Accounting for changes in income inequality: Decomposition analyses for Great Britain, 1968-2009

a research paper (No. 2012-17) by Mike Brewer (Institute for Social and Economic Research, University of Essex and Institute for Fiscal Studies) and Liam Wren-Lewis (Overseas Development Institute Fellow and ECARES, Université Libre de Bruxelles) published by Institute for Social and Economic Research

Non-technical summary

It is widely known that household income inequality in the UK is much higher than it was thirty years ago. However, the rise over this period has not been even. Instead, on many measures income inequality rose very quickly during the 1980s, and has changed little since 1991. This is all the more puzzling given the fact that individual wage and earnings inequality rose fairly steadily over the period, at least until 2000. These patterns are different from the US, where income inequality has continued to rise along with earnings inequality. This article investigates these recent changes in income inequality, which have remained relatively understudied compared with changes in earnings or wage inequality. We address the question “why did income inequality rise very rapidly over the period 1978 to 1991 but then remain relatively flat thereafter?”

To answer these questions, we decompose changes in income inequality into the contributions from different factors. We first decompose income inequality according to the income sources which have contributed to changing inequality (earnings from employment, investment income, state benefits, etc): this allows us to assess the share of changes in total inequality attributable to each income source. We then focus on decomposing inequality according to household characteristics which we expect to influence income (such as age, education, sex, and so on).

We find that inequality in employment and self-employment income amongst the economically active grew both before and after 1991, but, since 1991, a number of factors have mitigated the effect of this on inequality in total income. First, inequality between those with different employment statuses has fallen since 1991, primarily due to a fall in the number of unemployed people. Second, employment taxes have played a larger role since 1991 in mitigating the increase in inequality of gross employment income than they did before 1991. Third, investment income has become less unequal since 1991, largely due to the decline in its importance, which itself may be explained by a fall in nominal interest rates. Finally, a rise in the relative incomes of pensioners and households with children under five has pulled inequality down. Overall, these four factors have almost entirely offset the impact of the rise in earnings and self-employment income inequality since 1991.

Full text (PDF 46pp)

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