Category: Economics: Ch 11

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Inequality: the ‘defining issue of our day’?

Wes Streeting and Andy Burnham are seeking to become UK Prime Minister in a challenge to Keir Starmer. They have both responded to an essay by Tony Blair, former Labour Prime Minister, where he argued that current Labour policies were holding back business. But the essay never mentioned inequality. According to Burnham and Streeting, inequality and the related issue of poverty are fundamental to the crises facing society in western democracies. Countries’ economic success is typically measured in terms of growth in GDP. But when the benefits of growth go largely to those at the top of the income scale, while people on lower incomes struggle to make ends meet, this feeds resentment. Populist politicians stoke such resentment and offer simplistic solutions, such as protectionism, blaming outsiders and promising a return to better times.

But just what has happened to inequality over recent years and has poverty deepened? How are inequality and poverty affecting people’s lives and what is the impact on the economy? And what policies should governments follow to tackle the problem?

Income inequality

The chart shows UK inequality as given by the Gini coefficient, where 1 represents complete inequality, with one person earning the whole of national income and 0 represents perfect equality, with everyone earning the same. The higher the figure, therefore, the greater the inequality. As you can see, inequality is greatest when looking at original income – that is, income before taxes and benefits. Gross income includes benefits, and disposable income is income after both benefits and taxes. You can see that both benefits and taxes reduce inequality. When we take housing costs into account with the disposable income measure, however, inequality increases.

The chart shows that income inequality rose until the early 2000s, since when there have been only slight changes, although there has been a small decline recently.

The UK has higher income inequality than most high-income countries, although it is not as high as in the USA. It is sixth most unequal of the 38 OECD countries and the most unequal OECD member in Europe.

Globally, in 2025, the top 10% of the world’s population earned 53% of global income, while the bottom half earned just 8%. The reports listed below provide data and analysis on UK and global inequality.

Wealth inequality

When we turn to wealth, inequality in the UK is even greater. The richest 10% of households hold around 41% of wealth, while the poorest 50% hold just under 10%. The Gini coefficient is around 0.6. This has been drive by a rise in property and share prices and the system of inheritance whereby family wealth can accumulate over the generations.

Globally, the top 10% of the world’s population held 75% of global wealth in 2025, whereas the bottom 50% held just 2%. And a tiny group of people – the top 0.001% of the adult population (about 56,000 individuals) – held about 6% of global wealth, up from 4% in 1995. Such extreme wealth inequality has thus increased.

Inequality and poverty

There is no single measure of poverty. It could be measured in terms of basic needs. Here poverty would be where a person is unable to afford basic food, shelter, heating and lighting, clothing, footwear and basic toiletries. Normally, however, it is measured in relative terms. A typical measure, and one used by the Joseph Rowntree Foundation, is based on a proportion of median income. Poverty is defined as income below 60% of the median income, with deep poverty below 50% and very deep poverty below 40%.

In 2023/24, 14.2 million people were in poverty (20% of the population), of whom around 4.5 million were children. Of the 14.2 million, 6.8 million people (nearly half) were in very deep poverty,

Causes of poverty include one or more of the following: low skills or education, low pay, unemployment, inadequate benefits or a benefit system that is confusing or difficult to access, chronic sickness, disability, unavailability or cost of suitable housing, discrimination, a breakdown of personal relationships, substance abuse, abuse from others, a criminal record. Once in poverty, it becomes difficult to escape as people become deskilled, demotivated and judged by society.

But even if people are not earning less than 60% of median income, they can still struggle to escape inequality. Many people have low skills; many routine jobs are being replaced by automation or AI; many graduates face high debts; people struggle to get on the housing ladder; the rising cost of basic items dampens real incomes, especially of the low paid; people may face discrimination of various sorts; people do not have an option of joining a union in their workplace; people may have a large number of dependants.

The policy agenda

If inequality rises up the political agenda in the UK, especially with a potential leadership race in the Labour party, what might politicians focus on? The government has already done the following:

  • It has raised the minimum wage (the ‘National Living Wage’) substantially from £10.42 in 2023/24 to £11.44 in 2024/25, to £12.21 in 2025/26 and lowered the age limit from 23 to 21. There have been larger percentage rises for 18–20 year-olds and those under 18.
  • The two-child limit to the child benefit element in Universal Credit has been scrapped and so now parents are eligible for benefits for all children.
  • The Employment Rights Act has ended exploitative zero-hour contracts by providing rights to guaranteed hours.
  • It has expanded free school meal entitlements.
  • It has capped Universal Credit debt deductions at 15% of increased incomes (down from 25%) to help the poorest households retain more of their monthly income.
  • It has expanded free school meals and made more money available for free nursery place.
  • Landlords can no longer evict tenants for no reason; they must have a valid reason such as wanting to sell the property or severe rent arrears.
  • Landlords cannot increase rents more than once per year and tenants can appeal excessive or above-market rent increases to an independent tribunal.

But despite these policy measures, many claim that they will do too little to tackle inequality and poverty. Some on the left argue that taxes on property and other forms of wealth will be required to tackle wealth inequality. Others argue that more emphasis on education and training is necessary to provide workers with the skills to earn more in the labour market. Others argue for greater expenditure on public services.

Generally, however, measures to tackle inequality and poverty require government expenditure, which must be funded. This is why many on the centre left argue that economic growth is a necessary condition for any significant redistribution. It is, they argue, the best way of providing the tax revenue to fund redistribution.

Incentives and disincentives

Many on the right argue that redistributing incomes through higher taxes and benefits will act as a disincentive to work and to invest. As we argue in Essentials of Economics, higher income taxes could discourage people from working and investing; higher wealth taxes could discourage people from saving and investing.

The key to analysing these arguments is to distinguish between the income effect and the substitution effect of raising taxes. Raising income tax does two things.

  • It reduces disposable incomes. People therefore are encouraged to work more in an attempt to maintain their consumption of goods and services. This is the income effect. ‘I have to work more to make up for the higher taxes’, a person might say.
  • It reduces the opportunity cost of leisure. Since higher income taxes reduce take-home pay, an extra hour taken in leisure now involves a smaller sacrifice in consumption. Thus people may substitute leisure for consumption, and work less. This is called the substitution effect. ‘What is the point of doing overtime’, another person might say, ‘if so much of the overtime pay is going in taxes?’

The relative size of the income and substitution effects is likely to differ for different types of people. For example, the income effect is likely to dominate for those people with a substantial proportion of long-term commitments, such as those with families, with mortgages and other debts. They may feel forced to work more to maintain their disposable income. Clearly for such people, higher taxes are not a disincentive to work. The income effect is also likely to be relatively large for people on higher incomes, for whom an increase in tax rates represents a substantial cut in income.

The substitution effect is likely to dominate for those with few commitments: those whose families have left home, the single, and second income earners in families where that second income is not relied on for ‘essential’ consumption. A rise in tax rates for these people is likely to encourage them to work less.

Although high income earners may work more when there is a tax rise, they may still be discouraged by a steeply progressive tax structure. If they have to pay very high marginal rates of tax, it may simply not be worth their while seeking promotion or working harder.

What those on the centre and left argue is that tackling inequality and poverty requires more than just changing the tax and benefits system. What is required is policies that encourage greater upward social mobility, greater social cohesion and greater expenditure on infrastructure that will support the poor, such as greater expenditure on education and training, on support for very young children, on preventative healthcare, on social housing and on local public transport.

Articles

Reports

Data

Questions

  1. Is the UK becoming more or less equal? Does the answer depend on how inequality is measured?
  2. Is the world becoming more or less equal?
  3. Summarise the arguments against redistributing incomes from the rich to the poor.
  4. Summarise the arguments in favour of redistributing incomes from the rich to the poor.
  5. Explain the income and substitution effects of making income tax more progressive.
  6. How is the greater adoption of AI likely to affect income distribution?
  7. How does social mobility affect income distribution? What measures can be adopted to increase social mobility?
  8. Compare the relative merits and problems of raising income taxes, wealth taxes and expenditure taxes as means of redistributing incomes more equally.
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Will AI make the world less equal?

With businesses increasing their use of AI, this is likely to have significant effects on employment. But how will this affect the distribution of income, both within countries and between countries?

In some ways, AI is likely to increase inequality within countries as it displaces low-skilled workers and enhances the productivity of higher-skilled workers. In other ways, it could reduce inequality by allowing lower-skilled workers to increase their productivity, while displacing some higher-skilled workers and managers through the increased adoption of automated processes.

The effect of AI on the distribution of income between countries will depend crucially on its accessibility. If it is widely available to low-income countries, it could significantly enhance the productivity of small businesses and workers in such countries and help to reduce the income gap with the richer world. If the gains in such countries, however, are largely experienced by multinational companies, whether in mines and plantations, or in labour-intensive industries, such as garment production, few of the gains may accrue to workers and global inequality may increase.

Redistribution within a country

The deployment of AI may result in labour displacement. AI is likely to replace both manual and white-collar jobs that involve straightforward and repetitive tasks. These include: routine clerical work, such as data entry, filing and scheduling; paralegal work, contract drafting and legal research; consulting, business research and market analysis; accounting and bookkeeping; financial trading; proofreading, copy mark-up and translation; graphic design; machine operation; warehouse work, where AI-enabled warehouse robots do many receiving, sorting, stacking, retrieval, carrying and loading tasks (e.g. Amazon’s Sequoia robotic system); basic coding or document sifting; market research and advertising design; call-centre work, such as enquiry handling, sales, telemarketing and customer service; hospitality reception; sales cashiers in supermarkets and stores; analysis of health data and diagnosis. Such jobs can all be performed by AI assistants, AI assisted robots or chat bots.

Women are likely to be disproportionately affected because they perform a higher share of the administrative and service roles most exposed to AI.

Workers displaced by AI may find that they can find employment only in lower-paid jobs. Examples include direct customer-facing roles, such as bar staff, shop assistants, hairdressers and nail and beauty consultants.

Such job displacement by AI is likely to redistribute income from relatively low-skilled labour to capital: a redistribution from wages to profits. This will tend to lead to greater inequality.

AI is also likely to lead to a redistribution of income towards certain types of high-skilled labour that are difficult to replace with AI but which could be enhanced by it. Take the case of skilled traders, such as plumbers, electricians and carpenters. They might be able to use AI in their work to enhance their productivity, through diagnosis, planning, problem-solving, measurement, etc. but the AI would not displace them. Instead, it could increase their incomes by allowing them to do their work more efficiently or effectively and thus increase their output per hour and enhance their hourly reward. Another example is architecture, where AI can automate repetitive tasks and open up new design possibilities, allowing architects to focus on creativity, flexibility, aesthetics, empathy with clients and ethical decision-making.

An important distinction is between disembodied and embodied AI investment. Disembodied AI investment could include AI ‘assistants’, such as ChatGPT and other software that can be used in existing jobs to enhance productivity. Such investment can usually be rolled out relatively quickly. Although the extra productivity may allow some reduction in the number of workers, disembodied AI investment is likely to be less disruptive than embodied AI investment. The latter includes robotics and automation, where workers are replaced by machines. This would require more investment and may be slower to be adopted.

Then there are jobs that will be created by AI. These include prompt engineers, who develop questions and prompt techniques to optimise AI output; health tech experts, who help organisations implement new medical AI products; AI educators, who train people in the uses of AI in the workplace; ethics advisors, who help companies ensure that their uses of AI are aligned with their values, responsibilities and goals; and cybersecurity experts who put systems in place to prevent AI stealing sensitive information. Such jobs may be relatively highly paid.

In other cases, the gains from AI in employment are likely to accrue mainly to the consumer, with probably little change in the incomes of the workers themselves. This is particularly the case in parts of the public sector where wages/salaries are only very loosely related to productivity and where a large part of the work involves providing a personal service. For example, health professionals’ productivity could be enhanced by AI, which could allow faster and more accurate diagnosis, more efficient monitoring and greater accuracy in surgery. The main gainers would be the patients, with probably little change in the incomes of the health professionals themselves. Teachers’ productivity could be improved by allowing more rapid and efficient marking, preparation of materials and record keeping, allowing more time to be spent with students. Again, the main gainers would be the students, with little change in teachers’ incomes. Other jobs in this category include social workers, therapists, solicitors and barristers, HR specialists, senior managers and musicians.

Thus there is likely to be a distribution away from lower-skilled workers to both capital and higher-skilled workers who can use AI, to people who work in new jobs created by AI and to the consumers of certain services.

AI will accelerate productivity growth and, with it, GDP growth, but will probably displace workers faster than new roles emerge. This is likely to increase inequality and be a major challenge for society. Can the labour market adapt? Could the effects be modified if people moved to a four- or three-day week? Will governments introduce statutory limits to weekly working hours? Will training and education adapt to the new demands of employers?

Redistribution between countries

AI threatens to widen the global rich–poor divide. It will give wealthier nations a productivity and innovation edge, which could displace low-skilled jobs in low-income nations. Labour-intensive production could be replaced by automated production, with the capital owned by the multinational companies of just a few countries, such as the USA and China, which between them account for 40% of global corporate AI R&D spending. For some companies, it would make sense to relocate production to rich countries, or certain wealthier developing countries, with better digital infrastructure, advanced data systems and more reliable power supply.

For other companies, however, production might still be based in low-income countries to take advantage of low-cost local materials. But there would still be a redistribution from wages in such countries to the profits of multinationals.

But it is not just in manufacturing where low-income countries are vulnerable to the integration of AI. Several countries, such as India, the Philippines, Mexico and Egypt have seen considerable investment in call centres and IT services for business process outsourcing and customer services. AI now poses a threat to employment in this industry as it has the potential to replace large numbers of workers.

AI-related job losses could exacerbate unemployment and deepen poverty in poorer countries, which, with limited resources, limited training and underdeveloped social protection systems, are less equipped to absorb economic and social shocks. This will further widen the global divide. In the case of embodied AI investment, it may only be possible in low-income countries through multinational investment and could displace many traditional jobs, with much of the benefit going in additional multinational profit.

But it is not all bad news for low-income countries. AI-driven innovations in healthcare, education, and agriculture, if adopted in poor countries, can make a significant contribution to raising living standards and can slow, or even reverse, the widening gap between rich and poor nations. Some of the greatest potential is in small-scale agriculture. Smallholders can boost crop yields though precision farming powered by AI; AI tools can help farmers buy seeds, fertilisers and animals and sell their produce at optimum times and prices; AI-enabled education tools can help farmers learn new techniques.

Articles

Questions

  1. What types of job are most vulnerable to AI?
  2. How will AI change the comparative advantage of low-income countries and what effect will it be likely to have on the pattern of global trade?
  3. Assess alternative policies that governments in high-income countries can adopt to offset the growth in inequality caused by the increasing use of AI.
  4. What policies can governments in low-income countries or aid agencies adopt to offset the growth in inequality within low-income countries and between high- and low-income countries?
  5. How might the growth of AI affect your own approach to career development?
  6. Is AI likely to increase or decrease economic power? Explain.
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How to increase productivity – the key to economic growth

The productivity gap between the UK and its main competitors is significant. In 2024, compared to the UK, output per hour worked was 10.0% higher in France, 19.8% higher in Germany and 41.1% higher in the USA. These percentages are in purchasing-power parity terms: in other words, they reflect the purchasing power of the respective currencies – the pound, the euro and the US dollar.

GDP per hour worked (in PPP terms) is normally regarded as the best measure of labour productivity. An alternative measure is GDP per worker, but this does not take into account the length of the working year. Using this measure, the gap with the USA is even higher as workers in the USA work longer hours and have fewer days holiday per year than in the UK.

The productivity gap is not a new phenomenon. It has been substantial and growing over the past 20 years. (The exception was in 2020 during lockdowns when many of the least productive sectors, such as hospitality, were forced to close temporarily.)

The productivity gap is shown in the two figures. Both figures show labour productivity for the UK, France, Germany and the USA from 1995 to 2024.

Figure 1 shows output (GDP) per hour, measured in US dollars in PPP terms.

Figure 2 shows output (GDP) per hour relative to the UK, with the UK set at 100. The gap narrowed somewhat up to the early 2000s, but since then has widened.

Low UK productivity has been a source of concern for UK governments and business for many years. Not only does it constrain the growth in living standards, it also make the UK less attractive as a source of inward investment and less competitive internationally.

Part of the reason for low UK productivity compared to that in other countries is a low level of investment. As a proportion of GDP, the UK has persistently had the lowest, or almost the lowest, level of investment of its major competitors. This is illustrated in Table 1.

It is generally recognised by government, business and economists that if the economy is to be successful, the productivity gap must be closed. But there is no ‘quick fix’. The policies necessary to achieve increased productivity are long term. There is also a recognition that the productivity problem is a multi-faceted one and that to deal with it requires policy initiatives on a broad front: initiatives that encompass institutional changes as well as adjustments in policy.

So what can be done to improve productivity and how can this be achieved at the micro as well as the macro level?

Improving productivity: things that government can do

Encouraging investment. Over the years, UK governments have increased investment allowances, enabling firms to offset the cost of investment against pre-tax profit, thereby reducing their tax liability. For example, in the UK, companies can offset a multiple of research and development costs against corporation tax. The rate of relief for small and medium-sized enterprises (SMEs) allows companies that work in science and technology to deduct an extra 86% of their qualifying expenditure from their trading profit in addition to the normal 100% deduction: i.e. a total of 186% deduction. Meanwhile, since April 2016, larger companies have been able to claim a R&D expenditure credit, initially worth 11 per cent of R&D expenditures, then 12 per cent from 2018 and 13 per cent from 2020. This was then raised to 20 per cent from 2023.

Strengthening competition. A number of studies have revealed that, with increasing market share, business productivity growth slows. As a result, government policy sought to strengthen competition policy. The Competition Act 1998, which came into force in March 2000, and the Enterprise Act of 2002, enhanced the powers of the Office of Fair Trading (OFT) (a predecessor to the Competition and Markets Authority) in respect to dealing with anti-competitive practices. It was given the ability to impose large fines on firms which had been found guilty of exploiting a dominant market position. Today, one of the strategic goals of the Competition and Markets Authority (CMA) is the aim of ‘extending competition frontiers’ in order to improve the way competition works.

Encouraging an enterprise culture. The creation of an enterprise culture is seen as a crucial factor not only to encourage innovation but also to stimulate technological progress. Innovation and technological progress are crucial to sustaining growth and raising living standards. The UK government launched the Small Business Service in April 2000, later renamed Business and Industry. Its role is to co-ordinate small-business policy within government and liaise with business, providing advice and information. However, according to the OECD, there remains considerable scope for increasing the level of government support for entrepreneurship in the UK.

Improving productivity: things that organisations can do

In the podcast from the BBC’s The Bottom Line series, titled ‘Productivity: How Can British Business Work Smarter’ (see link below), Evan Davis and guests discuss what productivity really looks like in practice – from offices and factories, to call centres and operating theatres.’ The episode identifies a number of ways in which labour productivity can be improved. These include:

  • People could work harder;
  • Workers could be better trained and more skilled and thus able to produce more per hour;
  • Capital could be increased so that workers have more equipment or tools to enable them to produce more, or there could be greater automation, releasing labour to work on other tasks;
  • Workplaces could be arranged more efficiently so that less time is spent moving from task to task;
  • Systems could put in place to ensure that tasks are done correctly the first time and that time is not wasted having to repeat them or put them right;
  • Workers could be better incentivised to work efficiently, whether through direct pay or promotion prospects, or by increasing job satisfaction or by management being better attuned to what motivates workers and makes them feel valued;
  • Firms could move to higher-value products, so that workers produce a greater value of output per hour.

The three contributors to the programme discuss various initiatives in their organisations (an electronics manufacturer, NHS foundation trusts and a provider of office services to other organisations).

They also discuss the role that AI plays, or could play, in doing otherwise time-consuming tasks, such as recording and paying invoices and record keeping in offices; writing grants or producing policy documents; analysing X-ray results in hospitals and performing preliminary diagnoses when patients present with various symptoms; recording conversations/consultations and then sorting, summarising and transcribing them; building AI capabilities into machines or robots to enable them to respond to different specifications or circumstances; software development where AI writes the code. Often, there is a shortage of time for workers to do more creative things. AI can help release more time by doing a lot of the mundane tasks or allowing people to do them much quicker.

There are huge possibilities for increasing labour productivity at an organisational level. The successful organisations will be those that can grasp these possibilities – and in many cases they will be incentivised to so so as it will improve their profitability or other outcomes.

Podcast

Articles

Data

Questions

  1. In what different ways can productivity be measured? What is the most appropriate measure for assessing the effect of productivity on (a) GDP and (b) human welfare generally?
  2. Why has the UK had a lower level of labour productivity than France, Germany and the USA for many years? What can UK governments do to help close this gap?
  3. Find out how Japanese labour productivity has compared with that in the UK over the past 30 years and explain your findings.
  4. Research an organisation of your choice to find out ways in which labour productivity could be increased.
  5. Identify various ways in which AI can improve productivity. Will organisations be incentivised to adopt them?
  6. Has Brexit affected UK labour productivity and, if so, how and why?
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A four-day week – a solution to sluggish productivity growth? (Updated)

In a blog from March 2023 (reproduced below), we saw how there has been growing pressure around the world for employers to move to a four-day week. Increasing numbers of companies have adopted the model of 80% of the hours for 100% of the pay.

As we see below, the model adopted has varied across companies, depending on what was seen as most suitable for them. Some give everyone Friday off; others let staff choose which day to have off; others let staff work 80% of the hours on a flexible basis. Firms adopting the model have generally found that productivity and revenue have increased, as has employee well-being. To date, over 200 employers in the UK, employing more than 5000 people, have adopted a permanent four-day week.

This concept of 100-80-100, namely 100% of pay for 80% of hours, but 100% of output, has been trialled in several countries. In Germany, after trials over 2024, 73% of the companies involved plan to continue with the new model, with the remaining 27% either making minor tweaks or yet to decide. Generally hourly productivity rose, and in many cases total output also rose. As the fourth article below states:

The primary causal factor for this intriguing revelation was simple – efficiency became the priority. Reports from the trial showed that the frequency and duration of meetings was reduced by 60%, which makes sense to anyone who works in an office – many meetings could have been a simple email. 25% of companies tested introduced new digitised ways of managing their workflow to optimise efficiency.

Original post

In two previous posts, one at the end of 2019 and one in July 2021, we looked at moves around the world to introduce a four-day working week, with no increase in hours on the days worked and no reduction in weekly pay. Firms would gain if increased worker energy and motivation resulted in a gain in output. They would also gain if fewer hours resulted in lower costs.

Workers would be likely to gain from less stress and burnout and a better work–life balance. What is more, firms’ and workers’ carbon footprint could be reduced as less time was spent at work and in commuting.

If the same output could be produced with fewer hours worked, this would represent an increase in labour productivity measured in output per hour.

The UK’s poor productivity record since 2008

Since the financial crisis of 2007–8, the growth in UK productivity has been sluggish. This is illustrated in the chart, which looks at the production industries: i.e. it excludes services, where average productivity growth tends to be slower. The chart has been updated to 2024 Q2 – the latest data available. (Click here for a PowerPoint of the chart.)

Prior to the crisis, from 1998 to 2006, UK productivity in the production industries grew at an annual rate of 6.9%. From 2007 to the start of the pandemic in 2020, the average annual productivity growth rate in these industries was a mere 0.2%.

It grew rapidly for a short time at the start of the pandemic, but this was because many businesses temporarily shut down or went to part-time working, and many of these temporary job cuts were low-wage/low productivity jobs. If you take services, the effect was even stronger as sectors such as hospitality, leisure and retail were particularly affected and labour productivity in these sectors tends to be low. As industries opened up and took on more workers, so average productivity rapidly fell back. Since then productivity has flatlined.

If you project the average productivity growth rate from 1998 to 2007 of 6.9% forwards (see grey dashed line), then by 2024 Q3, output per hour in the production industries would have been 3.26 times higher than it actually was: a gap of 226%. This is a huge productivity gap.

Productivity in the UK is lower than in many other competitor countries. According to the ONS, output per hour in the UK in 2021 was $59.14 in the UK. This compares with an average of $64.93 for the G7 countries, $66.75 in France, £68.30 in Germany, $74.84 in the USA, $84.46 in Norway and $128.21 in Ireland. It is lower, however, in Italy ($54.59), Canada ($53.97) and Japan ($47.28).

As we saw in the blog, The UK’s poor productivity record, low UK productivity is caused by a number of factors, not least the lack of investment in physical capital, both by private companies and in public infrastructure, and the lack of investment in training. Other factors include short-termist attitudes of both politicians and management and generally poor management practices. But one cause is the poor motivation of many workers and the feeling of being overworked. One solution to this is the four-day week.

Latest evidence on the four-day week

Results have just been released of a pilot programme involving 61 companies and non-profit organisations in the UK and nearly 3000 workers. They took part in a six-month trial of a four-day week, with no increase in hours on the days worked and no loss in pay for employees – in other words, 100% of the pay for 80% of the time. The trial was a success, with 91% of organisations planning to continue with the four-day week and a further 4% leaning towards doing so.

The model adopted varied across companies, depending on what was seen as most suitable for them. Some gave everyone Friday off; others let staff choose which day to have off; others let staff work 80% of the hours on a flexible basis.

There was little difference in outcomes across different types of businesses. Compared with the same period last year, revenues rose by an average of 35%; sick days fell by two-thirds and 57% fewer staff left the firms. There were significant increases in well-being, with 39% saying they were less stressed, 40% that they were sleeping better; 75% that they had reduced levels of burnout and 54% that it was easier to achieve a good work–life balance. There were also positive environmental outcomes, with average commuting time falling by half an hour per week.

There is growing pressure around the world for employers to move to a four-day week and this pilot provides evidence that it significantly increases productivity and well-being.

Additional articles

Original set of articles

Questions

  1. What are the possible advantages of moving to a four-day week?
  2. What are the possible disadvantages of moving to a four-day week?
  3. What types of companies or organisations are (a) most likely, (b) least likely to gain from a four-day week?
  4. Why has the UK’s productivity growth been lower than that of many of its major competitors?
  5. Why, if you use a log scale on the vertical axis, is a constant rate of growth shown as a straight line? What would a constant rate of growth line look like if you used a normal arithmetical scale for the vertical axis?
  6. Find out what is meant by the ‘fourth industrial revolution’. Does this hold out the hope of significant productivity improvements in the near future? (See, for example, last link above.)
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Is a flat-rate income tax a good idea?

At an event at the London Palladium on 6 December staged to protest against elements in the recent Budget, the Conservative leader, Kemi Badenoch, was asked whether she would introduce a flat-rate income tax if the Conservatives were returned to government. She replied that it was a very attractive idea. But first the economy would need ‘rewiring’ so that the tax burden could be lightened.

A flat-rate income tax system could take various forms, but the main feature is that there is a single rate of income tax. The specific rate would depend on how much the government wanted to raise. Also it could apply to just income tax, or to both income tax and social insurance (national insurance contributions (NICs) in the UK), or to income tax, social insurance and the withdrawal rate of social benefits. It could also apply to local/state taxes as well as national/federal taxes.

Take the simplest case of a flat-rate income tax with no personal allowance. In this system the marginal and average rate of tax is the same for everyone. This is known as a proportional tax.

Most countries have a progressive income tax system. This normally involves personal allowances (i.e. a zero rate up to a certain level of income) and then various tax bands, with the marginal rate rising when particular tax thresholds are reached. In England, Wales and Northern Ireland, there are three tax bands: 20%, 40% and 45%. Thus the higher a person’s income is, the higher their average rate of tax.

A regressive tax, by contrast, would be one where the average rate of tax fell as incomes rose. The extreme case of a regressive tax would be a lump-sum tax (such as a TV or other licence), which would be same absolute amount for everyone liable to it, irrespective of their income. This was the case with the ‘poll tax’ (or Community Charge, to give it its official title), introduced by Margaret Thatcher’s government in 1989 in Scotland and 1990 in the rest of the UK. It was a local tax, with each taxpayer taxed the same fixed sum, with the precise amount being set by each local authority. After protests and riots, it was replaced in 1993 by the current system of local taxation (Council Tax) based on property values in bands.


Figures 1 and 2 illustrate these different categories of tax: see Figure 11.12 in Economics, 12th edition. (Click here for a PowerPoint.) Income taxes in most countries are progressive, although just how progressive depends on the differences between the tax bands and the size of personal tax-free allowances. A flat-rate income tax with no allowances is shown by the black line in each diagram, the slope in Figure 1 and the height in Figure 2 depending on the tax rate.

Arguments for a flat-rate income tax

Generally, arguments in favour of flat-rate taxes come from the political right. The two main arguments in favour are tax simplification and incentives.

Advocates argue that a flat tax system makes tax collection easier and makes tax evasion harder. If there are no exemptions, then it can be easier to check that people are paying their taxes and working out the correct amount they owe. It is argued that, in contrast, high tax rates on top earners can encourage tax evasion.

Flat taxes can also be part of a drive to reduce the size of the informal economy. As the VoxEU article states:

Unlike progressive taxes, which include complex and numerous exceptions left to the tax collectors’ discretion, the flat tax is clear cut. In combination with the low rate, its simplicity considerably reduces the stimuli for being informal.

Several post-communist countries in Eastern Europe adopted flat taxes, but for most they were seen as a temporary measure to reduce the informal sector and clamp down on tax evasion. Most have now adopted progressive taxes, with the exceptions of Bulgaria and until recently Russia.

The second major argument is that lower taxes for higher earners, especially for entrepreneurs, can act as a positive incentive. People work harder and there is more investment. The argument here is that the positive substitution effect from the lower tax (work is more profitable now and hence people substitute work for leisure) is greater than the negative income effect (lower taxes increase take-home pay so that people do not need to work so much now to maintain their standard of living).

Then there is the question of tax evasion. With high rates of income tax for top earners, such people may employ accountants to exploit tax loopholes and hide earnings. This could be seen as highly unfair by middle-income earners who are still paying relatively high rates of tax. Even though a move to flat taxes is likely to mean a cut in tax rates for high earners, the tax take from them could be higher. There is evidence that post-communist and developing countries that have adopted flat taxes have found an increase in tax revenues as evasion is harder.

The Laffer curve is often used to illustrate such arguments that high top tax rates can lead to lower tax revenue. Professor Art Laffer was one of President Reagan’s advisers during his first administration (1981–4): see Box 11.3 in Economics, 11th edition. Laffer was a strong advocate of income tax cuts, arguing that substantial increases in output would result and that tax revenues could consequently increase.

The Laffer curve in Figure 3 shows tax revenues increasing as the tax rate increases – but only up to a certain tax rate (t1). Thereafter, tax rates become so high that the resulting fall in output more than offsets the rise in tax rate. When the tax rate reaches 100 per cent, the revenue will once more fall to zero, since no one will bother to work. (Click here for a PowerPoint)

However, as Box 11.3 explains, evidence suggests that tax rates in most countries were well below t1 in the 1980s and certainly are now, given the cuts in income tax rates that have been made around the world over the past 20 years.

Arguments against flat-rate income taxes

The main argument against moving from a progressive to a flat-rate income tax in an advanced country, such as the UK, is that is would involve a large-scale redistribution of income from the poor to the rich. If the tax were designed to raise the same amount of revenue as at present, those on low incomes would pay more tax than now, as their tax rate would rise to the new flat rate. Those on high incomes would pay less tax, as their marginal rate would fall to the new flat rate.

If a new flat-rate tax in the UK also replaced national insurance contributions (NICs), then the effect would be less extreme as NICs are currently initially progressive, as there is a personal allowance before the 8% rate is applied (on incomes above £12 570 in 2024/25). But above a higher NI threshold (£50 270 in 2024/25), the marginal rate drops to 2%, making it a regressive tax beyond that level. Figure 4 shows tax and NI rates in England, Wales and Northern Ireland for 2024/25. (Click here for a PowerPoint.)

Nevertheless, even if a new flat-rate tax replaced NICs as well as varying rates of income tax, it would still involve a large-scale redistribution from low-income earners to high-income earners. The effect would be mitigated somewhat if personal allowances were raised so that the tax only applied to mid-to-higher incomes. Then the redistribution would be from middle-income earners to high-income earners and also somewhat to low-income earners: i.e. those below, or only a little above, the new higher personal allowance. If, on the other hand, personal allowances were scrapped so that the flat tax applied to all incomes, then there would be a massive redistribution from people on low incomes, including very low incomes, to those on high incomes.

One of the arguments used to justify a flat-rate tax is that its simplicity would ensure greater compliance. But in an advanced country, compliance is high, except, perhaps, for those on very high incomes. Most people in the UK and many other countries, have tax deducted automatically from their wages. People cannot avoid such taxes.

As far as the self-employed are concerned, they file tax returns online and the software automatically works out the tax due. There are no complex calculations that have to be performed by the individual. There is come scope for tax evasion by charging various expenditures to the business that are really personal spending, but the tax authorities can ask for evidence and sometimes do, with penalties for false claims.

What tax evasion does take place, could still do so with a flat tax. At a rate of, say, 20%, it would still be financially beneficial for a dishonest person to lie if they could get way with it.

Conclusions

If the government did try to introduce a flat-rate income tax, there would probably be an outcry. Also, as some rich people would gain a very large amount of money, the number of people gaining would be lower than the number losing if the total revenue raised were to remain the same. In other words, it would be politically difficult to achieve if the number of losers exceeded the number of gainers.

It is true that if the top rate of income tax were very high, then reducing it might bring in more revenue. But at 45%, or 47% if you include NICs, the top marginal rate in the UK is relatively low compared with other countries. In 2024, the UK had the second lowest top rate of tax out of Western European countries (behind Norway and Switzerland) and only the 16th highest out of 33 European countries when Central and Eastern European countries are also included (see the final ink below under ‘Information’). Reducing the UK’s top rate would be unlikely to bring in more revenue and would redistribute income to high-income earners.

Articles

Information

Questions

  1. Distinguish between progressive, proportional, regressive and lump-sum taxes. Into which of these four categories would you place (a) VAT, (b) motor fuel duties, (c) tobacco duties, (d) road-fund licence, (e) inheritance tax? Where the answer is either progressive or regressive, how progressive or regressive are they?
  2. What are the income and substitution effects of changing tax rates?
  3. Explain the Laffer curve and consider whether it is likely to be symmetrical.
  4. Discuss the desirability of having a flat tax set at a relatively high rate (say 25%) with tax-free personal allowances up to the level of income considered to be the poverty threshold. (In the UK the poverty threshold is often defined as 60% of median income.)
  5. In the London Palladium event where Kemi Badenoch stated that flat taxes were a very attractive idea, she also said that ‘We cannot afford flat taxes where we are now. We need to make sure we rewire our economy so that we can lighten the burden of tax and the regulation on individuals and on those businesses that are just starting out, in particular’. What do you think she meant by this?
  6. Find out what Bulgaria’s experience of a flat tax of 10% has been.