THE MICROSIMULATION UNIT
Poverty in Britain: the impact of government policy since 1997
A projection to 2004-5 using microsimulation
Holly Sutherland1
Microsimulation Research Note No. MU/RN/44
May 2004
1 Introduction
This note updates and revises the estimates provided in Sutherland, Sefton and Piachaud (2003) (SSP henceforth) of the likely reduction in poverty rates by 2004-5 - the Government’s target year for reducing child poverty by one quarter - and of the impact of policy changes since 1997 on poverty.
These estimates are derived using POLIMOD, the Microsimulation Unit’s tax-benefit model based on 1999-2000 Family Resources Survey (FRS) data (see Appendix 1). These data are the same as those used in the earlier study. The estimates are updated in the sense that:
? policy changes that have been announced since late 2003 for the fiscal year 2004-5 are included in the calculation of simulated incomes for 2004-5 (see Appendix 2); policies are expressed in 2004-5 prices;
? incomes before taxes and benefits are projected to 2004-5 levels (October 2004).
They are revised in the sense that:
? the projection of incomes from 1999-2000 forward to 2004-5 and backward to 1997 makes use of the most recently-available estimates of changes in income by source.
These statistics may themselves have been subject to revision or improvement and in some cases (notably, for rent) our method of projection has been revised (see Appendix
3);
? some minor mis-interpretations of the nature of recent or prospective policy changes have been corrected, following more details being announced;
? estimates of means-tested benefits and credits make use of the latest of take-up figures published by DWP (2004) and Inland Revenue (2003).
Since the method has been revised and corrected, albeit to a rather small extent, the difference between the estimates provided in SSP and those provided here should not be taken as the change in poverty between 2003-4 and 2004-5 nor of the impact of policy changes implemented or announced between these two points in time.
Throughout we use a poverty line of 60% of contemporary median equivalised income, as in SSP, and provide estimates using income measures on both an After Housing Costs (AHC) and a Before Housing Costs (BHC) basis. Poverty rates and income distributions based on 1 I am grateful to John Hills, David Piachaud and Tom Sefton for useful discussions. Family Resources Survey data for 1999-2000 have been made available by the Department for Work and Pensions (DWP) through the UK Data Archive. The DWP and the Data Archive bear no responsibility for the analysis or interpretation of the data reported here.
simulated incomes are reported in sections 2 and 3. Section 3 also includes some analysis of average changes in income across the income distribution (not provided in SSP). As in SSP and most official analysis to date we use the McClements equivalence scale to adjust for differences in household size and composition. Corresponding estimates of some of the key statistics using the modified OECD equivalence scale are provided in Section 4. It is this scale that will be used in the future for official evaluation of poverty and changes in poverty (DWP, 2003).
2 Projected changes in poverty 1996-7 to 2004-5
Table 1 presents projected relative poverty rates in 2004-5 compared with rates in 1997 using simulated incomes. These figures take account of changes in policies (taxes and benefits) and projected changes in pre-tax and benefit income (such as earnings growth). They do not take account of changes in composition (such as changes in employment). See SSP (2003; chapter 2) for an analysis of the role of composition change in poverty reduction. Projections of income forward and backwards from 1999-2000 are clearly subject to uncertainties. In particular, projecting beyond the period for which we have aggregate data (from late 2003 or early 2004 to October 2004) involves significant guesswork. For instance, we assume that average earnings continue to grow at the same rate as in the most recent year for which we have data, that is, at 3.7 per cent. This is slower rate of growth in real terms than for several years. If actual earnings growth were to be faster, the relative poverty line (i.e. the median) would be higher, and with it the proportion measured as in relative poverty. The projections represent a best estimate at the time of writing, but no more than that. Details are provided in Appendix 3.
Table 1 Simulated estimates of poverty rates in Britain in 1997 and 2004-5
All Children Children in 2
parent families
Children in 1
parent families
People over
pension age
Number (000) Rate
(%)
Number
(000)
Rate
(%)
Number
(000)
Rate
(%)
Number
(000)
Rate
(%)
Number
(000)
Rate
(%)
BHC 1997 10,150 18 3,150 25 1,940 20 1,210 40 2,160 21 BHC 2004-5 8,080 14 1,940 15 1,290 13 660 22 1,950 19 Reduction 2,070 4 1,200 9 650 7 550 18 210 2 AHC 1997 13,580 24 4,290 33 2,370 24 1,920 63 2,750 27 AHC 2004-5 10,930 19 3,250 25 1,800 18 1,460 48 1,760 17 Reduction 2,650 5 1,040 8 580 6 460 15 990 10
Source: POLIMOD based on 1999/2000 Family Resources Survey data
Note: Poverty is measured as the numbers of people living in households with equivalised income below 60% of the current median (McClements equivalence scale). 2004-5 incomes are based on projections including the tax-benefit system as announced up to Budget Statement of March 2004 (HM Treasury, 2004). Population composition is as in 1999-00. Figures are rounded to the nearest 10,000 persons or percentage point. This does not necessarily mean that estimates are statistically significant to the level shown. Rows or columns may not add due to rounding.
This is an updated and revised version of Table 13 in SSP (2003).
The results shown in Table 1 are very similar to the earlier estimates for 1997 to 2003-4 in SSP (2003). The they suggest that the target reduction in child poverty of one quarter by 2004-5 will be just met on an AHC basis and will be met more comfortably on a BHC basis, assuming that changes in composition of the population have no affect. Overall poverty rates fall by 4 percentage points on an AHC basis and 5 percentage points on a BHC basis. For the elderly, the same discrepancy in poverty reduction on the two income measures that was observed in SSP (2003) remains. The poverty rate falls by 10 percentage points from 27 to 17 per cent on an AHC basis but by only 2 percentage points from 21 to 19 per cent on a BHC basis.
Figure 1 shows the modelled cumulative income distributions for the whole population, for children and for people over pension age in relation to BHC and AHC poverty lines in 1997 and 2004-5. The poverty lines are shown at 60 per cent of contemporary median incomes, but one can use these charts to visualise the poverty rates using lower or higher proportions of the median as poverty thresholds. For example, 50 per cent of the BHC median under 1997 policies (but in 2004-5 prices) is ￡157.22 per week and 8.9 per cent of people (10.4 per cent of children; 10.6 per cent of elderly) were in households with equivalised income below this level.
Figure 1 shows the extent to which the right-ward shift in the poverty line mitigates the effect of increasing income levels on relative poverty rates. For example, on a BHC basis the child poverty rate in 2004-5 using the 1997 poverty line is as low as 10%.
Figure 1: Cumulative income distribution and relative poverty lines under 1997
and 2004-05 policies and incomes
BHC AHC
(a) Whole population
(b) Children
(c) People over pension age
Source : POLIMOD
Equivalised BHC household income (￡ per week in 2004/5 prices)% o f p e n s i o n e r s
Equivalised AHC household income (￡ per week in 2004/5 prices)
% o f p o p u l a t i o n
Equivalised BHC household income (￡ per week in 2004/5 prices)% o f p o p u l a t i o n
Equivalised BHC household income (￡ per week in 2004/5 prices)% o f c h i l d r e n
Equivalised AHC household income (￡ per week in 2004/5 prices)
% o f c h i l d r e n
Equivalised AHC household income (￡ per week in 2004/5 prices)
% o f p e n s i o n e r s
3. The impact of tax and benefit changes
We can also use policy simulation to give a measure of the impact of policy change by itself. Table 2 shows the 2004-5 estimates as before in Table 1, but by comparison with what would have happened if the tax and benefit system of 1997 (uprated by prices) had still applied in 2004-5. Poverty rates would have been higher in 2004-5 than they were in 1997. For example, 27 per cent of children would be poor (BHC) instead of 25 per cent, as shown in Table 1. In other words, if nothing had been done, poverty would have increased (assuming no changes in composition). Other things being equal the policy changes listed in Appendix 2 have reduced the AHC poverty overall rate by 26 per cent, for children by 28 per cent and for the elderly by 48 per cent (on a BHC basis the percentage reductions are 29, 43 and 29 respectively.)
Table 2 Simulated estimates of poverty rates in 2004-5: projected 2004-5 tax-benefit
system and price-indexed 1997 system
All Children Children in 2
parent families
Children in 1
parent families
People over
pension age
Number (000) Rate
(%)
Number
(000)
Rate
(%)
Number
(000)
Rate
(%)
Number
(000)
Rate
(%)
Number
(000)
Rate
(%)
BHC 1997 11,430 20 3,420 27 2,000 20 1,420 47 2,760 27 BHC 2004-5 8,080 14 1,940 15 1,290 13 660 22 1,950 19 Reduction 3,350 6 1,480 12 710 7 770 25 810 8 AHC 1997 14,750 26 4,480 35 2,400 25 2,080 68 3,360 33 AHC 2004-5 10,930 19 3,250 25 1,800 18 1,460 48 1,760 17 Reduction 3,820 7 1,230 10 600 6 630 21 1,590 16
Source: POLIMOD based on 1999/2000 Family Resources Survey data
Note: Poverty is measured as the numbers of people living in households with equivalised income below 60% of the within-scenario median (McClements equivalence scale). 1997 system is based on parameters of tax and benefit systems as in April 1997, uprated for price inflation only. 2004-5 tax-benefit system is as announced up to Budget Statement of March 2004 (HM Treasury, 2004). Population composition is as in 1999-00 and incomes are all at projected 2004-5 levels. Figures are rounded to the nearest 10,000 persons or percentage point. This does not necessarily mean that estimates are statistically significant to the level shown. Rows or columns may not add due to rounding.
This is an updated and revised version of Table 12 in SSP (2003).
The overall distributional effect of the policy reforms is illustrated in Figure 2, which shows the average percentage change in BHC income in each decile group (by equivalised BHC household income) comparing incomes under the 2004-5 system with those under the price-adjusted 1997 system. The changes are shown for all individuals and for children and the elderly in particular. All decile groups up to the eighth gain on average, and the gains are somewhat – although not dramatically – larger for children than in general. The final set of bars show the overall change and indicate that, as a group, the elderly benefit by most in percentage terms.
Projected 2004-05 system compared to price-indexed 1997 system
Source: POLIMOD
4.
An alternative “counterfactual”
The scale of the gains shown in Figure 2 is only robust if we accept that the alternative to the 2004-5 system to have been the 1997 tax and benefit system indexed by prices . An alternative counterfactual assumption would be that 1997 tax and benefit systems were indexed by some measure of household income growth. We illustrate this scenario by indexing all the parameters governing the 1997 tax and benefit system by the increase in average earnings (34 per cent, compared with a 19 per cent increase in prices). Figure 3 shows what the distributional impact of the actual reforms looks like by comparison with this earnings -indexed base.
Looking at the impact on the population as a whole, aggregate household incomes are very slightly higher under the actual 2004-5 tax and benefit system than they would have been under the 1997 system indexed by earnings. There is little difference in the overall resource cost to government and impact on households taken as a whole between the actual reform package and an alternative world in which 1997 policy had been maintained in relation to earnings, but without any structural reforms. However, the diagram shows that the distributional effects of the actual reforms remain more progressive than the earnings-linked base. There has been an effective transfer from higher-income to lower-income households. This redistribution has achieved the reductions in relative poverty shown in Table 2.
12345678910ALL
decile of equivalised household disposable income (1997 policies)
% c h a n g e i n i n c o m e
Projected 2004-5 system compared to earnings-indexed 1997 system
Source: POLIMOD
Interestingly, on this basis, the redistribution now clearly benefits children by more than the elderly or the population in general (see the final set of bars in Figure 3). With earnings indexation, state pension incomes under the 1997 system are relatively more generous and the 2004-5 system appears less advantageous than under the price indexation assumption. 5.
An alternative equivalence scale
A recent government review of child poverty measurement recommended the use of the modified OECD equivalence scale and BHC incomes in future, instead of the McClements scale and figures based on both AHC and BHC incomes (DWP, 2003). Table 3 shows poverty estimates for (a) 1997 policies on 1997 incomes (b) 1997 policies (indexed by prices) on projected 2004-5 incomes and (c) 2004-5 policies on 2004-5 incomes, all using BHC incomes adjusted by the OECD scale. Appendix 4 compares the two scales. Figure 4 shows the same results as in Figure 3, but using the OECD scale and Figure 5 shows the BHC cumulative distributions for (a) and (c) (as in Figure 1) using the OECD scale.
Generally, while the use of the alternative equivalence scale increases measured poverty rates somewhat, there is little effect on the change in poverty rates shown in Table 3 compared with those in Tables 1 and 2. Brewer et al (2004) carry out a more extensive investigation of the effects of using the alternative scale on child poverty statistics, and have similar findings.
12345678910ALL
decile of equivalised household disposable income (1997 policies)
% c h a n g e i n i n c o m e
Table 3 Simulated estimates of poverty in 1997 and 2004-5: Before Housing Costs and
using the modified OECD equivalence scale
All Children
Children in 2
parent families Children in 1 parent families
People over pension age
Number (000) Rate (%) Number (000) Rate (%) Number (000) Rate (%) Number (000) Rate (%) Number (000) Rate (%) (a) 1997 policies and incomes
10,910 19 3,460 27 1,980 20 1,480 49 2,410 24 (b) 1997 policies, 2004-5 incomes
12,160 21 3,650 28 2,120 22 1,630 53 3,120 31 (c) 2004-5 policies and incomes 8,830 16 2,250 18 1,330 14 920 30 2,220 22 Reduction (c) - (a) 2,080 4 1,210 9 650 7 560 18 200 2 Reduction (c) - (b)
3,330
6
1,400
11
790
8
700
23
900
9
Source: POLIMOD based on 1999/2000 Family Resources Survey data
Note: Poverty is measured as the numbers of people living in households with equivalised income below 60% of the within-scenario median (modified OECD equivalence scale). Figures are rounded to the nearest 10,000 persons percentage point. This does not necessarily mean that estimates are statistically significant to the level shown. Rows or columns may not add due to rounding.
Figure 4: Average percentage difference in income: Projected 2004-05 system compared to price-indexed 1997 system (ranking by household income adjusted by the modified OECD equivalence scale)
Source:
POLIMOD
1234567
8910ALL
decile of equivalised household disposable BHC income (1997 policies)
% c h a n g e i n i n c o m e
Figure 5: Cumulative income distribution and relative poverty lines under 1997
and 2004-05 policies and incomes using the modified OECD equivalence scale
(a) Whole population (b) Children
(c) People over pension age
Source : POLIMOD
6. Concluding points
Revised and updated simulations of the effect of policy changes by 2004-5 result in similar – and somewhat strengthened - conclusions about the effect of government policy to date on poverty as were drawn in SSP (2003). Additions to the value of the Child Tax Credit since the SSP analysis, offset to some extent by the effects of growth in Council Tax and the failure to index all elements of the system results in projected poverty rates that suggest that the child poverty target for 2004-5 will be just met on an AHC basis and will be met more comfortably on a BHC basis. However, as before, this conclusion assumes that compositional changes have no adverse effect on poverty and this may not turn out to be the case.
Adopting an alternative equivalence scale has little effect on the assessment of the size of the change in poverty. However, the decision to focus attention in UK analysis on the same
Equivalised BHC household income (￡ per week in 2004/5 prices)
% o f p o p u l a t i o n
Equivalised BHC household income (￡ per week in 2004/5 prices)
% o f p e n s i o n e r s
Equivalised BHC household income (￡ per week in 2004/5 prices)
% o f c h i l d r e n
measure of relative poverty as is used in assessments made at the EU level (BHC income using the modified OECD scale) means that instead of three measures (AHC and BHC using McClements plus the EU measure) there will in the future be just one (DWP, 2003). The analysis reported here, together with that in SSP (2003) and other studies (Brewer et al., 2004) shows that different measures do not necessarily always behave in the same way. There are dangers in relying on just one measure since movement in a particular measure can be due to particular influences on the level of the poverty line and its relationship with benefit levels. Given the essential arbitraryness of a poverty line set at a percentage of median income it seems important to retain as much richness as possible in the ways that incomes themselves are measured and compared, in order to provide the basis for a complete understanding of the underlying influences.
Conventionally policy changes are assessed against a neutral counterfactual of price indexation. Thus if incomes are maintained in real terms then the household is considered to be neither a gainer nor a loser. However, we have seen that indexation is not sufficient to protect a household from falling into relative poverty if median incomes are growing in real terms. An alternative is to adopt “constant shares” as the neutral position. In this case households whose share is reduced are considered losers. The counterfactual is that the tax and benefit system would be uprated by average incomes. Redistribution on top of this is not necessary if the status quo is to be maintained, but is necessary if relative poverty is to be reduced. We have seen that the share of resources available to households through the tax and benefit system hardly increased between 1997 and 2004-5 as a proportion of average income (Figure 3). However, there was some redistribution of shares: losses outweighed gains in the top half of the distribution and on average households in the bottom half increased their share. In particular, there was redistribution towards children in the bottom half. (Again, this leaves aside changes in the shares of pre-tax and benefit income that might have taken place between 1997 and 2004-5.)
References
Brewer M., A. Goodman, M. Myck, J. Shaw and A. Shephard, 2004. Poverty and Inequality in Britain: 2004, IFS Commentary 96.
DWP. 2003. Measuring Child Poverty. London: DWP.
DWP. 2004. Income Related Benefits: Estimates of Take-Up in 2001/2002. London: DWP. DWP. 2004a. Households Below Average Income – 1994/5 to 2002/03. Leeds: Corporate Document Services.
HM Treasury. 2004. Budget 2004: Prudence for a Purpose: A Britain of stability and strength, HC 301. London: TSO.
Inland Revenue. 2003. Working Families’ Tax Credit: Estimates of Take-up rates in 2001-02.
London: Inland Revenue.
Redmond G., H. Sutherland and M. Wilson. 1998. The arithmetic of tax and social security reform: a user's guide to microsimulation methods and analysis. Cambridge: Cambridge University Press.
Sutherland H., T. Sefton and D. Piachaud. 2003. Poverty in Britain: the impact of government policy since 1997. York: Joseph Rowntree Foundation.
https://www.doczj.com/doc/401013298.html,/bookshop/details.asp?pubID=563
Appendix 1 Policy simulation using POLIMOD
POLIMOD is a tax-benefit microsimulation model constructed and maintained by the Microsimulation Unit in the Department of Applied Economics at the University of Cambridge. See Redmond et al. (1998) for more information. The household income variables used here to measure poverty have been deliberately defined to be as similar as possible to those used in the Household Below Average Income (HBAI) statistics (DWP, 2004a). There are some minor departures from HBAI methodology due to the fact that we must simulate taxes and benefits (and earnings, where these are affected by the Minimum Wage) in order to evaluate changes in the rules that govern them. The 1999/2000 FRS micro-data are updated to 2004/5 levels of prices and incomes in order to evaluate contemporary policy changes, whereas HBAI statistics for a given year use data collected in that year. In addition, there are some differences which arise because some components of income (taxes and benefits) are simulated rather than using values recorded in the survey data.
POLIMOD calculates liabilities for, or entitlements to income tax, National Insurance contributions (NICs), Child Benefit, Family Credit (FC), Working Tax Credit (WTC), Child Tax Credit (CTC) Income Support (IS) - including income-related Job Seekers Allowance and pensioners’ Minimum Income Guarantee (MIG) - Housing Benefit (HB) and Council Tax Benefit (CTB). The effect of the minimum wage is modelled by assuming that all with hourly earnings below the relevant minimum are brought up to it and that working hours do not change. Resulting changes in earnings then affect tax and benefits. Otherwise, elements of income are drawn from the recorded values in the FRS dataset. The main effect of simulating the tax and benefit components of income is to narrow the income distribution to some extent. POLIMOD captures the effects of non- take up of pre-2003 means-tested benefits (FC/WFTC, IS, HB and CTB) by applying the take-up proportions estimated by the DWP (2004) and Inland Revenue (2003) using data for 2001-2. For example we assume that some 15% of lone parents do not receive the FC to which they were entitled, and 32% of pensioners do not receive the IS (MIG) to which they are entitled. We assume that take-up behaviour is not affected by changes in the size of benefit entitlements. Little is known about what to expect in relation to take-up of the new tax credits, introduced in 2003. We assume that take-up of income-tested CTC will be the same as IS (on a case-by case basis); take-up of WTC is assumed to be the same as WFTC in 2001-2 and to have the same probability for the new groups who are eligible. Take-up of both parts of the Pension Credit (Guarantee Credit and the Savings Credit) is assumed to be the same as that for MIG (IS for pensioners).
Appendix 2: Summary of main modelled changes in tax and benefit policy 1997 – 2004-5
Changes that are due for implementation part way through a fiscal year are modelled as though they apply all year.2Amounts are weekly and in current prices and differences are expressed in real terms, unless otherwise specified.
The National Minimum Wage was introduced in 1999.By October 2004 the hourly rate for employees aged 22 and over was ￡4.85, the rate for young (18-21) and trainee workers was ￡4.10 and the rate for 16-17 year olds was ￡3.00.
Lone parent benefit abolished (the 1997 benefit would have been worth ￡7.20 in 2004/5 prices).
Child benefit increased in real terms by ￡3.35 for first or only children and ￡0.35 for other children.
Maternity pay: the flat rate element increased substantially in ￡100 in 2003/4. The 2004/5 level was ￡36.70 per week higher in real terms than the level in 1997.
Basic state retirement pension(and widows’ pension) has been increased in real terms by ￡5.50 (Cat. A) or ￡3.30 (Cat. B).
Winter fuel allowance: increased from a low level in 1997 to ￡200 per year for households containing a person aged over 60, with a further payment of ￡100 if aged over 70. Incapacity benefit is reduced by 50p for every ￡1 of occupational or personal pension income over ￡85 per week.
Working Families Tax Credit (WFTC) replaced family credit in 1999 and this was replaced in turn in 2003 by the Child Tax Credit (CTC) and the Working Tax Credit (WTC). The CTC also subsumes the Children’s Tax Credit, which was itself a replacement for tax allowances for couples and lone parents (see below under income tax), the child elements of Income Support and child additions to non-meanstested benefits for adults.
Compared with Family Credit in 1997 the maximum value of CTC is higher per child (by 128% in real terms for young children but less – 38% and 10% for children aged 11-15 and 16-17 respectively). The credit is tapered away according to gross income (with a lower effective taper than in Family Credit, which depended on net income) and investment income is included (rather than capital limits and tariff income as in IS and FC). A minimum payment equivalent to the couple and lone parent tax allowances (but somewhat higher, and significantly higher for families with babies under 1 year old) is paid for those with incomes up to the income tax higher rate threshold. For higher incomes, it is tapered away. Compared with the child amounts in Income Support in 1997, the CTC payments are 120%, 50% and 26% greater for children aged 0-10, 11-15 and 16-17 respectively (worth approximately ￡23, ￡14 and ￡9 in real terms per week). However, the lone parent premium which has been abolished, would have been worth ￡5.60 in 2004/5. The amounts paid extra for disabled children have been increased.
The Working Tax Credit (WTC) uses similar rules about work conditions as Family Credit (and Disability Working Allowance) but extends entitlement to some groups without children or disabilities (working 30+ hours) and operates with a lower taper. The Child Care Tax Credit is linked to entitlement to WTC (but is not modelled here).
2 For example, the minimum wage is uprated part-way through 2004-5. The uprated amount is assumed to apply throughout the year.
The Pension Credit (PC) replaces the Minimum Income Guarantee (IS for people aged 60+). It has two parts, both of which are assessed jointly for couples: the Guarantee Credit (GC), based on MIG but with some relaxation of rules, and the Savings Credit(SC) which is an additional top-up for those with modest incomes above the MIG and/or basic pension level. In the GC, for those aged 60+ and their partners the upper capital limit is removed and the assumed tariff rate of income from capital is halved. Hours of work conditions are removed and some sources of income are exempted from the income test. Benefit levels are increased in real terms by up to ￡27 for single pensioners and ￡40 for couples (less for those aged 75+ who were already paid higher premia in 1997). In addition the Savings Credit is for people aged 65+ and their partners. This tops up small amounts of qualifying income above the level of the basic state pension at a rate of 60p per ￡ of income (assessed jointly), up to a maximum. The SC is reduced by any income in excess of the Guarantee Credit level at a rate of 40%. Capital limits for pensioners on PC are increased but for all others they are reduced in real value. (These have not been uprated since 1988.)
Housing benefit(HB) and Council tax benefit(CTB) changes match those for Income Support (and, where relevant, Pension Credit and Child Tax Credit) except that the real value of the 1997 lone parent premia which were abolished is ￡12.80 in 2004/5 prices.
National insurance contributions: Class 1 employee contribution lower earnings limit (LEL) increased by ￡17 in real terms; upper earnings limit (UEL) increased by ￡50; contributions on earnings below the LEL (“entry fee”) abolished (worth up to ￡1.48 per week). Class 1 rate increased from 10% to 11% and extra 1% charged on all earnings above the UEL. Class 2 (self-employed) contributions reduced by ￡5.25. Class 4(self-employed) lower profits limit aligned with the Class 1 LEL (a reduction of ￡69); Class 4 upper profits limit aligned with the Class 1 UEL (an increase of ￡50); the rate of Class 4 increased from 6% to 8% and an extra 1% charged on profits above the upper profits limit.
Income tax schedule: introduction of a 10% lower rate; this applies on the first ￡2,020 of annual taxable income, including income from investments (replaces 20% lower band); standard rate reduced from 23% to 22%.
Income tax allowances: Personal allowance not indexed in 2003/4 so its 2004/5 value is 1.25% less than its 1997 value in real terms. Age-related personal allowances increased by more than inflation; Married couples allowance (MCA) for couples both aged under 65 and Additional personal allowance for lone parents abolished. (Under 1997 policy these would have been worth ￡6.00 per week in 2004/5 prices.) Age-related MCA increased so that pensioner couples do not lose. Age-related personal allowances increased to 7-10% more than their 1997 real value..
Mortgage tax relief abolished. (In 1997 the maximum annual relief was 15% of the annual interest on ￡30,000.)
Council tax increased in real terms by 39% (on average). This represents a real increase of about ￡6.15 per week on a Band D Council Tax in 2004/5 prices.
Appendix 4: Equivalence scales
Household income is “equivalised” to take account of variations in household size and composition. The McClements equivalence scale is used, as shown below. The relativities are slightly different depending on whether it is the AHC or BHC income concept that is used. For comparison the modified OECD scale is also shown. (It has been re-based so that a couple =1, to make comparisons with the McClements scale easier). The modified OECD scale is commonly used in international comparisons of income distribution and has been adopted as standard by Eurostat. The McClements scale gives a particularly low weight to babies and children aged under 3, relative to the OECD scale.
Equivalence scale relativities
McClements (BHC) McClements
(AHC)
Modified
OECD
First adult 0.61 0.55 0.67 Spouse of first adult 0.39 0.45 0.33 Other second adult 0.46 0.45 0.33 Third adult 0.42 0.45 0.33 Fourth + adults 0.36 0.40 0.33 Child aged 0-1 0.09 0.07 0.20 Child aged 2-4 0.18 0.18 0.20 Child aged 5-7 0.21 0.21 0.20 Child aged 8-10 0.23 0.23 0.20 Child aged 11-12 0.25 0.26 0.20 Child aged 13 0.27 0.28 0.20 Child aged 14-15 0.27 0.28 0.33 Child aged 16-18 0.36 0.38 0.33