1. ECONOMIC INEQUALITY BRIEF – DRIVERS OF INEQUALITY- SEPTEMBER 2015 Scottish Government: Communities Analysis Division Wealth Bottom 40% get 5% of total wealth Income is unevenly distributed in Scotland. The chart to the right shows that the distribution of income is dominated by a small proportion of very high income households. In 2013/14, the bottom 40 per cent of households (blue bars) had around a fifth of total household income; the ‘middle’ 50 per cent (black bars) had just over half of all income – this is consistent over time. The top 10 per cent of households (orange bars) had around a quarter of all household income – with the top 2 per cent alone having nearly 10 per cent. Top 10% get 44.0% of total wealth Wealth inequality is far more unevenly distributed. In the period 2010 to 2012, the least wealthy 40 per cent of households (blue bars) in Scotland owned less than 5 per cent of wealth; the ‘middle’ 50 per cent (black bars) owned around half of wealth; and the wealthiest 10 per cent of households (orange bars) owned 44 per cent of wealth. The top 2 per cent alone owned 20 per cent of all personal wealth in Scotland. Rising income inequality plays a key role in determining a household’s ability to accumulate wealth. Inequality in Scotland and the UK has been rising since the early 1980s. There are many drivers of income and wealth inequality and their interactions are complex. This brief focuses on income inequality and begins to explore drivers widely thought to influence it. Income Bottom 40% get 22% of total income Top 10% get 24% of total income

2. Inequality has real economic and social costs High levels of inequality have a negative impact on long-term economic growth and prosperity. Lower income inequality is correlated with faster and more durable growth, and greater stability. Concentration of income can restrict the economy in the long run by limiting the potential of people to contribute in a productive way. The OECD recently estimated that rising income inequality in the UK reduced GDP per capita growth by 9 percentage points between 1990 and 2010. Income inequality is thought to undermine educational opportunities available for the lowest income individuals, hampering skills development and reducing social mobility. Greater income inequality is associated with greater inequalities in other areas. Health and social problems are worse in countries with greater income inequalities. Health and social problems are related to the range and distribution of income within countries. Increasing average income and decreasing poverty does not in itself address the inequalities in society. Reducing income inequality needs to address the distribution of income across the whole population. Income inequality can even impact on trust and engagement in society. Evidence from the Equality Trust suggests that countries with higher levels of inequality have lower rates of both social and civic participation, lower levels of voter turnout and lower levels of trust (which can prevent relationships forming and impact other social issues including happiness, crime and health).

3. Job polarisation and increasing lower paid ‘non-standard’ work are likely to increase income inequality. Change between 2001 and 2010. Change between 2011 and 2013. The change in the share of hours and jobs held by lower/higher paid occupations could increase income inequality. This shift to ‘non standard work’ is linked to technological development and changes in labour demand and are reflected in job polarisation – a decline in the share of jobs an hours in the middle of the workforce. Between 2001 and 2010 there appears to be a ‘hollowing out’ of medium skilled work. Different data is available for 2011-2013 (due to changes in the Standard Occupational Classifications) and cannot be directly compared, but show greater increases in demand for higher skill/wage jobs and hours in that period. There is a gradual decline in traditional, permanent work in favour of ‘non-standard’ work like part time or temporary work and self employment. Over the past decade in Scotland the share of jobs that are full time has gradually fallen from 75 per cent to 71 per cent in 2014. Non standard work can be attractive to people seeking work flexibility, but this comes at a cost as it is generally lower paid than full time work and is more likely to be done by women and young people.

4. Top earners have increased share of total income whilst workers’ bargaining power has weakened Unionisation in Scotland and the UK fell 22 and 23 per cent respectively since the mid-nineties. In the UK, the number of employees covered by collective bargaining fell by 34 and 18 per cent in the private and public sectors respectively. Employees covered by collective agreement Employees in unions Over a similar period, the share of income going to the highest earning percentiles increased dramatically, compared to the rest of the taxable earnings distribution. The chart below shows how the income of the top 1 per cent grew far more than the rest of the income distribution. This suggests that the power of top earners to influence their earnings has increased. Top earners’ share of income increased sharply Change in share of total income among income taxpayers, 1997-98 to 2010-11, Scotland The influence of unions on wages depends on the number of workers who are covered by collective agreements. The decrease over time suggests a diminishing influence of workers on wages.

5. The structure of the economy has changed and increased inequality As with many advanced economies, there has been a general shift in the Scottish economy from manufacturing toward services. The chart below shows how manufacturing has substantially decreased share of total GDP over the past few decades whilst business services, finance, Government and other services have substantially increased share. Many economists argue that financial sector deregulation in the 1970’s led to increases in inequality as the financial services sector has become larger and more profitable relative to the rest of the economy (Stiglitz, 2015, Rewriting the rules). Share of total GDP

6. Growth in high and low wage sectors may have increased inequality The previous slide showed strong growth in financial and services sectors whilst manufacturing has substantially decreased its share of output. The chart below shows the spread of earnings within different sectors. The key points are are: finance/insurance have widely unequal hourly earnings and some of the highest earnings in the economy – strong growth in the financial sector is likely to have increased overall inequality; earnings in the services sector tend to be more concentrated in lower earnings ranges – growth in the services sector is also likely to have contributed to increasing inequality over the past few decades; the decrease in size of manufacturing, may have contributed to the hollowing out of middle income jobs. Source: Annual Survey of Hours and Earnings

7. Lower top rates of tax have increased inequality Progressive taxation of income and inheritance were partly a response to the wars of the 20 th century (see charts for historical rates), athough confiscatory levels of taxation, e.g. higher than 70%, were used in the UK and US to discourage incomes and estates seen to be socially unacceptable, rather than raise revenue. Top income tax rate UK Data from Picketty: http://piketty.pse.ens.fr/en/capital21c2http://piketty.pse.ens.fr/en/capital21c2 Expansion of top managerial pay in more recent decades may also be related to reduced top rates of income tax. When tax rates are lower there is more incentive to negotiate higher pay. Redistribution via tax and benefits has reduced inequality but tax has been less effective than benefits. According to Prof. David Bell, Stirling University) cash benefits reduce the Gini by around 14 percentage points, whilst taxes (including income tax, National Insurance and council tax) reduce the Gini by around 4 percentage points. Since 1994 there has been relatively little change in the relative roles of taxes and benefits in reducing inequality. Lower marginal tax rates on top incomes and lower capital gains and wealth taxation have made the accumulation of wealth easier for the better off.

8. Globalisation and technological change create global economic trends but national policies influence final levels of inequality Globalisation and technological change were traditionally used to explain growth in inequality. Globalisation can result in advanced economies ‘outsourcing’ low skilled work to other countries and putting a premium on high skilled workers. Technological progress can increase productivity of highly skilled workers more than lower skilled workers. Increased demand for high skilled workers increases its ‘wage premium’, relative to lower skilled work. Risk of Computerisation of US jobs Source: Frey and Osborne, 2013 Studies even suggest that a substantial proportion (over 40 per cent) of jobs could be at risk of computerisation over the next two decades. Jobs most at risk are those with lower wages and skill requirements. Whilst compelling, this type of evidence may overstate risk, as it does not take into account the emergence of completely new jobs as a result of technological change. But prominent economists like Stiglitz argue that whilst drivers like globalisation and technological change are “forces to be reckoned with… even the biggest global trends, while clearly shapers of the economy, can be shaped and pushed toward better outcomes” (Rewriting the Rules, 2015). He argues that it is countries’ laws, policies and tax systems that structure the economy and determine inequality.