It has been 50 years since the UK Central Statistical Office, the predecessor of the Office for National Statistics, first published comparable analysis looking at the effects taxes and benefits have on household incomes. “The Incidence of Taxes and Social Service Benefits” was one of the first publications anywhere in the world to give such a complete examination of these issues.
Since 1961, the analysis has looked each year at the impact not just of cash benefits (such as the state pension and child benefit) but also a number of benefits in kind received by households, such as education and the National Health Service. From a tax perspective, both direct taxes (such as income tax and employees’ National Insurance contributions) and indirect taxes on expenditure (such as fuel and alcohol duties, and VAT/purchase taxes) are included. This short story focuses on some of the key changes in average income, taxes and benefits for the overall population of households.
In 1961, it was estimated that the average original income for households was £960 per year. Original income is defined as income before any benefits or taxes, and includes income from earnings, private pensions and investments. As Figure 1 shows, original income first exceeded £5,000 in 1979, growing to over £10,000 by 1987, and to over £20,000 in 1998/99. By 2011/12 the average original household income had risen to £31,500.
Figure 1: Average original household income in the UK, 1961-2011/12
However, in order to understand properly how average household incomes have changed over the last 50 years, it is necessary to adjust these figures for inflation. In 2011/12 prices, average original income in 1961 was £12,900, meaning that average incomes are now almost two and a half times higher in real terms, having grown at an average rate of 1.8% per year over the period.
As shown in Figure 2, original income has not grown evenly over the entire 50 year period. As it largely comes from employment and investment, original income typically increases during periods of growth and stagnates, in real terms, during economic downturns. Between 1961 and 1973, household original income grew at an average 3.0% per year, after adjusting for inflation. There was then a prolonged period of lower, more erratic, growth before sustained growth eventually returned to in 1984.
The late 1980s saw some of the fastest rates of growth of original income during the last 50 years with growth averaging 5.8% per year between 1984 and 1990. There was then another period of stagnation which coincided with the early 1990s recession before income grew strongly again, at an average rate of 5.2%, between 1995/96 and 2001/02. The early to mid 2000s saw a reduction in income growth with an average rate between 2001/02 and 2006/07 of 1.4% per year. Since then, original income has declined at an average rate of 2.1% per year.
Figure 2: Composition of gross household income in the UK, adjusted for inflation, 1961-2011/12
The share of gross income made up of cash benefits more than doubled between 1961 and 2011/12
Gross income, which is original income plus cash benefits received from the state, grew at an average rate of 2.0% per year after inflation, rising from £14,000 in 1961 to £37,500 in 2011/12. This faster rate of growth was due to income from cash benefits growing more rapidly than original income, rising from £1,100 to £6,000 over the period. This means that cash benefits now make up a greater proportion of households’ gross income, up from 7.6% in 1961 to 16.0% in 2011/12.
This increase in the proportion of income that comes from cash benefits can be attributed to a number of factors. One reason has been the increase in the proportion of the population who are over state pension age, although growth in non-age-related benefits over the period has been faster than growth in state pensions. A selection of the changes to the cash benefits available to households that have occurred over this period can be seen in Figure 4.
Over the last 50 years, cash benefits have tended to make up a higher proportion of gross income during the times when original income has stagnated, including the early 1980s and 1990s, as well as following the most recent economic downturn.
The effective total tax rate peaked in the 1980s at 39.4% of household income
Since it was first carried out in the 1960s, this analysis has also looked at the impact of both direct taxes and indirect taxes on household incomes. In 1961, after accounting for inflation, the average household paid approximately £4,000 in direct and indirect taxes, compared with £12,900 in 2011/12.
Figure 3: Effective tax rate in the UK as a percentage of gross household income, 1961-2011/12
Some of the main changes to taxes over the last 50 years are highlighted in the accompanying timeline. Since the 1970s, the general pattern of change in headline rates of tax has been for reductions in income tax, and increasing Employee’s NI contributions and VAT. However, many other factors, including the income levels at which income tax and NICs are levied, as well as changing working patterns, household compositions and demographics, have also had substantial influence on how these taxes have affected average household incomes.
One way of looking at the changing impact of taxes on households is to consider the total effective tax rate – that is, the total amount paid by households in both direct and indirect taxes as a percentage of their gross income. Figure 3 shows that the effective tax rate grew during the 1960s and 1970s from 28.4% in 1961 to a peak of 39.4% in 1983. However, since then the trend has been downward, reaching a low of 32.8% in 2009/10, before increasing slightly over the last two years to 34.6%. During the recessions of the 1970s, early 1980s and early 1990s, the effective tax rate tended to increase as taxes tended not to fall as quickly as income. However, in the late 2000s downturn, the effective tax rate fell, before rising back up, due, in part, to the recent changes in the standard rate of VAT.
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