(1)    the methods used by HMRC to assess the yield from the top rate are likely to produce an underestimate of the revenue-raising potential of the 50p rate in the tax system as it currently stands;

(2)     even if the HMRC estimate is correct, for the most part it reflects easily correctible anomalies in the tax system which allow a large proportion of high income individuals to avoid paying 50% tax relatively easily. Reforming the system to close these loopholes would ensure that the 50p rate raises substantially more revenue than it does now.

Why the HMRC research most likely underestimates the yield from the 50p tax rate

Based on the number of people paying tax with gross incomes above £150,000 in 2009/10 (the last tax year before the 50p rate was introduced), HMRC have estimated that the 50p rate would have raised about £7 billion if the behaviour of taxpayers was unchanged after the tax was introduced. However, it is implausible that there would be no behavioural effect whatsoever of the tax increase. While most research shows that the effect of the tax system on work effort (e.g. hours of work) is very small for the types of workers who are likely to be affected by the 50% rate, the rate does increase the incentive to undertake tax avoidance activity – that is, finding ways to avoid paying income tax at 50p by exploiting loopholes in the tax system. Some examples of possible avoidance activity are:

• Converting income into capital gains (taxed at a maximum rate of 28% in the UK) ;
• Allocating income to a spouse or partner;
• Bringing forward a stream of income before the 50p rate is introduced, thus managing to pay tax at the old rate;
• Entering into artificial avoidance schemes.

There may also be some impact in terms of high earners migrating out of the UK, although as Richard Murphy discusses in a recent report for the TUC, this impact is likely to be small.

In the event, HMRC data for 2009/10 (the year before the 50p rate was introduced) and 2010/11 (the first year of its existence) appear to show a very large increase in income tax revenue in 2009/10 and a very large drop in 2010/11. This suggests that tax avoidance through ‘forestalling’ (moving taxable income forward from 2010/11 to 2009/10 to pay tax at 40% rather than 50%) inflated tax receipts in 2009/10 and depressed them in 2010/11 (and possibly subsequent years as well). The HMRC report on the impact of the 50p rate shows that total income for individuals with incomes above £150,000 increased from £101.3bn to £115.7bn from 2008/09 to 2009/10 before falling to £87bn in 2010/11 (HMRC, Table 5.1).

Forestalling on this scale makes it pretty much impossible to estimate the ‘long-run’ yield from the 50% tax rate on the basis of the 2009/10 and 2010/11 data alone, because there is no real way of knowing how much of the drop in income in 2010/11 is due to forestalling and how much is due to other, longer run, avoidance factors depressing taxable income, or other behavioural impacts on work by top earners. HMRC’s approach uses a time series regression of data  from the last two decades to estimate the relationship between total net incomes for individuals with net incomes of above £150,000 per year, total net incomes for individuals with net incomes between £115,000 and £150,000 (used as a control group unaffected by the 50% rate) and average UK equity prices. However, the extent of the financial crisis and ensuing recession which unfolded from 2008 onwards in the UK – as well as the equity price bubble of the late 1990s – mean that the coefficients from this kind of regression are most unlikely to be stable over time. Hence it is not clear that HMRC can reliably forecast what the longer-run impact of the 50% tax rate on revenues would be using this approach.

The key parameter which is important for evaluating the effect of increases in top rate tax on the amount of revenue received by the Exchequer is the Taxable Income Elasticity (TIE). This parameter measures the extent to which the taxable income of top earners falls – due to tax avoidance, or other changes in behaviour by high income individuals – as the tax rate rises. The higher the TIE estimate, the lower the yield from an increase in the top rate of tax and the lower is the ‘revenue-maximising’ rate of top tax – the rate above which net revenue from a tax increase is actually negative.  The HMRC analysis produces an estimate for TIE of around 0.46, suggesting that the revenue-maximising top rate of income tax is 48%. This is the reason why the OBR’s costing for the reduction in the 50p top rate of tax to 45p is only £100 million – because with a TIE of 0.46, a 50% top rate is actually above the revenue-maximising rate. Reducing the rate from 50% to 48% would raise revenue if HMRC is right, while reducing the rate to 45% loses very little revenue compared with 50%.

But is the estimate of 0.46 correct? HMRC provides a review of some of the estimates of TIE – mainly based on US research, but also including a study by Brewer, Saez and Shephard (2008) for the Institute for Fiscal Studies’s Mirrlees review of the tax system based on UK data, which also produces an estimate of 0.46 based on the effects of the changes to top marginal rates in the UK between 1979 and 1988. However, as explained in the IFS’s Green Budget released earlier this year, the accuracy of the TIE estimate by Brewer et al relies crucially on the assumption that the share of income going to the richest 1% of people in the UK compared to the share of income going to the next richest 4% of people in the UK would have changed by the same amount between 1979 and 1988 (when the top tax rate was reduced from 83% to 40%) as it in fact did change over that same period. There is in fact no real reason to expect this to be the case. To the extent that the income share of the top 1% was tending to increase relative to the next richest 4% anyway, the estimate by Brewer et al overstates TIE for the UK.

Furthermore, a recent review of estimates of TIE by Saez, Slemrod and Giertz (2012) suggests that many of the earlier studies included in HMRC’s review of the literature on TIE produced estimates of TIE (for the United States) that were excessively high due to flaws in the data and the methodology used. Saez et al claim, on the basis of more recent evidence, that  “the best available estimates [of TIE] range from 0.12 to 0.40”,  although they also suggest that “the TIE is higher for high-income individuals who have more access to avoidance opportunities, especially deductible expenses”. Hence, a TIE of 0.46 for UK top earners, while not impossible, would be on the high side of recent estimates.

Furthermore, recent research by Piketty, Saez and Stantcheva (2011) suggests that a high TIE estimate  may actually be a reason to increase rather than decrease tax rates, for distributional reasons. Piketty et al suggest that there are three ways in which top earners can respond to changes in tax rates:

1. The supply response, whereby lower tax rates stimulate economic activity among top earners (through greater work effort, for example);
2. The tax avoidance response, as catalogued above;
3. The bargaining response, reflecting the possibilities for top earners to increase their compensation packages where corporate governance arrangements are weak and pay does not reflect performance accurately (a situation which arguably describes the UK very well). The idea here is that the lower the top tax rate, the higher the incentive for highly paid employees to engage in bargaining behaviour to increase their net incomes.

Piketty et al use data from 18 OECD countries from the 1970s to the 2000s to estimate the relationship between top tax rates and taxable income for high earners and find an overall TIE of around 0.5 for top earners. However, they also find that the tax avoidance component of the elasticity is rather small – around 0.2. The elasticity for the bargaining response  – which shifts resources from people further down the income distribution to top earners, thus exacerbating inequality – accounts for 0.3 of the elasticity. What this means is that increasing the rate of top income tax may cut the yield, but it mainly does so because the pre-tax distribution of income is being equalised. In other words, if Piketty et al are correct then increasing the top rate would redistribute pre-tax income from the highest earners to people further down the income distribution as well as redistributing post-tax income.  In other words, reductions in the top rate of tax exacerbate inequality rather than delivering increased productivity and growth.

The HMRC estimate reflects easy opportunities for tax avoidance

We have seen that HMRC’s estimate of the taxable income elasticity is problematic for several reasons. But even if the HMRC estimate is (a) an accurate reflection of the TIE for top incomes and (b) reflects tax avoidance rather than bargaining behaviour among the high paid (which are both questionable assumptions), it is clear that much of this avoidance activity could be significantly reduced or eliminated by changing the tax system to eliminate obvious loopholes. Some good examples would be:

• Increasing the rates of Capital Gains Tax to align them with income tax marginal rates, as suggested in the 2010 Liberal Democrat manifesto. This would eliminate an incentive to reduce tax bill by converting income into capital gains – a measure which is available to many top rate tax payers;
• Limiting the scope for reallocating income to partners or spouses;
• Limiting the scope for artificial tax avoidance behaviour.

Indeed, a limited set of anti-avoidance measures was announced by the Chancellor in his budget speech and the projected success of these measures this was part of the basis for his assertion that the new measures contained in the 2012 Budget would raise 5 times as much from the very rich as the 50p rate did. This suggests that the Chancellor agrees that effective anti-avoidance measures can increase revenue. But if this is the case, then closing the opportunities for avoidance would be a good way of increasing the revenue from the 50p rate without producing a massive giveaway to the top 1% of taxpayers.

In summary, HMRC’s estimate that the 50% rate of income tax raised less than a billion pounds in the 2010/11 tax year has to be viewed as a premature and uncertain piece of analysis. The department was set a near-impossible task by the Chancellor in trying to evaluate the yield from the 50% rate based on data that have been hugely distorted by taxpayers shifting their income forward from 2010/11 to 2009/10 to avoid paying tax at the higher rate in the first year of its operation. This short-run effect swamps any longer-run trends and makes it pretty much impossible to identify how much the 50% rate would have eventually raised had it been left in place. Furthermore, the justifications from previous literature used to support HMRC’s contention that the taxable income elasticity for UK top incomes is as high as 0.46 are highly questionable. Finally, the reduction in the top rate from 50% to 45% is likely to increase the inequality of pre-tax incomes as well as post-tax incomes if bargaining effects for top earners are important – exacerbating the problems faced by the “squeezed middle”.

At Today’s TUC/unionlearn “Skills Investment” seminar in Congress House, I will be outlining the results of a recent research project carried out by Landman Economics, funded by unionlearn, which looks at the extent of current tax relief on training and the options for the future.

The government does not publish official estimates of how much tax relief is worth to businesses, but my calculations using data from the National Employer Skills Survey and HMRC statistics suggest that tax relief reduced businesses’ tax payments by around £4.9 billion in the 2010/11 tax year. This amount comprises relief on the cost of training itself (£2.9 billion) and relief on the wages foregone by employees undertaking training (£2.0 billion).

Given the amount of government revenue foregone in tax relief for training, it makes sense to ask whether the current arrangements are the most effective use of public funds. My research used data from the UK Labour Force Survey about which employees and self-employed people are training (by earnings level and qualifications) to assess the likely costs and distributional impacts of a number of different options for reform.

The analysis resulted in a recommendation for two major reforms to tax relief.

First, corporation tax and income tax relief on training should be restricted to training which leads to an accredited qualification, or other accreditation such as Continuing Professional Development. This would reduce the costs of tax relief by up to 90% of its current total cost, and would target relief better on training that delivers increases in productivity, with a more progressive distributional impact than the current system.

Second, relief should be introduced on employer NICs for employees undertaking training. The cost of this measure would roughly offset the savings from the restriction of coporation tax and income tax relief to accredited qualifications. Employer NICs relief would be claimable by a much wider range of organisations than can claim current tax reliefs – including public and voluntary sector employers.

The final recommendation from the project is that the government should publish statistics on the extent of tax relief claimed by businesses each year – based either on survey data or administrative data from (modified) tax returns. Given that this is the single most expensive training support policy in the UK, despite my recent research we still know remarkably little about which businesses are claiming it, and what its overall effects are in encouraging training. Better data would help researchers address this question in much more detail in the future.

But would a more equal distribution of income reduce the level of efficiency in the economy and hence make us worse off overall? Conventional economists have often argued that it would, because of the effects of progressive taxation on reducing the rewards for work and entrepreneurship, and reduced returns to investments.

Next week the TUC publishes a new Touchstone Extra report, Fairness and Prosperity, which addresses precisely this question; I’ll be launching the report at an online seminar on Monday together with Richard Wilkinson of Spirit Level fame (you can register here). In the report,  I ask whether a more equal distribution of income would joepardise the UK’s economic prospects. Or rather, is more equality just what we need to improve our prosperity and well-being?

The report first looks at the relationship between inequality and economic performance using a sample of developed countries in recent years. I find no relationship at all between the level of inequality in each country and economic growth between the mid-1990s and the mid-2000s. Meanwhile, more complex academic research using regression models which control for other factors which might affect growth in different countries also fails to establish any consensus view on the relationship between inequality and prosperity. In short, the conventional view that there is a trade-off between equaility and efficiency is simply not borne out by empirical evidence at the cross-country level.

By contrast, recent research by the epidemiologists Richard Wilkinson and Kate Pickett (in their book The Spirit Level), and the OECD (in its Society at a Glance publication), suggests that there is a clear relationship between income inequality and a range of health and social outcomes, when looking at two-way correlations. For example:

• Countries with more inequality have worse outcomes for women on indicators like political participation, employment and earnings, and social and economic autonomy;
• Maths and literacy scores for schoolchildren are lower in countries that are more unequal;
• Countries with greater inequality have higher rates of homicides relative to population size.

Why does the intuition from conventional economics on these matters turn out to be so flawed? The report examines several reasons why greater equality might be associated with better, not worse, economic performance.  For example:

• It may well be that rewards for high earners in the labour market are completely out of kilter with the value of what those high earners actually produce – this certainly seems to be the case in banking, for example. Thus, high earnings inequality could be a symptom of a malfunctioning labour market rather than a well-functioning labour market;
• Countries with greater inequality of incomes tend to be less socially mobile – children from poor backgrounds are more likely to stay poor in later life and vice-versa for children from rich backgrounds, which can mean that people are less well matched to suitable openings in the labour market (as ‘good jobs’ are allocated on an ‘old school tie’ rather than a meritocratic basis);
• In countries like the UK and US where there are relatively few restrictions on the amounts individuals, corporations or other organisations can donate to political parties, increases in wealth and income inequality are likely to have a knock-on impact on inequalities in political campaign financing. This may cause policies to be followed which are not in the interests of the majority of voters but a small segment of the super-rich instead, which can lead to policies being enacted which have adverse impacts on prosperity for the country as a whole. In the light of the recent revelations about phone hacking at News International – a company itself based on the consolidation of power into the hands of the Murdoch dynasty – it is also worth asking whether the concentrations of power that go hand-in-hand with high inequalities impair the ability of the media to function in a fit and proper manner.

It is likely that these negative effects of inequality on economic performance cancel out the positive correlation suggested by conventional economics, leading to there being no overall relationship between inequality and economic growth. At the same time, there are several theories in the academic literature which may explain the fact that inequality seems to be bad for health and social outcomes. The two most important of these are the possibility of an “evolutionary instinct for fairness” and the idea that it is income growth relative to other people in society, rather than in absolute terms, which affects health and social outcomes. Both of these theories are discussed in some depth in the report.

The conclusion of this research is that we do not have to tolerate greater inequality to ensure enhanced economic performance. Quite the reverse in fact: there is good evidence that the high level of inequality in the UK is responsible for lower life expectancy, increased infant mortality, higher homicide rates, lower degrees of trust between citizens, and a range of other negative outcomes in the nation’s economic and social cohesion.

Reducing inequality should be a priority for government policy. In particular, policymakers should look at limiting the extent to which the super-rich are allowed to continue ‘racing away’ from those on average incomes in the United Kingdom, as there is considerable evidence that this particular feature of the last thirty years of British economic history is particularly damaging, leading to a range of problems including greater inequality of life chances, inequalities in political influence and quite possibly lower growth and innovation than if we were a more equal society.

Specifically, policymakers should look at high pay in the private sector, close loopholes in the tax system that allow certain highly paid workers to pay much lower effective rates of tax than other people on the same gross earnings (e.g. the Capital Gains Tax system as it now stands), and assess the impact of tax and spending decisions with regard to income and gender inequalities in a much more systematic way than the government manages to do at the moment.

There has been considerable debate among economists and other commentators as to the revenue-raising potential of the 50p rate.  HM Treasury’s analysis in the November 2008 Pre Budget Report (where the original plan for an additional rate on incomes above £150,000 per year was proposed, at a rate of 45%) and the March 2009 Budget (where the rate was raised to 50%) suggested that the 50p rate would raise a total of £2.4 billion extra revenue per year by the 2012-13 tax year.

By contrast, research carried out by Brewer et al (2009) for the Institute for Fiscal Studies (IFS)’s recent Mirrlees Review of the tax system suggested that the previous top tax rate of 40 percent was the revenue maximising rate, and that an increase to 50p was likely to reduce revenue rather than increasing it. The IFS argued that the 50p rate would reduce revenue because taxpayers on gross incomes of over £150,000 are relatively adept at taking action to reduce their tax burden – for example by:

• reclassifying income as capital gains (which are subject to a much lower tax rate);
•  incorporating into a small company (a tempting option for ‘sole traders’ small businesses or partnerships, because corporate profits are taxed at a much lower rate than earned income, and company dividends are not subject to national insurance contributions);
• engaging in complex avoidance schemes (one of the reasons for the complexity of tax legislation in the UK is the need for the law to address the plethora of complex avoidance schemes marketed by tax advisers);
• (in the most extreme scenario) leaving the country altogether.

The IFS used UK data from the income tax cuts of 1988 (where the then Chancellor of the Exchequer, Nigel Lawson, reduced the top income tax rate from 60% to 40%) to estimate the response of taxable incomes to a change in tax rates. It is on this estimate that they base the contention that the 50p rate will lose money. However, they admit that it is difficult to estimate the gains or losses from the 50p rate with any precision based on this approach. The difference between HM Treasury and IFS’s estimate of the revenue from the 50p rate is driven by different estimates of the taxable income elasticity – the extent to which taxable income responds to a change in the marginal tax rate. However, there are a large number of factors which could affect this calculation – for example, a change in the underlying distribution of gross incomes, the rate of growth in the UK economy as a whole, changes to the taxation of corporate income, changes to capital gains taxation, and the finer detail of changes to allowances and reliefs in the income tax system. Nigel Lawson’s 1988 reduction in the top income tax rate took place when the economy was already booming as Britain emerged from the severe recession of the early 1980s. Therefore, it is quite possible that tax revenues would have risen even more in the post-1988 period if the top rate of tax had been kept at 60% rather than being lowered to 40%.

More generally, a recent summary of the literature on estimating taxable income elasticities by Saez et al (2010) is sceptical about the ability of research such as IFS’s actually to be able to isolate the underlying efficiency effects of changes to top tax rates:

“there is compelling evidence of substantial responses of upper income taxpayers to changes in tax rates, at least in the short run. However, in all cases, the response is either due to short-term retiming or income shifting. There is no compelling evidence to date of real responses [e.g. changes in work effort, etc.] of upper income taxpayers to changes in tax rates… estimates of the elasticity of taxable income in the long run (i.e. exceeding a few years) are plagued by extremely difficult issues of identification, so difficult that we believe that there are no convincing estimates of the long-run elasticity of reported taxable income to changes in the marginal tax rate.”

(Saez, Slemrod and Giertz, “The elasticity of taxable income with respect to marginal tax rates: a critical review”, NBER Working Paper 15012.)

Because there were no changes to the top rate of income tax between 1988 and 2010 there are no more recent estimates of the impact of top tax changes on revenue in the UK on which to draw. However, there is some evidence from the one-off payroll tax on bankers’ bonuses which was introduced in the 2009 Pre-Budget Report. This tax imposed a 50% tax on any bonus paid by a bank to an employee of more than £25,000.  The original Treasury estimate from the 2009 Pre-Budget Report was that the bonus tax would raise £550 million. However, based on actual data on bonuses being paid in the 2009-10 tax year, the estimates of the yield from the bonus tax were revised upwards to £1.3 billion in the 2010 Budget – more than double the original estimate. In other words, the Treasury – presumably using a methodology similar to the one used for its estimate of the revenue impact of the 50p income tax rate – vastly underestimated the revenue yield from the bonus tax. It therefore seems reasonable to infer that yields from the 50% tax rate will also be larger than the Treasury estimates, if anything. Moreover, in many ways the one-off bonus tax is a lot easier to avoid than the 50% rate, assuming that the 50% rate stays in place for a number of years. Banks could have chosen to defer bonuses until the following year, for example. So the high yield from the bonus tax is strong (if indirect) evidence that yields from the 50% rate will exceed Treasury expectations.

In January 2011, the first indications of the yield from the 50% rate arrived, with the publication of HMRC data on income tax yields including PAYE (pay-as-you-earn) receipts from the first few months of the 2010-11 tax year. Initial analysis by the economist Duncan Weldon suggests that the 50p rate could be responsible for a large growth in income tax revenues. Income tax revenues in January 2011 were £23.8 billion compared with £20.2 billion in January 2010 – an increase of around 18 percent. This compares with revenue from National Insurance Contributions of £9.2 bn compared with £8.8 billion in January 2010 – an increase of around 4.5 percent. This analysis should be treated with caution for two reasons. First, the data are for one month only, and PAYE revenue estimates can be volatile from month to month. Second, the data do not include self-assessment returns, where payments for the 2010-11 tax year will not be due until 31 January 2012. While most employees who are higher-rate taxpayers will be covered by PAYE (although they may well have to supplement this with a self-assessment return for unearned income), all self-employed income taxpayers are on self-assessment and so the data from January 2011 are a very incomplete picture. Nonetheless, the increase in income tax yields so far is an encouraging sign for advocates of the 50% rate as a revenue-raiser.

However, this has not stopped right-of-centre commentators from trying to debunk the 50p rate. In March, right-wing think-tank the Adam Smith Institute (ASI) issued a report on “The Revenue and Growth Effects of Britain’s High Personal Taxes.” The £350 billion figure (actually £35 billion averaged per year over ten years) is extrapolated from a survey of tax advisers undertaken by ASI and the Association of Certified Chartered Accountants, where the tax advisers asked their clients whether they were considering becoming non-resident in the UK. Appendix 2 of the ASI report sets out the main assumptions of the analysis, which unfortunately  does not mention how many advisers were surveyed, whether the sample was representative, and how serious the clients surveyed might be about moving. Clients who had already moved were also included in the total of individuals ‘contemplating non-residency’ – which assumes it is possible to move twice!

Based on this evidence, ASI assumes that between 12% and 23% of UK taxpayers paying income tax at marginal rates of 40% or higher will leave the UK over the next 10 years – this would mean between 400,000 and 770,000 people leave, based on current HMRC estimates of the number of taxpayers in the UK. However, it must be said that there is simply no evidence at all from the economics literature that employees are this mobile across national borders in response to  changes in marginal tax rates. Moreover, for almost 90% of the group which ASI are looking at, the marginal rate of tax is unchanged at 40%, because they earn less than £150,000. In short, the analysis vastly exaggerates the labour mobility implications of the income tax top rate increase.

ASI’s misinterpretation of the evidence also extends to their cross-country work on tax rates. Using data provided by the accountants KPMG they argue that ranked against the 86 largest economies in the world, the UK has the 83^rd highest marginal tax rate. In fact, analysis by the OECD of the highest total effective tax rates in OECD economies – including employee social security contributions as well as income tax – suggests that the UK has the 6^th highest combined top rate in the OECD (out of 30 countries) but is only about 3 percentage points above the median OECD top rate – hardly a huge outlier, and most unlikely to be enough to cause significant ‘brain drain’ from the UK. Furthermore, our standard VAT rate (which is also a big part of the tax burden on labour) was also below the OECD median of 19 percent – until George Osborne increased it to 20 percent in January.  Overall, the ASI report looks more like right-wing scaremongering than serious economic analysis.

In summary, it is as yet unclear what the yield from the 50% top income tax may be, but initial signs are encouraging, while attempts by the right to debunk the policy are unconvincing. In the 2011 Budget George Osborne announced that the Treasury is to conduct a review of the 50p rate with a view to recommending whether it should be retained or not. While Mr Osborne’s instincts will probably be to abolish the rate, if it does turn out to be a revenue raiser he will have to either cut spending or raise other, less progressive, taxes to do so – both of which options are likely to be unpopular in the run-up to the next general election.

Earlier this week our TUC report “Where the money goes“, which shows that the coalition government’s planned spending cuts are likely to impact much more heavily on the poorest UK households than the richest, was subject to robust criticism by Simon McGrath at Lib Dem voice.

In this article we respond to these criticisms.

Simon claims that “the methodology is ingenious because it is bound to produce the results [we] want” because, for the 30% or so of public spending for which we have no information on how the use of public services varies across the population, we assign the value of this spending to households on a “flat rate basis”. So, for public services such as defence or environmental protection, we assume that households receive the same benefit from this spending regardless of their income (with some adjustment for family size).

It’s true that this kind of approach will always produce the result that spending cuts to the “flat rate” allocation leave the poorest households worse off. But if we think about what it would cost to provide the service privately instead, this makes sense. For example, if the police force was abolished and households had to employ private security guards to protect themselves and their property, the price of a security guard (of a given quality) would be the same no matter what the household’s income was. From this perspective it seems obvious that public services provided to all households on an equal basis involve redistribution from rich to poor. We make no apology for including this assumption.

Simon argues that by our logic, money spent on ID cards and IT systems in the NHS increases equality. To the extent that they represent spending that households place a positive value on, that logic is correct. Of course, it is quite possible for the government to spend money on things that people don’t actually want. Indeed, one of us argued in a publication for Compass in November 2009 (“in Place of Cuts“) that ID cards were an obvious candidate for a painless spending cut. However, if it is that easy to identify huge amounts of spending which are unwanted by the public, why did the first £6 billion of cuts by the Coalition, back in June, contain cuts to core services like the Future Jobs Fund and Child Trust Fund, which were clearly valued? We would argue that the vast majority of public spending is spending that people actually value rather than white elephants.

But there is a deeper point here. The poorest households are also getting hit harder from the cuts in cash terms. This is because many of the services being cut (education, housing, social care, etc.) have spending that is pro-poor – and which our model does not allocate on a flat-rate basis. As the graph on page 48 of our report shows, the poorest fifth of households lose about £700 a year in welfare services like these by 2012, whereas the richest fifth lose services of about £400 in value. In fact, our model allocates about 70% of public spending in an income-related way, and only 30% on a flat-rate basis – which we think is the most sensitive of any such analysis in recent years. Part of the overall patter of the impact of the cuts is therefore down to this non-’flat rate’ component of public spending, which is even more progressive than the flat rate part.

Simon also points out that Labour had committed to £25bn of cuts which would have resulted in an impact of inequality of a similar shape to the Coalition’s cuts of £42bn by 2012 (although not quite as severe). In fact, the comparable figures once reduced debt interest payments are taken into account are £39bn coalition cuts (including benefit cuts) versus £23bn cuts inherited from Labour (not £34bn versus £25bn as Simon claims). So, including benefit cuts, the coalition are making around 70% more spending cuts by 2012-13. This is because the coalition have chosen a path a fiscal consolidation that is faster than that which they inherited, and they have chosen to rely more heavily on spending cuts to do so.

If Labour had won the election and then implemented their £23bn of cuts, we would certainly have criticised them on much the same grounds. However, the other side of the coin is the tax and benefit measures which Labour introduced to help reduce the deficit, which were unambiguously progressive; whereas the additional tax rises and benefit cuts, and the income tax allowance increase, introduced in George Osborne’s emergency budget were (as the IFS has shown) unambiguously regressive.

Here, the Lib Dems played a very important part in making these changes regressive, since it was their policy to make £3.7bn income tax cuts in the June Budget – which were not only regressive, but made the corresponding spending cuts that much deeper.

We certainly do not assume that if Labour had won the 2010 election, no cuts would have had to be made. But the Coalition did not have to choose this precise balance of spending cuts and tax increases; it could have relied more on tax rises and less on spending cuts, as Labour planned to. And it certainly didn’t need to resort to regressive tax changes to help close the deficit.

However, analysis of the impact of increases or cuts in public spending on services where households do not receive a monetary amount, but instead ‘benefits in kind’ – for example health, education and public investment in transport infrastructure – is pretty much non-existent. Most public spending is of this type, and yet we know very little about how it is distributed among the population or what its effects are. This leads to a very one-sided public debate, with organisations like the Taxpayers’ Alliance clamouring for cuts in taxes while failing to acknowledge that if tax is cut, spending will have to be cut too – and that impacts on the provision or quality of public services.

New research by Tim Horton of the Fabian Society and myself, released today, attempts to fill in the missing side of the debate over tax and public spending by looking at the amount of spending which goes on households of different types. We do this by using data from several household surveys on which households in the UK use different types of public service – such as the NHS, state education, or social housing. By combining this with HM Treasury’s Public Expenditure Statistical Analyses (PESA) dataset – showing the amount of spending on different public services – we are able to estimate how much is spent on households in cash terms and as a proportion of their income, given household demographics (e.g. number and age of adults and children in the household), their housing tenure, the region they live in, and various other information about household circumstances. Elements of public spending which are conceptually difficult to allocate to individual households – such as defence or environmental protection – are allocated on a ‘flat-rate’ basis to households in proportion to household size.

When the calculations are done in this manner, the results are striking. Average public spending per household (including benefits and tax credits) is around £21,400. There is a clear income gradient: the poorest 20% of households receive an average of around £24,000, whereas the richest 20 per cent receive around £14,000. For many catergories of public spending – including education, housing and social care – poorer households receive more in cash terms than richer households. For all the categories of spending we look at, the impact of spending is progressive, in that poorer households benefit more from spending as a share of their net income than richer households.

The upshot of this is that the current Government’s plans to cut spending – which involve cuts to all departments except health and international development which could average as much as 25% of total departmental budgets – are almost certainly going to be deeply regressive. Until the Spending Review on 20^th October we do not know exactly where the axe will fall in most cases. But, excluding the impact of tax and benefit changes (which the IFS has already modelled) and assuming uniform cuts in all non-ringfenced departments except education and defence – which the government has indicated will get off somewhat more likely – we find that the cuts will impact the poorest 10% of households over ten times more (as a share of income) than the richest 10 percent of households.

Thus, the Coalition Government’s economic policy is likely to hit the poorest households worse on two fronts. Their chosen combination of tax rises and benefit cuts is regressive – but the impact of spending cuts is likely to be even more so. These findings will provide much food for thought for progressively minded activists in both the current governing parties as we move towards the political party conference season.

For thirty years, the mainstream economic orthodoxy was that  the way to economic success lies in deregulating product, labour and financial markets as much as possible. Given that the banking crisis was an object lesson in how deregulation could, in some circumstances, deliver not economic success, but instead near-armageddon, we might have thought that this would lead to some reconsideration of whether deregulation was always and everywhere the best policy after all.

However, the proponents of deregulation – including the Conservative party (but also some leading politicians in the Liberal Democrats and Labour parties), business groups such as the Institute of Directors, Confederation of British Industry and British Chambers of Commerce, and right-wing think thanks such as the Institute of Economic Affairs have instead insisted that the economic crisis means we need to deregulate still further, particularly in the labour market.

The message is that red tape and regulation are strangling business and that we need to restrict workers’ statutory rights, pare back the minimum wage and reduce the power of trade unions in order to have an employment-led recovery.

It is easy to see why the deregulationist view is attractive to the Right. It delivers straightforward policy prescriptions which fit with neo-liberals’ instinctive dislike of regulations and organised labour institutions. But the fundamental problem for proponents of this view is almost none of its assumptions are borne out by the evidence.

The latest ToUChstone pamphlet, The Red Tape Delusion: Why deregulation won’t solve the jobs crisis by Stewart Lansley and myself, examines in detail whether there is a relationship between the degree of regulation in the labour market and various aspects of the economy’s performance – the unemployment rate, productivity growth, and so on. We survey a vast array of evidence on cross-country economic performance as well as empirical studies of the effect of particular regulatory (or deregulatory) measures in the UK and other industrialised countries – for example the employment effect of minimum wages, the relationship between trade union density and productivity growth, the impact of employment protection legislation on employment, and so on.

The overall findings are that there is no evidence whatsoever that moderate levels of labour market regulation impede economic performance, and a good deal of evidence that  some types of regulation can improve aspects of economic performance. For example:

• There is no evidence that a minimum wage set at the current UK level impedes employment creation or increases unemployment.
• The modest re-regulation of the British labour market in the last decade has been achieved without detriment to employment creation. Indeed, the impact of the 2008-09 recession on UK unemployment – which has risen by much less than in the early 1980s and 1990s recessions – suggests that the slightly more regulated labour market of the last decade has been working well.
• Trade unions have no significant negative consequences for labour market outcomes, and have positive effects in promoting workplace cohesion and social justice.
• Co-ordinated wage bargaining systems are associated with lower unemployment.
• Active labour market policies, if well designed, can make a substantial difference to the employment prospects of the long-term unemployed.
• Generous unemployment benefits of limited duration (with ongoing social assistance provided for those in need) combined with job search requirements are effective in reducing long term unemployment.

Given that the UK is already a very lightly regulated economy (of the leading industrialised economies, only the United States is less regulated), there is nothing to be gained in terms of improved economic performance from deregulating further. On the contrary, it is quite possible that reducing or scrapping regulations could actually make the UK labour market perform worse ­ reducing the rate of productivity growth, for example.

At a time when an increasing number of commentators are reviving the mantra of deregulation in the hope of capitalising on the public’s fears of higher unemployment in the wake of the recession, this new ToUChstone publication provides a welcome blast of evidence-based reality and shows that deregulating the labour market won’t deliver improved economic performance.