Discussion of inequalities has long been at the forefront of economic and political debate due to the concerns regarding the widening gap between the rich and the poor. Income inequality describes the extent to which income from revenue streams is distributed unevenly amongst the national population. Statistics from the Organization for Economic Cooperation & Development (OECD) depict the United Kingdom (UK) has one of the highest levels of income inequality in the world, with quite a large differential between the top and bottom quintiles. Income inequality does not just effect income and living standards but has flow on effects regarding family situations and even the scope of opportunities available to individuals with largely disproportionate incomes. In order to counteract this prevalent and growing economic issue, injecting investment into education and training programs to increase the quality of human capital would greatly benefit the UK, as an educated workforce is the foundation for sustainable wages growth and ultimately a prospering economy.
Context
The basis of growing income inequality in the UK stems from strong wages growth for the top 1% of the population, but stagnant to low wages growth for the bottom quintile. This decreasing pay progression for the low skilled workers leads to a weakened labor market creating a self-fulfilling prophecy of economic insufficiency. As per the IFS income growth for the median households has stalled due to wages growth declining by 0.3% and inflation increasing by 1.8% due to the political uncertainty regarding Brexit and the EU referendum. Reductions in transfer payments and welfare benefits to low-income families have also suppressed low-income family income by 1.6% (IFS 2019). Furthermore, over the 2018 UK fiscal year, the top quintile covered 42% of disposable income, whilst the bottom quintile covered only 7%, illustrating the significant disparity between the rich and the poor (McGuinneas 2019). All these factors concurrently have led to the UK Gini Coefficient being 0.34, significantly higher than in the 1970s, indicating increasing levels of inequality (0 being perfect equality and 1 being perfect inequality). To make matters worse, income inequality is expected to rise into the 2020s due to two main factors: increasing real earnings for high earners and cuts to benefits to low-income households by 7% in 2021-22.
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Increasing housing costs, stemming from rising mortgage repayments limits income growth for the lowest earners by up to 5%. Low wage earners also tend to have low levels of education, stemming to restricted blue collar job opportunities and ultimately decreasing returns to scale restricting the productive potential of the overall economy.
Advances in the technological sector and computing have pushed wages to high skilled tech-based workers. Globalization and import competition have made manufacturing and administrative jobs redundant forcing low-income earners out of employment. Outsourcing menial jobs offshore and rising innovation entrepreneurship have shifted the combination of the labor force towards high tech, high skilled firms and have hollowed out the job market.
Income inequality also has flow on effects regarding family structures as less educated low-income families tend to have more volatile family environments as illustrated by the figure below. In the UK especially, most low-income families have no patriarch or father figure leading to disparity in family stability and a lack of parental investment in children leading to higher rates of inequalities for future generations, i.e. 8% difference in stability.
Income inequality ultimately is a result of a disparity between the top and bottom quintiles and in the UK, there has been a stark increase in top incomes, where the top 1% used to control 3% of national income in the 1970s, almost tripling to 8% in 2017.
Furthermore, amongst the FTSE100 companies an executive’s wages has increased exponentially by about 145 times compared to average workers, albeit not all these income streams are law abiding with the use of tax havens and other unexplained pay benefits. Higher levels of transfer payments from the government have helped to stem the flow of income inequality even though earnings inequality increased, as per the figure below showing the constructive effects of benefits for low-income earners, especially for the lowest 10% of the population increasing their net income by approximately 25%. Nevertheless, this methodology is not sustainable in the long run, as increasing transfer payments are funded by taxation revenue, meaning higher levels of taxes disincentivize high earners to reside in the UK, shifting out productive human capital, which limits overall economic growth as the skilled population emigrate away. In relation to the low-income earners there will also be a sense of human pride and dignity with the fact that they want to increase their income through employment rather than handouts from the government.
Thus, the most effective method to close the income gap is to increase the levels of education for low skilled workers, as it builds up their knowledge and expertise to catch up with white collar workers, to create a more holistic and productive labor force that enables technical efficiency.
Policy Options
To counteract the widening income inequality in the UK- an impediment to economic growth and development, it is strongly recommended that the UK government invest a large percentage of their budget and other fiscal measures towards education and training programs. The decision to invest in the acquisition of a more educated and skilled workforce by the UK government leads to an increasing rate of productivity gains in terms of future earnings job security and general increase in economic output. A more educated population provides a more efficient, effective and flexible citizenry. However, since there are benefits to the population that are externalized the demand curve demonstrating the private marginal benefit will undercut the real social benefits. As a solution to this problem the UK government can either subsidize supply to bring down the supply curve, subsidize demand by discounting the individuals’ willingness to pay or take responsibility for the provision of education and training programs at the optimum price and quantity. The UK government does engage in all three aspects by providing free education for pupils aged 5-16, as well as having government funded universities for tertiary education; incentivizing undertaking these endeavors by providing tax discounts, student allowances and concessions to make the cost of living slightly less expensive whilst students invest in their human capital. Education is the fundamental way for profitable returns on investment with people, as more educated individuals can undertake higher levels of vocational training to further their industry specific skills on the job. Active labor market policies to reduce unemployment amongst low earners such as re training schemes will also help to reduce income inequality by bridging the skills gap to nullify the effects of frictional unemployment when workers have a mismatch of skills compared to jobs available in the workforce.
There is also the argument for the taxation aspect regarding reallocation and redistribution of income. By employing a progressive tax system, the government directly taxes gross income of high earners to redistribute to low earners through welfare and cash benefits to cover housing and child support. Direct taxes across the increasing tax brackets help to reduce the wage gap and reduce inequality, however creates a disincentive effect for individuals to not work as hard as most of their wages are being taxed. On the contrary, handouts from the government create a potential moral hazard as low-income earners could be content on receiving money from the government rather than entering the workforce to seek employment. However regressive indirect taxes such as the Value Added Tax (VAT), offset the positive impact of income taxes, as the tax burden falls onto low earners as most of their income is spent on consumption compared to high earners who can diversify their earnings into savings and investment. Thus, ‘benefits in kind’ such as education or healthcare which are provided for free or heavily subsidized or discounted at consumption, increases disposable income exponentially for low-income earners lowering the gap between the rich and poor.
Conclusion
In summary, income inequality is a fierce talking point amongst economic and political debate and there has been a vast search to find a remedy for it. By exhausting all possible options and examining the taxation redistribution and its disincentive effects through progressive tax and welfare payments compared to educational investment, it can be ascertained that education has greater positive flow on effects, despite the increased-up front cost to the government. Ultimately, increased school quality leads to decreased intergenerational inequality as it creates a more cultivated and productive workforce that can maximize output given the adequate resources to do so.
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