60% 80% 100% 120% 140% Percentage contribution Source: OECD (2012) pp.33

Poverty

What is poverty? Destitution, relative deprivation, capability or functioning in society, livelihood sustainability? But how do we measure this? Economists have tended to compare people s incomes relative to a certain poverty line Those with income under the poverty line are in poverty

How do we choose a poverty line? Absolute Poverty line $1 a day poverty line (in 1990 prices) (Ravallion et al 1991) US government basket of goods and services

Calculating absolute poverty Count the proportion of people below that poverty line Draw a line of real-terms income Lowest Highest Income

Absolute poverty over time Count the proportion of people below that poverty line Draw a line of real-terms income Lowest Highest Income

How do we choose a poverty line? Absolute Poverty line $1 a day poverty line (in 1990 prices) (Ravallion et al 1991) US government basket of goods and services Relative Poverty lines

Calculating relative poverty Take (e.g.) 60% of that amount. Everyone with income less than this is in relative poverty. Find the middle person s income (the median) Lowest Income Highest

Relative poverty over time a moving target...then 60% of median income the relative poverty line grows too... If median income grows......even with no change to incomes of low-income people, relative poverty goes up Lowest Income Highest

How do we choose a poverty line? Absolute Poverty line $1 a day poverty line (in 1990 prices) (Ravallion et al 1991) US government basket of goods and services Relative Poverty lines have important implications No effect of top income inequality If median income falls poverty may fall too Relative poverty is a kind of inequality We could use a Poverty Gap measure, which puts weight on how far households are from the poverty line

Relative Poverty by subgroups (GB) 45% 40% 35% 30% 25% 20% 15% 10% 5% 0% 1979 1983 1987 1991 1995 1999 2003 2007 Children Pensioners Working-age adults without children Source: Author s calculations using the FRS and FES, multiple years. Poverty measured using BHC incomes.

Fiscal redistribution and child poverty under Labour Labour s direct tax and benefit policies clearly driven by child poverty targets Increased annual entitlements to net state support by average of 4,000 for poorest half of households with children, compared to default (mostly price) indexation or by 1,165 compared to GDP-indexation In 2010-11, 18 billion more spent on child-contingent benefits/tax credits than if Labour had just applied default indexation rules (Browne and Phillips, 2010).

A very close correspondence between movements in benefit levels and child poverty levels Couple, 3 children, no work Lone parent, 1 child, no work Lone parent, 1 child, part-time work Change in BHC relative child poverty rate in UK 1999-00 + + + - 2000-01 + + + - 2001-02 + + + - 2002-03 + - + - 2003-04 + + + - 2004-05 + + + - 2005-06 - - - + 2006-07 - - - + 2007-08 - - - + 2008-09 + + + - 2009-10 + + + - 2010-11 + + + - Entitlements grew faster than relative poverty line (median income) Entitlements grew more slowly than relative poverty line (median income) Source: Table 5.7 from Cribb, Joyce and Phillips (2012)

Government policy and poverty Current government argued in Child Poverty Strategy that a focus merely on incomes would be too narrow And that policy should focus more on long-term causes We know from recent experience that income-based poverty measures highly sensitive to fiscal redistribution Unsurprisingly given welfare cuts, IFS researchers forecast child income poverty to rise in coming years (absolute and relative) Important tradeoffs: Redistribution versus financial work incentives Government tax revenue not spent on benefits could be spent on education or deficit reduction Government has made clear that it thinks costs of much more redistribution in coming years would be too great

Problems with measuring living standards Two reasons for thinking we are underestimating living standards lower down the distribution

Benefit incomes are under-recorded Administrative data ( billion) HBAI data ( billion) % of total expenditure recorded in HBAI data Basic State Pension 69.8 63.4 91 Pension Credit 8.3 4.5 55 Tax credits 28.1 19.5 69 Child Benefit 12.0 11.4 95 Housing Benefit 21.4 16.3 76 Disability Living Allowance All benefits and tax credits 11.9 9.5 80 193.1 154.4 80 Source: Table D.1. in Cribb, Joyce and Phillips (2012)

Those with the lowest incomes do not have the lowest consumption 490 420 350 Median Expenditure 280 210 140 70 Median expenditure 0 0 100 200 300 400 500 Income Source: Brewer and O Dea (2012)

Income v Consumption Saving Income/Consumption Borrowing Borrowing Consumption Income Age Income or consumption? Consumption is conceptually better measure of living standards But income is easier to measure and more data on income in the UK

Comparing Gini coefficient from Income and Consumption 0.38 0.36 HBAI Inc 0.34 0.32 0.30 Consumption 0.28 0.26 0.24 0.22 0.20 1978 1982 1986 1990 1994 1998 2002 2006 2010 Source: Brewer and O Dea (2012)

Problems with measuring living standards Two reasons for thinking we are underestimating living standards lower down the distribution Benefit spending under-recorded in the data Incomes at the bottom of the distribution don t match consumption Furthermore Inequality in consumption has grown much less quickly than inequality in income People face different prices- can we measure living standards in another way?

Material deprivation as an alternative indicator Percentage of working age adults unable to afford item With dependent children Without dependent children 2007 08 2010 11 2007 08 2010 11 Able to keep accommodation warm 7.4 9.4 6.6 8.5 Two pairs of all-weather shoes for each adult 7.5 8.7 4.3 5.7 Money for decent decoration of home 15.6 15.7 9.5 10.6 Household contents insurance 14.6 16.7 8.5 9.8 Replace or repair major electrical goods (e.g. refrigerator) when broken 17.7 21.9 10.2 13.6 A small amount of money to spend each week on yourself, not on your family Have friends or family around for a drink or meal at least once a month 28.8 31.6 12.3 15.8 13.8 15.5 9.7 11.3 Replace any worn-out furniture 25.5 31.0 14.4 18.1 Adult has a hobby or leisure activity 14.8 15.7 6.4 8.4 A holiday for at least one week a year, not at home or relative s home 33.3 39.5 24.3 28.9 Regular savings of 10 a month or more for rainy days or retirement 35.5 38.4 25.7 30.4 Memo: Relative income poverty rate (BHC) 18.1 16.0 14.0 14.6 Memo: Absolute income poverty rate (BHC) 14.9 15.2 12.6 14.7 Source: Table 6.7 from Cribb, Joyce and Phillips (2012)

Regional variation in child poverty and deprivation Rate (%), 2008-09 to 2010 11 Relative income poverty rate Material deprivation rate, old items, updated weights Region North West 22.0 32.3 Yorkshire and the Humber 25.0 30.8 London 18.8 30.3 North East 24.8 30.1 West Midlands 27.2 30.0 Wales 22.5 26.9 East Midlands 18.3 26.8 South West 16.0 24.8 Northern Ireland 24.0 24.5 Scotland 19.5 22.4 South East 12.6 20.6 East of England 15.3 20.1 Source: Table 6.5 from Cribb, Joyce and Phillips (2012)

Variation in local prices and housing costs Poverty in high living cost areas underestimates the level of material deprivation Differences in housing costs are important too People who own their own home, without a mortgage look like they are poorer than renters on housing benefit We could impute the benefit from owning one s own house Or we could look at low incomes measured AHC (after housing costs are deducted). This is especially relevant for pensioners, and for those whose rent is covered by housing benefit or live in social housing

Summary Income inequality rose quickly in the 1980s, since 2000 mainly been inequality at the very top of the distribution Leading explanation of inequality is changing returns to skills Poverty can be defined using an absolute or relative income measure Different groups have benefited differentially from the generosity of government tax and benefit policy There are still many difficulties understanding living standards, especially at the bottom of the income distribution

References (1) Acemoglu, D. (2002) Technical Change, Inequality and the Labor Market, Journal of Economic Literature 40 (1) Adam, S., and Browne,J. (2010) Redistribution, work incentives and thirty years of UK tax and benefit reform, IFS Working Paper 10/24 Atkinson, A. (2008) The Changing Distribution of Earnings in OECD countries, Oxford University Press, Oxford Blundell, R., and Etheridge, B. (2009) Consumption, income and earnings inequality in Britain, Review of Economic Dynamics Blundell, R., and Preston, I. (1998) Consumption inequality and income uncertainty, Quarterly Journal of Economics 113, pp. 603-640 Brewer, M., and O Dea, C. (2012) Measuring Living Standards with income and consumption: Evidence from the UK, IFS Working Paper W12/12, Institute for Fiscal Studies, London.

References (2) Cribb, J., Joyce, R., and Phillips, D. (2012) Living Standards, Poverty and Ineqaulity in the UK: 2012 IFS Commentary no. 124, Institute for Fiscal Studies, London Goldin, C., and Katz, L. (2008) The Race Between Education and Technology, Harvard University Press, Cambridge MA Goodman, A. and Shephard, A. (2002), Inequality and living standards in Great Britain: some facts, IFS Briefing Note 19, Institute for Fiscal Studies, London Gregg, P. and Wadsworth,J. (2008) Two Sides to Every Story: Measuring Polarization and Inequality in the Distribution of Work, Journal of the Royal Statistical Society Series A Machin, S. (2001) The Changing Nature of Labour Demand in the New Economy and Skill- Biased Technology Change, Oxford Bulletin of Economics and Statistics 63 (S1) OECD (2011) Divided We Stand: Why Inequality Keeps Rising OECD Publishing Ravallion, M., Datt, G., and van de Walle, D. (1991) Quantifying Absolute Poverty in the Developing World, Review of Income and Wealth no.37 pp 345-361