Britain’s tax system is progressive and takes significantly more money from the rich than the poor, the Institute for Fiscal Studies, a respected think-tank, said on Monday in research designed to pre-empt “less than ideal” official statistics suggesting otherwise.
The target of the IFS’s study was the Office for National Statistics’ annual publication on the effect of tax on household income, due to be published on Thursday, which generally finds that Britain’s tax system has no effect on income inequality.
The IFS charged that the statistical agency’s results come from poor analysis of the data. Its study found that the ONS did not take account of employer national insurance contributions, mismeasures top incomes, fails to treat taxable benefits correctly and mistakenly classifies many people who spend a lot of money as poor.
The research, ironically funded by another government agency, the Economic and Social Research Council, reflects unease in official circles that the ONS has been slow to update its methodology in the face of significant expert criticism. The agency is also under fire for failing to reform its measure of inflation.
The UK Statistics Authority, the regulator of official statistics, shares the IFS’s concern, the Financial Times understands.
“The surprising ONS conclusion that ‘overall, taxes had a negligible effect on income inequality’ is due to some less than ideal analytical choices, and under more appropriate choices one obtains the result that indirect and direct taxes are in fact progressive,” the IFS report concluded.
Using official data for measuring the gap between rich and poor, the IFS research showed that people living in households in the richest 20 per cent of the population had on average £96,000 a year of income from market sources — employment, private pensions and investments. Those in the bottom 20 per cent had market incomes on average of only £7,700, leaving them with more than 12 times as much income from private sources.
Once direct taxes had been applied and households had received the social security from the state, the average spending power of the richest fifth fell to £64,000 while the poorest fifth’s disposable income rose to £12,500, shrinking the income differential so that the richest 20 per cent have five times as much net income than the poorest 20 per cent.
The IFS said that state benefits do more work in redistributing than taxes because the payments are heavily concentrated among the poorest people while taxes are paid across the income distribution.
Looking at the whole effect on inequality, the IFS calculated that direct taxes account for 30 per cent of the reduction in inequality between market incomes and final incomes with benefits accounting for 70 per cent.
One of the largest differences between the IFS work and that of the ONS is over value added tax. Officials say it is regressive, with the poor paying a larger share of their income in VAT than the rich.
However, the IFS said the ONS was incorrectly classifying people who were temporarily poor, but still spent a lot of money, as permanently poor. It argued that if the effect of indirect taxes, such as VAT, were considered on the basis of how much people spent, rich and poor tended to pay a similar proportion in tax.
“The tax and benefit system significantly reduces the gap between rich and poor, with benefits playing a particularly big role,” said Pascale Bourquin, a research economist at the IFS, who pointed out that while some taxes, such as council tax, may be regressive they were balanced out by the wider tax and benefit system.
“What matters for income inequality is the progressivity of the tax and benefit system as a whole, and not a specific part of it. The government should achieve its desired amount of redistribution using those parts of the tax and benefit system best suited to that particular job,” she added.
