Income inequality: the poor aren't always poor

Cuts to benefits and tax breaks for higher earners have provoked criticism of the Conservative government and now a think-tank has said the changes are creating short-term inequality, not helping alleviate it.

It may not come as a surprise that if you cut in-work benefits for the poorest while allowing the richest to keep more of their money by reducing the top rate of income tax from 50p to 45p, then inequality is going to increase.

In conclusion, the more in-work benefits are offered then the smaller the gap between the richest and poorest.

However, this isn't the full picture and if you look long-term the impact changes. Just 7% of people receive more in benefits than they pay in taxes over their entire lifetime whereas in a single year, 36% of people receive more benefits than they pay in taxes.

This shows that the poor don't always stay poor, and the rich don't always stay rich. How much does the tax and benefit system actually affect inequality?

The Institute of Fiscal Studies research shows at any point in time those in the bottom income decile will only be there for 22% of their life and those in the richest decile will only be there for 35% of their life.

This means that while a snapshot of the tax and benefits system may draw us to conclude that inequality is widening, when taken over a lifetime the inequality isn't a severe as first thought.

So what does this mean for future taxes? The IFS, quite sensibly, wants the government to look at the impact the system has over the long-term rather than the short-term.

The IFS looks specifically at VAT because those with lower incomes are disproportionately hit by the goods tax. Unusually, it draws the conclusion that reformation of the tax should include zero rate VAT and reduced rate VAT being eliminated but a fairer overall tax being introduced in its place.

It wants to redistribute the burden of taxes and payment of benefits more fairly, which is to be commended, but let's hope that the government doesn't seize on the VAT reform – and in particular the elimination of the zero-rate - without looking at the wider tax and benefits system.

Unfortunately, with government's looking for short wins over five year periods, reforming tax and benefits with a long-term perspective is unlikely and we are left with reforms that offer short-term gains and vote winning headlines.

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