Tag Archives: regressivity

The distributional implications of universality (again)

Paul Johnson, the director of the IFS, has an article in the Times (also available on the IFS website without a paywall) about how different ideas about fairness are behind some of our political disagreements. There’s plenty to agree with in the piece. But when he touches on a couple of themes that regular readers of the Policy Sketchbook will be somewhere between familiar with and bored of – social care reform and redistribution – Paul says some things that I think are a bit misleading.

Here are the offending paragraphs:

“The Conservatives got into dreadful trouble over their manifesto proposals on social care funding. We have spent decades making no progress on how to reform the funding system, partly because of the way we think about fairness. Some think it unfair that anyone should have to use their own assets, including their house, to pay for care. Yet one of the reasons why proposals to cap the amount that anyone has to pay have not been implemented is because, compared with the system we have today, the winners would be the relatively well-off.

In fact, this is a fundamental disagreement about the role of the state as much as it is about fairness. If you think the state is there to provide a degree of social insurance, stepping in where private insurance markets don’t work to pay for those who are unlucky enough to need care, then you are likely to favour it paying all the costs above a certain level. That’s how we tend to think of the NHS. But if you think the state is there just to redistribute money from rich to poor then you might think it unfair.”

This is a familiar take: moving to universal benefits means less redistribution and benefits the well-off. But is it true? Well, that depends. The most important thing to remember when thinking about the distributional impact of changes in government spending is that the money doesn’t just appear out of thin air. The effect of a policy on the level of redistribution that government does depends on how it is paid for. By choosing different funding sources you can get pretty much any distributional effect you want, but some scenarios are more relevant and plausible than others.

Three different ways of paying for a universal benefit

So let’s take a look at the distributional consequences of moving from a means-tested benefit to a universal one, paid for in different ways. We’ll use a stylised example for clarity, but the conclusions generalise pretty well. Imagine we have a benefit worth £1000 per person, but means-tested so that only the bottom 30% of the income distribution get it. An independent commission recommends making this universal, so that everyone gets the benefit regardless of their income. There are broadly three ways we can pay for this and each has different distributional consequences.

Reducing means-tested benefits to pay for universal benefits is regressive

One way to pay for the new universal benefit would be to reprioritise some money that is currently spent on means-tested benefits. It’s trivial to see that this is going to be regressive, but let’s run the numbers anyway. Let’s say we take the money that is currently spent on our stylised means-tested benefit and use it to fund a universal version. Instead of the bottom 30% of the income distribution getting a benefit worth £1000, everyone now gets one worth £300. The bottom 30% lose £700 each and everyone else gains £300. This is nailed-on regressive and it would be a similar story if the money were reprioritised from some other area of means-tested spending.

Means-testing one universal benefit to pay for another is distributionally neutral

Another way of paying for the new universal benefit is to reduce universality in another area. This is the sort of thing that was discussed in the wake of the Dilnot Report: universal coverage for social care could be funded by means-testing some of the universal benefits that older people currently get, like winter fuel allowance or free bus passes. The distributional consequences of the switch would depend on the details, but it would be roughly neutral – we are taking money away from the same people who will get more from the new benefit.

Paying for a universal benefit through higher taxes hits the rich

The third way that we could pay for the new universal benefit is through higher taxes. We can design taxes with various distributional profiles, but we can get an idea of who would be hit by a “typical” tax rise if we look at the distribution of current UK taxes as a whole.

The chart below (based on ONS data) shows the distributional impact of extending our £1000 benefit to the whole population and funding it through an increase in “general taxation” – by which we mean a tax rise with the same distributional profile as the current UK tax system. The (positive) green bars show the additional benefits people in each income decile get and the (negative) red bars show the additional taxes they pay. The red and green bars sum to zero because, at risk of labouring the point, the money has not appeared out of thin air.

The winners from this shift to universal benefits are not the poorest, who already got the benefit, but it would be misleading to say they are the “relatively well-off”. The winners are the people in the middle, especially those just above the current means-test threshold. The biggest losers by far (in cash terms) are the richest 10%. This is a key point: the main distributional effect of a tax-funded change from means-tested to universal benefits is to move money from the people at the top of the income distribution to the people in the middle.

But you may have noticed something else in the chart. The bottom 30% of the income distribution also lose out, because they pay more tax and don’t get any additional benefit. They don’t pay much in absolute terms, but relative to their income it’s quite a lot. The chart below shows the same figures as a proportion of income: the richest still pay the most on this measure, but now the poorest are not far behind.

Now, unless you think that the bottom 30% do rather too well out of government as things stand, this doesn’t seem particularly fair. Luckily, it’s cheap to fix, since the bottom 30% only pays 7% of the cost of this policy if the money is raised through general taxation. If we were to exempt them from these tax rises, we’d still have enough to fund a universal benefit worth £970 for the rest of the population. But the point is worth noting: if universal benefits are to be funded through tax rises, the additional taxes shouldn’t hit the poorest.

The size of the state

So we’ve seen three different ways of paying for a new universal benefit with three different distributional effects: regressive, neutral and progressive. It should be obvious by now that unless you are clear which one of these you think will happen, you shouldn’t be saying anything about the distributional consequences.

How we assume the additional spending will be balanced rather depends on our assumptions about the size of the state. If we believe that tax rises are impossible or highly undesirable, then we are going to want a new universal benefit to be paid for by reprioritising spending. Up to a point we can reprioritise from other universal benefits and get something distributionally neutral – but so much of the British state is already means-tested that (unless you are willing to go for pensions or the NHS) there is limited capacity for such reprioritisation. With a fixed public spending envelope and tax profile there is only so much universality you can afford if you also want to do a certain amount of redistribution and under these assumptions, Paul’s claim that “the winners would be the relatively well-off” is just about defensible – although for a small spending item like the Dilnot reforms it would be quite easy to reprioritise spending in a neutral or progressive way.

But if we assume that more universal benefits will mean higher taxes then the picture looks very different. As shown above, the biggest losers from this would be the richest and the winners would be the people in the middle. And there are a couple of reasons to believe that this is ultimately the more reasonable assumption.

The first is that the people who are in favour of universal benefits tend to be the people who are in favour of higher taxes. Elect a government that does one, they are likely to do the other. We can see this in the recent Labour manifesto, where universal free university tuition was proposed, funded by an increase in income tax. Although the Dilnot Commission didn’t say much about how its proposals should be funded, the previous abortive attempt at social care reform (Labour’s National Care Service) was to be funded by an increase in inheritance tax.

The second is that countries with more universal benefits tend to have higher tax rates. There’s more going on in these figures than just universality versus means-testing, but in general the countries with the most universal benefits, such as the Nordics, France and Belgium, raise the most in taxes. Internationally, means-testing goes with low taxes and universality goes with high taxes.

Some conclusions

To be fair to Paul, he is far from the only person to go around saying that universal benefits are regressive. It’s even true under certain assumptions – specifically that the UK must remain a low tax country. The problem is that no one who writes opinion pieces saying that universal benefits are regressive ever seems to find space to clarify that this is their assumption. If they did, readers would probably notice that this isn’t what the proponents of universality are usually proposing, and it isn’t what countries with more universal benefits do. Moving towards a European model with more universal benefits and higher taxes would most likely amount to a transfer from the rich to the people in the middle of the income distribution. I doubt that fans of redistribution would, as Paul suggests, think this is unfair.


Three golden rules for discussing progressivity

What does it mean for a policy to be progressive? The way this question is addressed by the media (and often by government) can be infuriating. It’s got to the point where I am tempted to say the term should be banned, but instead I am going to make one last attempt to clarify it by proposing three golden rules.

I was reminded of this issue when reading Jo Maugham’s analysis* of the impact of the new “social care precept”. This is essentially a £2bn rise in council tax, a significant proportion of which will be paid by poorer households. Here are the figures that Jo gives:

Who pays what in council tax

So is this tax progressive or not? Well, rich people pay more, and for some that’s good enough. Fraser Nelson, for example, likes to point out that “the top 3,000 taxpayers in Britain stump up more income tax than the lowest-paid 9 million”. It is more common to look at how paying tax affects the living standards of different groups by comparing tax paid as a proportion of income. By this measure, council tax is regressive.

This is as far as the discussion usually goes. But both of these comparisons have no basis in reality – unless that reality involves collecting these taxes and throwing the money in the sea. The fact is that this money will show up somewhere else, either as increased spending or lower taxes. Which brings me to my first golden rule: the distributional effect of a policy change can’t be assessed without looking at both sides of the equation.

Since this is called the “social care precept”, we might think that it will lead to increased spending on social care. It’s not easy to find numbers on how social care spending is split between income groups, but modelling done in 2011 for the Dilnot Commission (see figure 11 here) made some estimates. Reading the numbers off the chart, I get something like this.

Council tax and social care by income group

Social care spending is more heavily weighted towards poor people than council tax collection, so lower income groups make a net gain from this policy. That is, the introduction of this policy increases the total amount of redistribution that the government does, which is the only sensible definition I can think of for the word “progressive”, with reference to a change in policy.

Gain from spending council tax on social care

But is higher spending on social care really the effect of this policy? That is, if it weren’t for the social care precept, would we see lower social care spending? You could argue that social care spending is going to rise either way, since we’ve got more old people than ever. If it’s not paid for by council tax rises it will be paid for by higher taxes elsewhere, higher borrowing, or cuts to other services.

So this is my second golden rule: identify a realistic counterfactual. We need to know whether the policy leads to more redistribution than what would otherwise have happened. That “what” can have a huge impact on how we view the distributional consequences.

Let’s say we believe that without the social care precept higher social care spending would have to be funded through an increase in income tax – or perhaps higher borrowing now, funded by future increases in council tax. As Jo points out, income tax is much more targeted on rich people than council tax. Here’s the net effect of raising £2bn through council tax instead of income tax.

Gain from raising council tax vs income tax

This policy change would give money to the richest 20% at the expense of everyone else. I think we can all agree that’s regressive. So depending on the counterfactual, the social care precept is either highly progressive or highly regressive. Take your pick. We need to decide which counterfactual is more realistic. In this case, the first one is probably closer to the truth (raising income tax and borrowing more are not top of this government’s agenda) so I’d argue that the policy is probably progressive.

But there’s another more fundamental question here: how much redistribution do we want? Requiring all policy changes to be “progressive” implies that we think we don’t currently have enough. But at some point, if we were to go on increasing redistribution, we’d have too much. Views will differ wildly as to what the optimal level is, but in principle there must be one. I imagine few people think that there should be no redistribution and few think that redistribution should fully equalise living standards.

And even if we want more redistribution, we might not care if a policy is regressive if its effect on the overall level of redistribution is small and it achieves some other aims. The state does not exist solely for the purpose of moving money from the rich to the poor. My third golden rule is therefore this: the overall level of government redistribution is what matters. We need to know whether we want to increase or decrease it, and how much we care about small changes relative to other policy aims.

These rules really are essential. It is impossible to say anything about whether a policy change is progressive without considering both sides of the equation and being clear about what you think the alternative scenario is. It is impossible to know whether you actually want the policy to be progressive, or whether you care, without considering the overall level of redistribution.

These are not new insights and many organisations (the IFS, the OBR, sometimes even the Treasury) are quite diligent about doing distributional analysis properly. But much of the public discussion of “progressivity” fails to follow a single one of these rules, giving us a rather poor standard of debate on the state’s role in reducing inequalities.

* I’m not picking on Jo’s analysis because it is a particularly egregious example. On the contrary, I am picking on it because is one of the better examples of someone tackling this question, so Jo has done most of my work for me.