Addressing inequality in an independent Scotland

Inequality is at the centre of the debate on Scottish independence. In Scotland’s economy: the case for independence, the Scottish Government (2013) highlights the findings of its Fiscal Commission Working Group: ‘Scotland is currently part of a UK economic model and society which is one of the most unequal in the OECD. Inequality within the UK has increased in recent decades. Such patterns of inequality will continue to have a negative impact on growth and prosperity over the long-term’ (pa. 29). Independence, it is argued, would give the Scottish Government the fiscal levers necessary to address inequality.

Inequality is also at the heart of a wider debate around the causes of the current economic (e.g. Luchino and Morelli, 2012). Joseph Stiglitz– one of the economists on the Scottish Government’s Council of Economic Advisers – has argued that high levels of inequality are inhibiting recovery from the recession due to weak consumer demand among the poor. In addition, inequality holds back income tax receipts and limits the ability of people to invest in education or entrepreneurship (Stiglitz, 2012). However, the long-run effects of inequality on growth – and the point at which the positive effects of inequality on incentives outweigh its potential negative effects – are still contested in the economics literature.

Inequality in the UK increased significantly during the 1980s and 1990s (OECD 2011; Cribb et al. 2012). Since the late 1990s, individual earnings inequality has continued to increase, but at a much slower rate. Disposable income inequality however – net of benefits and taxes – has remained unchanged, when measured as the ratio of the 90th percentile of the income distribution to the 10th percentile. Measured by 95/5 ratio, disposable income inequality did increase between 2004-2009, before falling back to its 1997 level in 2010 (Figure 1).

Figure 1

Figure 1

The fact that disposable income inequality has remained static whilst individual earnings inequality has been rising suggests that the increases in redistribution that took place between 1997-2010, aimed particularly at raising the incomes of families with children, and of pensioner households, were relatively effective at stemming further increases in disposable income inequality. It does not however negate the fact that inequality in the UK remains high relative to most other countries, with inequality in Scotland only slightly lower than that in RUK.

However, while inequality in a broad sense has remained relatively unchanged since the late 1990s, the very highest 1-2% of earners have appropriated an increasing share of income. The richest 1% of Scotland’s adult population earned 6.3% of total pre-tax incomes in 1997, rising to 9.4% by 2009. One implication is that an increasing proportion of income tax liabilities are owed by an increasingly small proportion of high earners. The share of Scottish income tax liabilities owed by the highest earning 10% of taxpayers increased from 40% to 47% between 1997 and 2009, while the share of liabilities owed by the highest earning 1% of taxpayers increased from 14% to 20%.

Explanations for the increase in earnings inequality have focussed on the role of technological change and globalisation in increasing the returns to skill, and in reducing demand for middle-wage, semi-skilled occupations that can be routinized (Lee et al. 2013; Goos and Manning, 1997). Changes in labour market participation – in particular the rise in part-time working – have also been a major driver of the increase in weekly earnings inequality. Explanations for the rise in top-pay include increased demand for executive managers; an increased ability of executives to set their own pay and extract rents at the expense of shareholders; and behavioural responses to reductions in marginal tax rates (Picketty and Saez, 2006).

It would be difficult for a small, open economy to isolate itself from these wider trends in globalisation, technological change and working patterns. Indeed, inequality has increased more rapidly in Sweden, Finland and Denmark than it has in the UK since 1997. Sweden in particular experienced larger inequality growth between 1985 and 2008 than any other OECD country, and its top 1% of earners now appropriate 9% of total income – the same as in Scotland.

This is not to deny that an independent Scotland would have a wider range of fiscal levels to address inequality concerns. The rise in the share of top-income earners in total income offers scope for an independent Scotland to adopt a more progressive form of income taxation. The OECD has argued that ‘tax reforms that increase average tax rates without raising marginal rates (e.g. by scaling back tax reliefs) could enable greater redistribution without undue blunting of incentives’ (OECD, 2011). Nonetheless, in considering reform to tax policy, an independent Scotland would need to bear in mind the relatively high propensity of top-earners to shift their income from one jurisdiction to another, or to record it in other ways.

An independent Scotland would also be able to make changes to the welfare system. There is some evidence that such moves would be supported by the Scottish electorate. The 2011 British Social Attitudes Survey shows that 70% of Scottish respondents believe that the Government should spend ‘more’ or ‘much more’ on benefits for parents who work on very low incomes, compared to 57% of English respondents.  However, the challenges around the long-run fiscal position may constrain the extent to which such reform is possible.  

We should be concerned about the effect of the UK’s high inequality on social mobility, and on its potential negative effect on economic growth. Independence will give the Scottish Government access to the fiscal levers with which to address inequality, but it is not always straightforward for an open economy to act in isolation from wider trends. In the long-run, ensuring an effective skills and education policy within the context of the future demand for skills will be critical to addressing inequality in Scotland. And the advantage for the Scottish Government is that they already have access to this ‘lever’.

References

CRIBB, J., JOYCE, R. and PHILLIPS, D., 2012. Living standards, poverty and inequality in the UK: 2012. IFS Commentary C124. London: Institute for Fiscal Studies.

GOOS, M. and MANNING, A., 2007. Lousy and lovely jobs: The rising polarization of work in Britain. The review of economics and statistics, 89(1), pp. 118-133.

LEE, N., SISSONS, P. and JONES, K., 2013. Wage inequality and employment polarisation in British cities. London: The Work Foundation.

LUCCHINO, P. and MORELLI, S., 2012. Inequality, debt and growth. Report for the Resolution Foundation.

OECD, 2011. Divided we Stand: Why Inequality Keeps Rising. Paris: OECD.

PIKETTY, T. and SAEZ, E., 2006. The evolution of top incomes: a historical and international perspective.

SCOTTISH GOVERNMENT, 2013. Scotland’s economy: the case for independence. Edinburgh.

STIGLITZ, J., 2013. The price of inequality. London: Penguin.

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