6. How much do cash benefits and direct taxes reduce income inequality?

This section looks at the sources of earnings, benefits and taxes that make up the overall income measures and therefore the measurement of average household income used is the mean. For more information on the different measures of average household income see the ‘Things you need to know about this release’ section.

Overall, direct taxes and cash benefits lead to income being shared more equally between households (Figure 3). In the financial year ending 2016 (2015/16), before direct taxes and cash benefits, the richest fifth (those in the top income quintile group) had an average original income of £85,000 per year, compared with £7,000 for the poorest fifth – a ratio of nearly 12 to 1. This ratio has decreased since 2014/15 where the ratio was 14 to 1, indicating that inequality of original income has reduced slightly, according to this measure. Original income includes earnings, private pensions1, and investments.

Figure 3: Original, gross and disposable income by quintile group, all households, financial year ending 2016 Source: Office for National Statistics Notes: Households are grouped by their equivalised disposable incomes, using the modified OECD scale. Download this chart Figure 3: Original, gross and disposable income by quintile group, all households, financial year ending 2016 Image .csv .xls

Effect of cash benefits

In contrast to original income, the amount received from cash benefits such as tax credits, Housing Benefit and Income Support tends to be higher for poorer households than for richer households. The highest amount of cash benefits were received by households in the second quintile group, £9,600 per year compared with £7,600 for households in the bottom group, a trend that has remained unchanged from 1995/96. This is largely because more retired households are located in the second quintile group, compared with the bottom group, and in this analysis the State Pension is classified as a cash benefit.

The distribution of cash benefits between richer and poorer households has the effect of reducing inequality of income. After cash benefits were taken into account, the richest fifth had an average income that was roughly 6 times the poorest fifth (gross incomes of £87,600 per year compared with £14,800, respectively), a proportion that was broadly unchanged on the previous year.

Looking at individual cash benefits, in 2015/16, the average combined amount of contribution-based and income-based Jobseeker’s Allowance (JSA) received by the bottom 2 quintile groups decreased compared with 2014/15 (Reference Table 2 in the Household disposable income and inequality dataset). This is largely due to fewer households receiving this benefit, consistent with a fall in unemployment between these years, as well as the ongoing implementation of the Universal Credit (UC) system which, by April 2016, had been rolled out to almost 250,000 claimants1.

Claimants of UC and JSA are subject to the Claimant Commitment, which outlines specific actions that the recipient must carry out in order to receive benefits. This may also have impacted on the number of households in receipt of these benefits. JSA rates, along with other working age benefits, were increased by 1% in 2015/16, below the CPI rate of inflation.

The phasing out of Incapacity Benefit, Severe Disablement Allowance and Income Support paid because of illness or disability and transfer of recipients to Employment and Support Allowance (ESA) has seen average amounts received from the former benefits continue to fall in 2015/16, while average amounts received from ESA have risen, reflecting the increased number of claimants. The roll-out of Personal Independence Payment (PIP), which is replacing Disability Living Allowance (DLA) for adults aged under 65, also continued in 2015/16.

Figure 4: Summary of the effects of direct taxes and cash benefits on all households, financial year ending 2016 Source: Office for National Statistics Notes: Households are grouped by their equivalised disposable incomes, using the modified OECD scale. Download this chart Figure 4: Summary of the effects of direct taxes and cash benefits on all households, financial year ending 2016 Image .csv .xls

Effect of direct taxes

On average, households paid £7,800 per year in direct taxes, equivalent to 18.7% of their gross income. Richer households pay both higher amounts of direct tax and higher proportions of their income in direct taxes (Income Tax, National Insurance, and Council Tax and Northern Ireland rates). As a result, direct taxes also reduce inequality of income.

The richest fifth of households paid on average £20,100 per year in direct taxes, the vast majority of which was Income Tax. This corresponds to 23% of their gross income, broadly unchanged from other recent years.

The average direct tax bill for the poorest fifth was £1,600 per year, of which the largest component was Council Tax or Northern Ireland rates. This was equivalent to 11% of gross household income for this group, also broadly unchanged from other recent years.

The richest fifth of households had disposable incomes that were around 5 times that of the poorest fifth (£62,400 per year and £12,600, respectively), a similar ratio to 2014/15.

Indirect taxes and benefits in kind

Indirect taxes on expenditure (such as VAT and fuel and alcohol duties) and benefits in-kind provided by the state (such as education services and the NHS) also play a significant role in the redistribution of income. The full Effects of Taxes and Benefits on Household Income 2015/16 Statistical Bulletin, to be released May 2017, will provide further analysis of household income including the effect of both of these.

Notes for: How much do direct taxes and cash benefits reduce income inequality?