Programme interactions and fiscal drag in the UK tax-and-benefit system: effects on income inequality

This paper provides a comprehensive quantitative analysis of the UK tax-and-benefit system in 2023, focusing on its impact on income inequality. Using a microsimulation model and Family Resources Survey data, we find that the system reduced income inequality by 27.6 per cent, as measured by the Gini coefficient. While substantial, this effect falls short compared to some other OECD countries, such as Ireland and France. Both non-means-tested and means-tested benefits play important roles in addressing inequality. Fiscal drag, a form of stealth taxation that arises when inflation is not accompanied by corresponding increases in tax thresholds, is shown to be a substantially less equitable method of raising revenue than adjusting tax rates, since it imposes regressive effects, particularly on individuals near tax thresholds. Furthermore, increasing the Universal Credit standard allowance proves more effective at reducing inequality than lowering the taper rate, as it provides more targeted support to low-income households. Finally, we emphasize the influence of programme interactions, especially between non-means-tested and means-tested benefits, on income distribution.