One Nation or two?

Iain Duncan Smith says the government’s claim to be a One Nation government is at risk and that it is “in danger of drifting in a direction that divides society rather than unites it”. Government spokespeople, including the Climate Change Secretary, Amber Rudd, have been clear they think he is wrong – indeed the Prime Minister is defending the government’s One Nation credentials in the House of Commons today.

What have we seen in the first ten months of the first majority Conservative government in two decades to help you decide who is right? It’s worth dwelling on two areas in particular – who will gain or lose directly from tax, benefit, and minimum wage changes that have been announced, and the related but wider question of what has happened or is expected to happen to inequality.

Tax cuts have benefited the top half of the income distribution the most…

The Conservative manifesto included big commitments to cut income tax – specifically by increasing the Personal Tax Allowance to £12,500 and the Higher Rate Tax threshold to £50,000. Since the election the Chancellor has made progress on both commitments (at a cost of £4bn, with a further £2.5bn needed by the end of the parliament).

Most of the attention has been focused on income tax cuts, but the Capital Gains Tax cut announced last week is also focused on those on higher incomes – unsurprisingly because in general better off households are the ones making capital gains in the first place. Of the £30 billion of capital gains subject to CGT in 2013-14, half went to 35,000 individuals with incomes of £100,000 a year or more. It is their tax bill that is being cut.  However, limits on pensions tax relief have had the opposite effect for the richest ten per cent of households.

The distributional impact of all these tax cuts is fairly clear – they benefit households across the income distribution, but the biggest winners by far are better off households. This chart shows the overall effect of these tax cuts by 2020. Taken together the average gain among the richest 30 per cent of households is five times as much (£255) as the poorest 30 per cent of households (£50).

…while the National Living Wage will provide a welcome boost to incomes for households in the middle of the income distribution in particular…

It’s easy to forget now, but back in July George Osborne was the hero of the Conservative Party. He was roundly praised for announcing a major increase in the minimum wage (to £9 an hour by 2020 for those aged 25 and over) in his Summer Budget. The new National Living Wage provides a tangible symbol of One Nation Conservatism. We’re now ten days away from its introduction, which will give many low earners a 50p an hour pay rise. This will be followed by other significant rises right across the Parliament.

While it is not without major implementation challenges, this policy certainly has the hallmarks of a One Nation government and should be welcomed. While the biggest beneficiaries are by definition the lowest paid, the impact by household is fairly broadly shared with the middle in fact benefitting most because many minimum wage earners are second earners in higher income families.

…and the benefit squeeze will see significant income reductions for the bottom half of households

Alongside the commitments to tax cuts in the Conservative Manifesto was a plan for £12 billion of social security cuts. How that figure would be reached was left until the post-election Summer Budget last July, when it was revealed that working age benefits including tax credits and Universal Credit would bear the brunt of cuts.

These benefit cuts, including freezes to all working age benefits throughout the parliament, largely bear down on poorer households. The average loss among the poorest 30 per cent of households is, at £665, more than 20 times that of the losses faced by the richest 30 per cent of households (£30).

Taken together, RF analysis of all major post-election policy announcements to date shows that by 2020 the poorest 30 per cent of households are set to lose around £565, while the richest 30 per cent of households are set to gain around £280. [1]

We can also dig into these averages to look at specific case studies of families, which reinforce the big picture of those on higher incomes doing better. Here’s two examples drawn from the wider table below.

• A low-earning couple with three children could be over £3,000 worse off, despite the welcome pay boost received from the National Living Wage and a smaller gain from raising the PTA, as a result of UC cuts
• A high earning couple with two kids with a combined salary of around £100,000 gained £300 from PTA and HRT increases last week. This builds on the £130 gained from tax cuts in the Summer Budget

Inequality fell during the downturn and early recovery…

So where do these tax and benefit changes leave the wider question of inequality? We saw a small reduction in inequality in the wake of the financial crisis, driven by large income falls at the top of the income distribution in the big earnings squeeze. More encouragingly in the recent past we have seen a return to wage rises, and crucially faster earnings growth at the bottom of the distribution. These earnings increases, combined with swift rises in employment, have meant income gains for the bottom outpacing the top – that is to say what we call the “early recovery” has had something of a One Nation flavour to it.

…but it is set to rise again in the coming years

However, this pattern of falling inequality looks in danger of being reversed over the parliament as the chart below shows.

RF analysis shows that the richest half of households are due to receive the strongest income growth over what we call the “continued recovery” during this Parliament, while the poorest quarter of households are actually set to see their income fall over the next five years as a result of slower wage growth (despite the National Living Wage) a freezing in all working age benefits, and significant cuts to in-work support. As a result child poverty is set to rise over the parliament, having fallen steadily since the late 1990s. Further bad news is that these forecasts also predate the most recent downward revisions in earnings from the OBR.

Everyone will have their own take on whether the information above builds up to a case for or against this being a One Nation government. Looking backwards we have seen a fall in inequality and we are about to see a welcome rise in the minimum wage. But an eye to the future shows that much more needs to be done to make the balance of tax and benefit changes remotely progressive in the coming years. In the end it is in everyone’s interests that the government lives up to their own One Nation rhetoric – let’s hope they do.

[1] Notes: Impacts are estimated in 2020-21 accounting for the transition to Universal Credit, build-up of measures affecting flows to Universal Credit/Tax Credits; introduction of the National Living Wage and key changes to the tax and benefit system announced this parliament, including: increases to the personal tax allowance to reach £11,500 and higher rate threshold to reach £45,000 in April 2017, restricting pensions tax relief, cuts to capital gains tax, freezing fuel duty, cuts to Universal Credit work allowances, freezing working-age benefits for 4 years from April 2016, measures to remove the family element & limiting support to 2 children in tax credits/UC, abolishing class 2 NICs. Economic assumptions are consistent with OBR projections published at Budget 2016.