Effects of taxes and benefits on UK household income.

Daniel Lilley, 18 July 2023

Summary

Daniel Lilley and Tim Knox

This blog post summarises the most recent Office for National Statistics (ONS) data on the effect of tax and benefits on households across the UK covering the period 2021/22.

This ONS data provides a detailed guide to benefits and ‘benefits-in-kind’[1] received by households across all levels of income for the most recent year. The data also provides information on tax paid by households at different income levels. This allows us to understand the total number of households across the UK who receive more in benefits and benefits-in-kind than they pay in taxation – in simple terms, how many people in the UK ‘receive’ more from the state than they ‘contribute’ in taxes.

• In 2021/22, 53.8 per cent of individuals lived in households which received more in benefits than they paid in taxes, slightly down from last year’s record of 54.2 per cent (which the ONS has since revised to 55.0 per cent) but still the second highest figure on record. This is equivalent to 35.9 million individuals
  • It is only the second time this figure has exceeded 33.2 million individuals.
  • This is even more alarming than the 2020/21 result, as the 2021/22 year began in April 2021, and by 12 April 2021, lockdowns were mostly eased, before ending entirely on 17 May 2021.[2] Direct Covid response measures would have had little impact on the data for 2021/22.
  • The corresponding rapid decline in those receiving more in benefits than they pay in taxes has therefore not materialised.
  • The annual Consumer Price Index (CPI) inflation rate for the 2021/22 tax year was seven per cent.[3]

• The top income quintile paid an average of £40,794 more in taxes than they received in benefits in 2021/22.[4]
  • The top income decile paid an average of £64,530 more in taxes than they received in benefits in 2021/22.[5]
  • 2021/22 was also only the second year ever that the middle, non-retired income quintile received more in benefits than it paid in taxes.[6]
  • The rise in the net claimant ratio has never been higher for non-retired individuals than the last two years, at a time when there have never been more retired individuals who need to be financially supported.

• In 2021/22, the top quintile paid 67.7 per cent of all income tax, and the top decile paid 53.6 per cent. The other quintiles paid the following (from bottom quintile to second from top): 2.1 per cent, 4.3 per cent, 9.2 per cent, 16.7 per cent.
  • The top quintile paid 24.3 per cent of their gross income on income tax, compared with an average of 8.6 per cent across the other four quintiles.
  • In 2021/22, the bottom quintile paid 12.4 per cent of their gross income on VAT, this was over two and a half times as much as the top quintile, who paid 4.7 per cent of their gross income on VAT.

• Across all taxes, the top quintile paid 36.9 per cent of their gross income on tax, accounting for 49.4 per cent of all taxes.
  • Perhaps most surprisingly, the bottom quintile spent the highest fraction of their gross income on tax. They spent 38.4 per cent of their gross income on taxes, the other three (second from bottom to second from top) spent: 30.5 per cent, 30.4 per cent, 31.5 per cent.
  • The tax system is only effectively progressive across the top incomes, where it is highly progressive. Across the majority of the population, the tax burden is higher for those on lower incomes.

Responses to criticisms of previous

This piece is an update of Civitas report ‘An analysis of the effects of taxes and benefits on household income’ released in January 2023, which looked at data published by the ONS in July 2022 on national incomes, taxes, and benefits over time and between income groups.

This report was criticised by some in the public on various grounds which the following paragraphs attempt to redress.

Criticism 1: Benefits-in-kind are not benefits

The report’s headline figure of 54.2 per cent of individuals living in households which received more in benefits than they paid in taxes in 2020/21 (since revised to 55.0 per cent) included both benefits-in-kind (the imputed value of the NHS, state schools and so forth) and direct benefits (pensions, tax credits and so forth).

This was criticised as giving a misleading picture.

However, this accurately reflects the methodology and terminology as that used by the ONS.

This is also intuitive. Benefits-in-kind, such as the NHS, are services – or benefits – that are given to the UK population, having been paid for in tax. For example, instead of directly receiving the money to pay for a doctor’s appointment, one receives the appointment (the benefit in-kind) because the service is financed using tax receipts. This is a tax-financed benefit, even though it is not cash.

Criticism 2: We should not use the word ‘dependency’

A number of commentators took issue with describing those who receive more in benefits than they pay in taxes as ‘net dependent’ on the UK government.

In their release this year, the ONS clarified that the preferred terms are now ‘net recipients’ and ‘net contributors’.[7] We use these terms in this piece.

Criticism 3: The rise in net recipients is just the result of an ageing population

Yes, and no. It is true that 89.2 per cent of retired individuals live in net claimant households, compared with 46.0 per cent of non-retired individuals, which does mean that increases in the proportion of the population that are retired is likely to increase the net claimant ratio.

It is also true that the British population is ageing and has been for some time. This obviously puts put upwards pressure on the net recipient ratio.[8]

However, this ignores the fact that between 2010 and 2019 the net claimant ratio fell from over 52 per cent to under 48 per cent, at a time when the average age of the population increased by over a year, exceeding 40 for the first time ever.[9]

So the net claimant ratio can fall while the population ages: indeed, as the population ages, it is arguably all the more important to be aware of the net claimant ratio.

It is also not true that the single year-on-year lurch in the net claimant ratio from 2019/20 to 2020/21 could have much to do with an ageing population: the ageing population effect is a long-term effect that happens over decades, not in a single year.  

Criticism 4: The rise in net recipients was just the result of the Covid-19 pandemic

Again, yes and no. Covid response measures had a profound impact on people’s dependency, in financial and other terms, on the government (as was clearly acknowledged in our original report). This does not make the result less concerning, as the 2021/22 figure, which in theory should be largely unsullied by government measures in response to the Covid-19 pandemic, is still high by historic standards, at 53.8 per cent.

Nevertheless, Covid-19 and the government measures taken to contain it will clearly have a long-term and destructive impact on how the UK redistributive system works and surely need to be carefully monitored through data analysis such as this.

It is also important to stress that furlough payments were counted as income and not benefits by the ONS, muting the scale of the Covid response effect drastically in 2020/21. However, benefits-in-kind – NHS use, for example – did increase. Similarly, indirect tax receipts did fall, with people spending less money. The effect of this was amplified by the regressive nature of VAT, which significantly impacted the net claimant ratio.

Criticism 5: Income tax should not have been described as a wealth tax by stealth

This is technically correct. A wealth tax is a tax charged against the value of assets; an income tax is charged on a flow of earnings. Income tax was described as a becoming a de facto wealth tax by stealth on the grounds that it is mostly paid by those who are wealthy.  Income tax is highly progressive, partly to adjust for a tax system that is otherwise largely regressive, in that sense it works rather hard to ensure to the rich pay their way.

Criticism 6: An increase in net recipients is not the same as a growing state

This is correct in general but not in this instance. An increase in net recipients can be caused by a shrinking of the state – for example, lowering taxes across the population, ceteris paribus, would be expected to increase net recipients. The problem is that this hasn’t really been the case, other than a dip in indirect taxes in 2020/21. Income taxes are the highest they’ve been since World War II[10] and net recipients are at record highs, so in this instance an increase in net recipients is an increase in the size of the state.

Conclusion

This is the second year in a row that a majority of Brits (53.8 per cent) live in households which received more in benefits and benefits-in-kind than they contributed in taxes, equivalent to 35.9 million individuals. It is a record figure for a non-pandemic year.

This analysis raises important political and policy questions:

• Is it sustainable in the long-term to have a situation where more people ‘receive’ more from the state than they ‘contribute’?
• Does this give strong incentives to the electorate to favour ever higher state expenditure, particularly when the top fifth of earners pay half of all tax?

It should also be recognised that the costs of an ever-growing state are falling on a smaller number of working age households: the top tenth contribute more than £64,530 in tax than they receive in benefits and benefits-in-kind.

This analysis by Civitas shows that self-sufficiency in Britain is increasingly rare: most households receive more from the state than they contribute in taxes.

Although the majority of tax is paid by the rich, with the top fifth paying half of all taxes, the UK tax system is regressive across most of the income spectrum, with lower earners spending a larger proportion of their gross income on taxes than higher earners. The bottom quintile spent the highest fraction of their gross income on tax. They spent 38.4 per cent of their gross income on taxes, the next quintile spent 30.5 per cent, the middle quintile 30.4 per cent, the second from top quintile 31.5 per cent and the highest earners 36.9 per cent.

This is mostly because indirect taxes, especially VAT, are highly regressive. For example, in 2021/22, the bottom quintile paid 12.4 per cent of their gross income on VAT, over two and a half times as much as the top quintile, who paid 4.7 per cent of their gross income on VAT.

Technical note:

Equivalisation is the process of adjusting income figures to account for the fact that households with many members are likely to need a higher overall income, but a lower per capita income, to achieve the same standard of living as households with fewer members. Equivalisation considers the number of people living in the household and their ages. The ONS analysis uses the modified OECD scale.

Due to the use of equivalisation, some of the quintile group statistics on Table 2a of the ONS publications appear not to match the net recipient figures on Table 16. This is standard in data analysis such as this and is not a concern.

Tim Knox is a former director of the Centre for Policy Studies.
Daniel Lilley recently graduated from the University of Cambridge with a degree in
Economics.

[1] The ONS describe benefits-in-kind as ‘non-cash benefits such as the National Health Service, education, free childcare and travel subsidies’. ONS (2023) Effects of taxes and benefits on UK household income: financial year ending 2022. Available at: https://www.ons.gov.uk/peoplepopulationandcommunity/personalandhouseholdfinances/incomeandwealth/bulletins/theeffectsoftaxesandbenefitsonhouseholdincome/financialyearending2022 (Accessed: 18 July 2023).

[2] Ibid.

[3] ONS (2023) ‘Consumer Price Inflation, UK: May 2023’ Available at: https://www.ons.gov.uk/  (Accessed: 18 July 2023).

[4] ONS (2023) Effects of taxes and benefits on UK household income: financial year ending 2022. Available at: https://www.ons.gov.uk/peoplepopulationandcommunity/personalandhouseholdfinances/incomeandwealth/bulletins/theeffectsoftaxesandbenefitsonhouseholdincome/financialyearending2022 (Accessed: 18 July 2023).Table 2a, £53,320 in direct and indirect taxation and £12,526 in cash benefits and benefits-in-kind.

[5] Ibid. Table 2b, £76,735 in direct and indirect taxation and £12,205 in cash benefits and benefits-in-kind.

[6] Ibid. Table 2a. They received £563 more in cash benefits and benefits-in-kind than they paid in direct and indirect taxation.

[7] Ibid.

[8] ONS (2022) Population estimates for the UK, England, Wales, Scotland and Northern Ireland: mid-2021. Available at: https://www.ons.gov.uk/peoplepopulationandcommunity/populationandmigration/populationestimates/bulletins/annualmidyearpopulationestimates/latest (Accessed: 18 July 2023).

[9] Ibid.

[10] The Daily Telegraph (2023) ‘Budget 2023: Tax burden to hit highest level since Second World War’ 17 March. Available at: https://www.telegraph.co.uk/business/2023/03/15/budget-2023-childcare-pensions-tax-latest-ftse-100-markets/ ( Accessed 18: July 2023).