The tax burden

Fascinating article in the Guardian by Polly Toynbee , called
cooling the cutting fisticuffs – take a long, hard look at tax . What the article claims, and what I found particularly interesting, is that the bottom 10% of earners pay 46% of their income in tax, while the richest 10% pay only 34% of their income in tax. What is more, the top fifth of earners take 51% of the national income while the bottom fifth take 3%. This comes from a report by a centre-left pressure group called Compass , and I have no real reason to doubt its veracity.

Apparently the reason for this discrepancy is that the highest earners can take some (or most) of their income in the form of capital gains which is only taxed at 18%. So even though their salary is taxed at a high rate, their actual salary only makes up a small fraction of their total earnings – most of it coming in the form of capital gains. When I first read this I immediately thought that although this may be true, most low earners effectively recover what they lost through taxes in benefits, but I think this doesn’t really make a difference. The public sector makes up something like 40% of the UK’s economy. If we want to sustain what the public sectors offers people in the UK, we have to roughly recover 40% of the total income. We could of course decide that the public sector should only make up 30% of the UK economy which we could achieve by privatising some parts of the public sector, but I happen to believe that this would not be improve things in any way.

So assuming that we accept that the public sector is going to make up about 40% of the UK economy, how do we fund that? Well a simple way would be to take 40% of everyone’s income. This could be through both direct and indirect taxation, but at the end of the day we need this to fund the public portion of the economy. What you could then choose to do is to take a slightly higher fraction of the top earners’s income, leaving those on lower incomes with more money. You can even give some of money back to the lowest earners through benefits since they take such a small fraction of the total income, that this won’t really have a significant impact on government revenue. What you certainly don’t do is take less than 40% of the highest earners’s income. They take such a large portion of the total income that this will have a huge effect on the total amount of government revenue. How can we possibly expect to both sustain the public sector – which I think we should be doing – and draw down the deficit if we don’t at least tax the the highest earners at a rate that will give the government sufficient revenue.

In some sense this isn’t even a discussion about what is fair or not, it seems logical that the simplest way to ensure that government revenues are sufficient is to start by making sure that the highest earners are taxed appropriately. If not enough is recovered from the highest earners, it becomes increasingly difficult to get the remainder of what is required from the lowest earners since they take a smaller fraction of the total income. It seems ridiculous that we are only taking 34% of the total income of the top 10% of earners in a country that intends to have a public sector that makes up 40% of the economy. The top earners presumably would argue that they don’t rely on the public sector to the same extent as the lowest earners, but this is nonsense. Also, in an average sense, something like 40% of their income presumably comes from the public sector. In fact, since they take such a large fraction of the total income, more than 40% must come from the public sector and so taxing them at a higher rate, to a certain extent, is simply recovering public money.

The Wealth Gap

I have recently become quite interested in the wealth (or more accurately income) distribution in the UK. This was partly motivated by a couple of what I thought were interesting articles by Polly Toynbee in the Guardian. In the first article (which I can no longer find – maybe it wasn’t Polly Toynbee) a group of people are asked if they believe that a wealth gap exists in the UK. Most answered that they did, but when asked to guess the salaries of some top earners (solicitors, investment bankers, etc.), they generally guessed salaries significantly lower that what these top earners typically earned.

In the second article (which you can find here ) a group of high earners are again asked some questions about the wealth distribution in the UK. More than 50 % of people in the UK earn less than what this group thought was the poverty line, and less than 1 % earned more than what this group thought would put you in the top 10 %. Essentially these two articles illustrate – or supposedly illustrate – that the lowest earners believe there is a substantial wealth gap, but don’t realise quite how big it is, and the highest earners believe there isn’t really a substantial wealth gap, but only because they don’t really realise how little most people earn.

Although I haven’t investigated this in extensive detail, I have looked up some numbers related to the distribution of wealth in the UK. When considering any distribution it is quite important to understand the difference between things like the median and the mean (Stephen Jay Gould has an excellent book called Full House that explains some of these statistical terms extremely clearly). In the UK in 2004/2005 the mean annual income (pre tax) was about £23000. This, however, can be distorted by a small proportion of the population earning extremely high salaries. A better measure is the median which tells you, in some sense, the middle salary (i.e., 50 % of the population earns less than the median and 50 % earns more). In 2004/2005 the median, pre-tax income was about £16500, significantly less than the mean.

Although the median income has increased somewhat since 2004/2005, to something around £18500, I still find it quite remarkable that 50 % of the British working population earn £18500 per year or less. If, rather than considering indivduals, one considers households, it is slightly higher, but not by much. The mean household income for 2004/2005 was £31800 while the median was £24700. Again, these numbers will have increased slightly in the last couple of years, but I still find somewhat disturbing that 50 % of households survive on about £25000 or less, but does this indicate the presence of a wealth gap in the UK? Certainly, trying to run a household on less than £25000 per year must be pretty tough. That the top 1 % of earners have salaries more than 17 times greater than the bottom 10 % may suggest that a gap does indeed exist.

None of these numbers, however, convincingly illustrates that there is a substantial wealth gap in the UK. I then found a figure from the government’s office of national statistics which illustrates to a certain extent how wealth is redistributed. The figure (which you can read more about here) shows the average annual household income broken up into 5 groups (bottom 20 %, next 20 % etc. – known as quintile groups). The dark blue columns are the original annual household incomes and the light blue columns show the annual household incomes after tax and benefits. The bottom 20 % more than double their income to about £ 15000 per year, while the top 20 % lose almost 30 % of their income. The median (which would be roughly the 3rd quintile group) have a household incomes of just over £20000 per year which isn’t affected much by tax or benefits. The figure suggests that the top 20 % have average household incomes only 3 times greater than the bottom 20 %. The figures also suggests that the top 40 % of households end up with about 60 % of the total amount of money earned in a year, and the top 20 % end up with about 37 % of the total. Does this suggest an unfair distribution – I don’t really know. My first impression was that it actually looks quite reasonable.

Having started this post expecting to illustrate that there is indeed a wealth gap in the UK, I am finding myself now less convinced than I was when I started (interestingly Polly Tonybee was on the BBC news this morning stating once again that the UK – along with the US – does indeed have a very big wealth gap). Having said that, I do still find it disturbing that most households survive on less than about £25000 per year (after tax and benefits). I have also been using wealth here to mean income, so this doesn’t really illustrate how the actual wealth is distributed. Most of the numbers here are also based on taxable income. What I also don’t know is how much of the country’s income is given out in a manner that allows the receiver to avoid tax and therefore isn’t included in the analysis here. I was going to continue and talk about the Gini index which is an index for illustrating how income/wealth is distributed in a country but, since this is already quite long, I will leave it for a later post.