The IFS has launched a major five-year review into all aspects of inequality. The review is led by Sir Angus Deaton, the Scottish-born Professor of Economics and International Affairs at Princeton University. In 2015, he was awarded the Nobel Prize in Economic Sciences for his analysis of consumption, poverty, and welfare. The review will cover all aspects of inequality, including inequality of income, wealth, health, life-span, education, social mobility, housing, opportunity and political access, and by gender, age, ethnicity, family and geography. It will look at trends in and causes of inequality, the impacts of globalisation and political change, barriers to tackling inequality and poverty, and at various policy measures.
Although the published Gini coefficient in England and Wales has not changed much over the past 15 years, largely because of support given to the poor by tax credits, it did rise from 31.7 to 33.2 from 2015/16 to 2017/18 (the latest year for which figures are available). Other measures of inequality, however, have changed more dramatically. There is huge geographical inequality in income in the UK, reflected in inequality in health. Average weekly earnings in London are 66% higher than in the north east of England. And, according to the IFS, ‘Men in the most affluent areas can expect to live nearly 10 years longer than those in the most deprived areas, and this gap is widening’.
The UK has the greatest inequality of income of developed countries, with the exception of the USA. The IFS warns that the UK could follow the USA:
…where wages for non-college-educated men have not risen for five decades, and where rising mortality for less-educated white men and women in middle age has caused average life expectancy in America to fall for the last three years – something that has not happened for a century. We have not experienced anything similar in the UK but we have now had a decade of stagnant wages and there is recent evidence that ‘deaths of despair’ – deaths from suicide and drug and alcohol abuse – are now rising among middle-aged Britons. Sir Angus will go on to say:
‘I think that people getting rich is a good thing, especially when it brings prosperity to others. But the other kind of getting rich, “taking” rather than “making”, rent-seeking rather than creating, enriching the few at the expense of the many, taking the free out of free markets, is making a mockery of democracy. In that world, inequality and misery are intimate companions.’
The initial report, which introduces the IFS Deaton Review, points to some possible causes of growing inequality, including the dramatic decline in union membership, which now stands at just 13% of private-sector employees, with more flexible labour markets with growing numbers of workers on temporary or zero-hour contracts. Other causes include growing globalisation, rapid technological change making some skills redundant, the power of large companies and their shareholders, large pay rises given to senior executives, growing inequality of access to education and changing family environments with more single parents.
About one in six children in the UK are born to single parents – a phenomenon that is heavily concentrated in low-income and low-educated families, and is significantly less prevalent in continental Europe.
Then there is the huge growth in housing inequality as house prices and rents have risen faster than incomes. Home ownership has increasingly become beyond the reach of many young people, while many older people live in relative housing wealth. Generational inequality is another major factor that the Deaton Review will consider.
Inequalities in different dimensions – income, work, mental and physical health, families and relationships – are likely to reinforce one another. They may result in, and stem from, other inequalities in wealth, cultural capital, social networks and political voice. Inequality cannot be reduced to any one dimension: it is the culmination of myriad forms of privilege and disadvantage.
The review will consider policy alternatives to tackle the various aspects of inequality, from changes to the tax and benefit system, to legislation on corporate behaviour, to investment in various structural resources, such as health and education. As the summary to the initial report states:
The Deaton Review will identify policy responses to the inequalities we face today. It will assess the relative merits of available policy options – taxes and benefits, labour market policies, education, competition policy, ownership structures and regulations – and consider how policies in different spheres can be designed to complement each other and minimise adverse effects. We aim not just to further our understanding of inequalities in the twenty-first century, but to equip policymakers with the knowledge and tools to tackle those inequalities.
IFS Deaton Review
- Identify different aspects of inequality. Choose two or three aspects and examine how they are related.
- Why has inequality widened in most developed countries over the past 20 years?
- What is meant by ‘rent seeking’? Why may it be seen as undesirable? Can it be justified and, if so, on what grounds?
- What policies could be adopted to tackle poverty?
- What trade-offs might there be between greater equality and faster economic growth?
- What policies could be adopted that would both reduce inequality and boost long-term economic growth?
During the 1970s, commentators often referred to the ‘political business cycle’. As William Nordhaus stated in a 1989 paper. “The theory of the political business cycle, which analyzes the interaction of political and economic systems, arose from the obvious facts of life that voters care about the economy while politicians care about power.”
In the past, politicians would use fiscal, and sometimes monetary, policies to manipulate aggregate demand so that the economy was growing strongly at the time of the next election. This often meant doing unpopular things in the first couple of years of office to allow for popular things, such as tax cuts and increased government transfers, as the next election approached. This tended to align the business cycle with the election cycle. The economy would slow in the early years of a parliament and expand rapidly towards the end.
To some extent, this has been the approach since 2010 of first the Coalition and now the Conservative governments. Cuts to government expenditure were made ‘in order to clear up the mess left by the previous government’. At the time it was hoped that, by the next election, the economy would be growing strongly again.
But in adopting a fiscal mandate, the current government could be doing the reverse of previous governments. George Osborne has set the target of a budget surplus by the final year of this parliament (2019–20) and has staked his reputation on achieving it.
The problem, as we saw in the blog, Hitting – or missing – the government’s self-imposed fiscal targets is that growth in the economy has slowed and this makes it more difficult to achieve the target of a budget surplus by 2019–20. Given that achieving this target is seen to be more important for his reputation for ‘sound management’ of the public finances than that the economy should be rapidly growing, it is likely that the Chancellor will be dampening aggregate demand in the run-up to the next election. Indeed, in the latest Budget, he announced that specific measures would be taken in 2019–20 to meet the target, including a further £3.5 billion of savings from departmental spending in 2019–20. In the meantime, however, taxes would be cut (such as increasing personal allowances and cutting business rates) and government spending in certain areas would be increased. As the OBR states:
Despite a weaker outlook for the economy and tax revenues, the Chancellor has announced a net tax cut and new spending commitments. But he remains on course for a £10 billion surplus in 2019–20, by rescheduling capital investment, promising other cuts in public services spending and shifting a one-off boost to corporation tax receipts into that year.
But many commentators have doubted that this will be enough to bring a surplus. Indeed Paul Johnson, Director of the Institute for Fiscal Studies, stated on BBC Radio 4’s Today Programme said that “there’s only about a 50:50 shot that he’s going to get there. If things change again, if the OBR downgrades its forecasts again, I don’t think he will be able to get away with anything like this. I think he will be forced to put some proper tax increases in or possibly find yet further proper spending cuts”.
If that is the case, he will be further dampening the economy as the next election approaches. In other words, the government may be doing the reverse of what governments did in the past. Instead of boosting the economy to increase growth at election time, the government may feel forced to make further cuts in government expenditure and/or to raise taxes to meet the fiscal target of a budget surplus.
Budget 2016: George Osborne hits back at deficit critics BBC News (17/3/16)
George Osborne will have to break his own rules to win the next election Business Insider, Ben Moshinsky (17/3/16)
Osborne Accused of Accounting Tricks to Meet Budget Surplus Goal Bloomberg, Svenja O’Donnell and Robert Hutton (16/3/16)
George Osborne warns more cuts may be needed to hit surplus target Financial Times, Jim Pickard (17/3/16)
6 charts that explain why George Osborne is about to make austerity even worse Independent, Hazel Sheffield (16/3/16)
Budget 2016: Osborne ‘has only 50-50 chance’ of hitting surplus target The Guardian, Heather Stewart and Larry Elliott (17/3/16)
How will Chancellor George Osborne reach his surplus? BBC News, Howard Mustoe (16/3/16)
Osborne’s fiscal illusion exposed as a house of credit cards The Guardian, Larry Elliott (17/3/16)
The Budget’s bottom line: taxes will rise and rise again The Telegraph, Allister Heath (17/3/16)
Reports, analysis and documents
Economic and fiscal outlook – March 2016 Office for Budget Responsibility (16/3/16)
Budget 2016: documents HM Treasury (16/3/16)
Budget 2016 Institute for Fiscal Studies (17/3/16)
- Explain the fiscal mandate of the Conservative government.
- Does sticking to targets for public-sector deficits and debt necessarily involve dampening aggregate demand as an election approaches? Explain.
- For what reasons may the Chancellor not hit his target of a public-sector surplus by 2019–20?
- Compare the advantages and disadvantages of a rules-based fiscal policy and one based on discretion.
After each Budget, the Institute for Fiscal Studies analyses its effects. Given the highly charged political environment, with an election looming and the prospects of considerable public expenditure cuts to come, dispassionate analyses of the Budget are hard to find. The IFS’s analysis is a major exception.
The IFS summarises the Budget as being largely neutral. As Robert Chote, Director of the IFS, says in the opening remarks to the Post Budget Briefing:
In a Pre-Election Budget, perhaps the most that we can expect of any Chancellor is that he should observe the key tenet of the Hippocratic Oath and “above all, do no harm”. Judged against that modest yardstick, the broadly neutral stance of this Budget passes the test.
But, the Budget avoided giving details of the cuts which are planned for the future. None of the political parties are saying just how they will achieve the necessary reductions to the deficit, although the Liberal Democrats have given some details.
Judged against the more testing yardstick of providing a detailed picture to voters and financial market participants of the fiscal repair job in prospect beyond the election, the Budget will have fallen short of many people’s hopes. There are an awful lot of judgements still to be made, or revealed, notably with regards public spending over the next parliament. This greater-than-necessary vagueness allows the opposition to be vaguer than necessary too.
The articles below look at the Budget and at the IFS’s assessment of it. There are also links to the sections of the IFS report. It is worth reading them if you are to be able to make the ‘cool’ judgements that economists can provide – even if they do not always agree!
Budget leaves questions unanswered – IFS Reuters (25/3/10)
Budget 2010: IFS warns transport and housing spending has to be cut Guardian, Phillip Inman (25/3/10)
Labour ‘has cost the rich £25,000 every year’ Independent, Sean O’Grady (26/3/10)
The pain to come The Economist (25/3/10)
Chancellor’s ‘difficult balancing act’ BBC Today Programme (24/3/10)
Pain deferred until the polls close Financial Times, Chris Giles (25/3/10)
IFS Report: Budget 2010
Links to the various supporting articles and the opening remarks can be found here.
Details of the Budget
See references in Darling and a case of fiscal drag? for details of the Budget measures.
- What do you understand by the ‘structrual’ deficit and the ‘cyclical’ deficit?
- Why do cyclical deficits rise during a recession?
- Why has the structural deficit risen during this recession? Is this an example of hysteresis? (Explain.)
- What is the Fiscal Responsibility Act and why does the government now expect to over-achieve the requirements of the Act?
- What elements of government spending are likely to be cut most? Is this a wise distribution of cuts?
- Use the links to the PowerPoint presentations from the IFS Budget Report site to (a) analyse the state of the public finances; (b) summarise the main tax changes in the Budget.