All in all, it has been an equitable recession

Tomorrow’s Budget comes, of course, at a difficult time for the economy and for households. Five years after the recession started, national income is still lower than it was in 2007. So is productivity. So are household incomes. And government borrowing remains at exceptionally high levels.

In terms of its length, its depth, and its effect on average household incomes this recession is the worst in living memory. On these measures, it has been much longer and much deeper than the recessions of the 1980s and 1990s. And the consequences for the government’s finances have been much more severe.

Yet, concealed behind this enormous black cloud is some sort of a silver lining. Those of us who remember the early 1980s recall a period of mass unemployment and of rapidly widening income inequality. Unemployment rose very fast, and many benefits were cut, but many of those in work did very well.

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This time round, though, the bigger drop in national income has been accompanied by a much smaller increase in unemployment. In fact private sector employment levels are now higher than they were in 2007. While unemployment is higher than anyone would like, this recession has played out mainly through reducing real earnings. More people have stayed in work, but – after taking account of inflation – they are earning less than they were. This seems to apply right across the earnings distribution.

At the same time, so far at least, benefit levels have largely gone up in line with prices, such that in cash terms since 2007 benefit levels have risen by around 20 per cent, while average earnings have risen by nearer 10 per cent. The result has been a remarkably equitable recession. In 2010-11, the last year for which comparable data are available, income inequality fell by more than in any year since the data series began in 1960. While incomes fell right across the distribution, they fell less at the bottom than at the middle, and less at the middle than at the top.

There are some more subtle changes to the pattern of income inequality. This has been a bad recession in which to be young and just entering the labour market, but a relatively good one in which to be middle-aged or older. Incomes have fallen particularly fast among those in their 20s, and unemployment rates have risen faster for this group than for others. Those in their 50s and 60s and older have been less affected on average. Indeed, employment rates among older people have been remarkably robust.

What about the effect of tax and benefit changes? What has been the direct effect of government policy on the income distribution?

The answer to this question is sensitive to the exact period you look at. A lot of the announced benefit cuts, for example, have yet to be implemented. Indeed, many will start to be felt this year: raising many working-age benefits by less than the rate of inflation, cuts in housing benefit and reforms to disability living allowance among others. So, let’s consider the effects of all the tax and benefit changes announced since January 2010 as part of the overall fiscal consolidation package, including those yet to be implemented.

Across the whole income distribution, it is clear that the biggest losers will be those with the highest incomes. Those with incomes over £150,000 have seen the top rate of income tax rise to 45 per cent. Those with incomes over £100,000 have lost some or all of their income tax personal allowance. Tax relief for pension contributions has been severely restricted. National insurance contribution rates have increased. Child benefit has been withdrawn from individuals with incomes over £50,000. Not just in terms of pounds lost, but also as a percentage of their income, people in the top few per cent of the income distribution are the biggest losers. That is not to say, of course, that they will feel as much pain as those with less income who lose less but who may need it more.

And the next biggest losers are poorer people of working age, especially those with children – those in the bottom third or so of the income distribution. They will have lost most from the various cuts in benefits and tax credits. These cuts are substantial enough that the bill for working-age benefits is starting to fall after a long period of significant increases.

Two groups have, on average, been relatively protected from tax increases and benefit cuts. First, the elderly. State pensions have risen with prices – and faster than that this year. With the exception of the withdrawal of their higher personal tax allowance, few tax and benefit changes have hit them directly. The second group to suffer relatively little from tax and benefit changes have been those in the middle and upper middle parts of the income distribution, broadly those paying basic rate income tax.

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Those without children have been especially little affected. This group has benefited from increases in the personal allowance, are less dependent on benefits (and so have not lost much from benefit reductions) and have not been hit by some of the tax increases aimed at the very well off. Of course, all these groups have lost out from the increase in the main rate of VAT.

Layer those effects on to the changes in wages and employment levels and, so far, it is likely that inequality will be rather lower now than it was in 2007. The near future may be different. With more benefit cuts to come, and if real wages start to rise again, inequality is likely to start to grow again in the next year or two.

But so far the silver lining to our dreadful economic cloud has been that most of the pain has been spread among most of the population. This is not the 1980s. This is not a time of mass unemployment and big winners and big losers. Most of us are losers. The total losses may actually be bigger than those suffered in the 1980s, but they are more evenly spread.

• Paul Johnson is director of the Institute for Fiscal Studies

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