Moreover, the promised economic pay-off from this market and profit-led strategy never materialised. The rich used their political license not to create more wealth and a bigger pie, but to grab a larger share of it for themselves. As wages fell behind output, debt levels across the working population soared to unsustainable levels. Without this growing dependence on debt, living standards would have plunged and the economy would have faltered well before 2008.

Miliband acknowledges that New Labour’s economic strategy was badly flawed. He is now committed to a wholly new economic direction, one that accepts that the fruits of growth need to be more evenly shared. This is not just a matter of fairness. “Economic recovery”, as the Labour leader put it, “will be made by the many not the few”. In short, the equality/prosperity trade-off theory needs to be buried. Rather, prosperity depends on divvying up the cake more fairly. This is a decisive break with current economic orthodoxy.

It comes with the backing of a growing body of evidence.  For the last thirty years, the share of income going to wages in the UK– and most rich economies – has been falling. Across the nations that make up the OECD, the share had fallen by 5 percentage points since 1990. This has boosted global profits and personal fortunes at the top. This power shift from labour to capital was meant to unleash a new era of enterprise and faster growth. In fact, in the UK, post-1980, profit-led market capitalism has a poorer record on investment, productivity, growth and unemployment than its more regulated and much maligned predecessor.

For thirty years, much of the developed world has been part of a real life economic experiment. It is one that has led to a mass livelihood crisis for a growing proportion of the workforce. And it ended in tears in the Crash of 2008, just as the very similar pre-1929 experiment also brought economic implosion. The historical evidence is now overwhelming –  sharing the cake more evenly is associated with improved not lower rates of growth, and less not more turbulence.

This raises a whole new perspective for progressive politics. Having been told they were deluded, the market’s critics are winning the argument. Fairer and more resilient economies go hand in hand.

Recognising this is one thing, steering economies in the opposite direction is another. The global billionaire class shows no signs of acquiescing in an erosion of its muscle, privileges and wealth. Governments continue to dance largely to the tune of Wall Street and City financiers. Nevertheless, the public, political and intellectual mood is hardening.

As President Obama has put it, “Inequality is the defining issue of our time”. Last month, the head of the IMF, Christine Lagarde, went further: “Excessive inequality is corrosive to growth; it is corrosive to society… the economics profession and the policy community have downplayed inequality for too long”.

To date, such lofty anti-inequality rhetoric has been little more than talk. Indeed, the world’s corporate and financial elite has grown its wealth through the crisis while nearly everybody else has been getting poorer. Nevertheless the tide could be about to turn. “Capitalism may not have it quite so easy in the next phase”, writes one of Europe’s leading financial strategists, Albert Edwards of Societe Generale. “Labour will fight back to take its proper (normal) share of the national cake, squeezing profits on a secular basis”.

Secondly, the measure moves us towards a more punitive approach to welfare for those of working age. To date, those who have been most badly affected by successive cuts in the relative level of benefits have been the jobless. As a result, the UK has slipped towards the bottom of the rich world’s league table on jobless benefits. Its unemployment benefit ‘replacement rate’ (the proportion of earnings met by benefit) is already one of the meanest amongst rich countries. For a married couple with two children on average earnings, benefit rates meet 53 per cent of former net earnings compared with an OECD average of 76 per cent.

As Professor Jonathan Bradshaw of York University has shown, between 1948 and 1979 unemployment benefit doubled in real terms and rose slightly in relation to average earnings reaching 21% (18% in 1948) in the late 1970s. Since 1979, that trend has been sharply reversed – the benefit has been raised (along with other benefits) only in line with prices. As a result, the level of Jobseeker’s Allowance has halved as a percentage of average earnings: and now stands at a lowly 11%.

Even this minimalist rule – linking benefits merely to prices – is now being broken. Benefits – for the low paid as well as those out of work – will fall in real terms in each of the next three years. The resulting savings of £3.8 billion mean an equivalent cut in the living standards of the poorest in society. Since it is unlikely their real value will be subsequently restored, this will mean a permanent reduction in the value of benefits, leading to a further leveraging of the gap between the poorest and the better off, and between different groups of benefit recipient. (Pensioners, for example, are to be protected with the state pension to rise by 2.5% this year.)

Underlying these policy shifts has been a successive failure of economic management. Britain’s welfare system has come to play a greatly extended role, way beyond its original aims. Beveridge always envisaged that a commitment to full employment and decent pay were essential to limit the role played by welfare. This plan held broadly true up the early 1970s.

Over the last thirty years, however, welfare has been forced into a role for which it was never designed – that of a safety net for the growing inability of the economic system to provide decent livelihoods and work opportunities for a rising proportion of the workforce. Unemployment since 1980 has averaged more than three times that of the two post-war decades, while the proportion of those in low paid jobs (at wages less than two-thirds of the median) has almost doubled to more than 21%. This is the second highest rate (behind the US) amongst rich countries.

The cost of welfare has soared in the UK largely because it has become a prop for the failures of the Anglo-Saxon model of market capitalism. Since 1980, the share of output going to wages has been falling with the cut concentrated amongst those on low earnings. It is these labour market trends that have driven an ever expanding welfare bill. Every fall of a pound in gross wages of amongst the bottom third of the distribution brings a hike in the cost to government (in higher benefits and lower taxes) of slightly less than 50p.

In cutting this bill (and thus raising the level of poverty) this latest measure also brings a further weakening of this prop. We now have an economic model that is unable to produce enough jobs at decent wages and a welfare system no longer able to compensate for this failure. As a result, we are moving back to the Poor Law philosophy of the Victorian age, an era of mass low pay in which claimants had few rights and benefit levels were set so low that the jobless had little choice but to take low paid work.

The government’s latest clampdown marks a further shift towards a welfare system that is fast losing its fundamental purpose, to protect those most in need. One longer-term side-effect of the 1931 political fallout over benefit cuts was a debate that eventually led to the Beveridge reforms. Tomorrow’s crucial vote on the Welfare Benefits Up Rating Bill is also likely to trigger a new urgency for a root and branch reform that provides a welfare system fit for today’s more turbulent times and which does not penalise the poor and the unemployed for a failed model of capitalism. That has already begun with the debate on ‘pre-distribution’. That now needs to be matched by a parallel debate on the role of welfare.

The root cause of the growing gap has been the way the gains from growth have become increasingly colonised by big business and a small financial elite over the last three decades. Wages have been squeezed in favour of profits and living standards for most have fallen well behind GDP growth.

Yet more and more opinion is now coming to accept that economic stability and durability depends on linking living standards more closely to growth. This decoupling is also a key explanation for the current  paralysis.  Inequality has sucked consumer demand out of the economy and has not been replaced by a boost to exports or investment.

To lessen future instability, governments need to move from a passive to a much more pro-active role by making the distribution of the cake a central element of strategic economic planning.

In the UK, the ‘distribution question’ has barely featured in the policy-making machinery. Although there were plenty of internal debates about social mobility and tackling poverty under Labour from 1997, the wider issue of the macro-economic implications of inequality were ignored by the Treasury to the Cabinet Office. No single economic forecasting model in the UK incorporates the impact of changes in the concentration of income on vital outcomes like private investment, living standards and overall demand.

When independent researchers first showed how living standards have been little better than stagnant since 2003, the findings came as a complete surprise to government. When shown the evidence by the TUC in late 2008, advisers at number ten were dismissive. One senior government economist went so far as to deny the figures were true.

One of the dominant pre-occupations of the development of economic thinking through and beyond the nineteenth century was why labour ended up with such a small share of the cake. It is time to return to this pre-occupation. Until recently, the government machine was only interested in what was happening to changes in overall output – GDP – and not how the fruits of that growth were being shared. That has now changed with the report of the Office for National Statistics,  Measuring National Well-Being. Recognition is an important step, but bringing growth and living standards into line requires a new approach to economic management.

First, through the addition of a new set of economic indicators and targets beyond growth, inflation and unemployment. These should include the wage share, pay ratios and the share of income held by the top. Each indicator should be given a target compatible with economic stability. Thus the wage share target could be set at the average of the two post-war decades ( around 60 per cent)—a level that brought equilibrium at a high level of employment and growth along with sustained stability. It is currently well below this target and according to the Office for Budget Responsibility, is heading lower. The ratio of pay between the very top and the middle stands at well above 100:1— close to triple the typical pattern of the 1950s and 1960s. The top 1 per cent holds more than 15 per cent of national income— a near threefold increase over the 1970s, and well above the level consistent with stability.

Secondly, government should bring together the best available research on the most effective policy instruments – from tax and industrial policy to the role of collective bargaining and corporate governance – for meeting these targets.  When the targets are breached—as all of them are at the moment—then policy needs to be adjusted accordingly. Larry Summers, former adviser to President Obama and Treasury secretary under Clinton, has made a similar proposal in respect of fiscal sustainability and credit creation. He has called for the introduction of ‘contingent commitments’ with the Federal Reserve making assurances about action when thresholds are reached in areas like unemployment and inflation.

The level of inequality in society is too important to be left to the forces of the market and to the muscle-power of the few. But unless government takes a more decisive role, accepting its obligation to promote faster growth and its more even distribution, the gap between the runaway rich and the rest will continue to soar.

A longer version appears in the current issue of The Political Quarterly.

Although details are sparse, Miliband’s new thinking has the potential to become a critical turning point in Labour’s philosophy, one which marks the most significant move away from the third way politics of New Labour that we have seen to date.

At the heart of New Labour reformism was a new economic strategy – that freeing up markets would promote economic dynamism. Though this would lead to greater inequality, it was argued, this could be ameliorated by using the proceeds of higher growth to boost transfer payments, largely through a revamped tax credit scheme aimed at subsidizing the lowest paid. With Labour determined to disguise the costs and impact of the approach, it became known as a policy of ‘stealth redistribution’ by its critics.

For a progressive party, it was a strategy that was always difficult to defend. Taking a hands-off approach to markets meant that the income gap continued to rise under Labour, with the top one per cent holding an even larger share of total incomes by 2010. Although there was a big injection of support for families on low incomes, the impact on the historic level of poverty inherited in 1997 was relatively modest. Poverty fell but only through a huge hike in the cost of welfare spending.

Moreover, despite the theory, allowing a small financial elite to accumulate even larger fortunes did nothing to expand the size of the pie, with the surge in personal fortunes coming from the transfer of existing, not the creation of new, wealth. Despite the ‘stealth`, the strategy was always going to hit the inevitable political and economic limits to redistribution, especially as, with the continuation of a regressive tax system, the costs were born largely by those with middle incomes..

Miliband has acknowledged these failings and is hinting at an alternative strategy: one that aims to secure a more equal distribution of the pie before the application of taxes and benefits with less of the heavy lifting to come from income support. It is an approach that has even greater resonance with the prediction by the Institute of Fiscal Studies that the income divide is set to continue to widen even when growth returns.

How effective such an approach proves to be in capping and reversing current trends depends on how radical Miliband is planning to be. A weak version of pre-distribution might aim merely to raise the earnings floor a little, by boosting wages at the bottom. Any moves to raise the real value of the minimum wage and encourage the wider application of the living wage would be welcome, would help reduce poverty amongst the low-paid, but would have a marginal impact on wider inequality.

A much more radical step would require measures aimed at lowering the ceiling and breaking up the existing concentration of income and wealth. It would mean reversing some of the central and damaging economic trends of the last thirty years, crucially by raising the share of output paid in wages, and reducing the widening pay gulf of the last thirty years. This would mean building a very different economic and business model and would require a big shift in social and cultural norms and a much greater degree of intervention by the state. It would require different forms of regulation, the transfer of power from big business to the workforce through a boost to the role of collective bargaining, tougher boardroom constraints and the weakening of the economic grip still held by the City.

On his side, Miliband can draw on the mounting evidence that greater equality and efficiency go hand in hand, with more equal societies able to generate faster growth and greater dynamism. Taking the radical road would thus provide a more robust economy but would also mean a head-on clash with the powerful financial and big business vested interests that continue to control much of the British economy. But if Labour ends up taking the easier option, the consequence is clear: Britain will continue to sit at the near-summit of the global poverty and inequality league.

The key lessons of the 2008 crash are now becoming clear. For the last thirty years, some of the world’s most important economies have been applying a faulty theory on the way the economy works. Demand in most large economies is wage-led not profit-led. That is, a lower wage share leads to lower growth. This is also true in aggregate of the global economy.

The evidence from the last 100 years is that more equal societies soften, and more polarized ones intensify, the gyrations of the business cycle. Inequality is not just an issue about fairness and proportionality, it is integral to economic success. A capitalist model that allows the richest members of society to accumulate a larger and larger share of the cake merely brings a lethal mix of demand deflation, asset appreciation and a long squeeze on the productive economy that will end in economic turmoil.

Yet that model has survived the second deepest recession of the last 100 years largely intact. In contrast, the economic crisis of the 1930s was to give way to a very different model of political economy, one that eroded the extremes of wealth that had helped create the crisis.

Today, it is largely business as usual. The world’s rich have been the main winners from the global recession. In the United States, profits and dividends have risen since 2008 while real wages have fallen. According to the American economist, Emmanuel Saez, average real family income declined by a remarkable 17.4 per cent between 2007 and 2009.

Profits and dividends are up largely because wages are down. As JP Morgan Chase chief investment officer, Michael Cembalest, has documented, “U.S. labor compensation is now at a 50-year low relative to both company sales and U.S. GDP.”

A key consequence of this trend is that all income growth in the US in 2010  went to the wealthiest 10 percent of households, and 93 percent to the wealthiest one per cent.

In the UK, there has been a similar, if less extreme pattern. Real wages have fallen on average by seven per cent in the last two years and are set to continue to fall. Indeed, the independent Office for Budget Responsibility (the OBR) has forecast that the wage share will have fallen by a further four percentage points between 2010 and 2006. In contrast, incomes at the top have continued to rise through the slump. In 2007, the ratio of the median earnings of FTSE 100 top executives to median wages stood at 92:1. By 2011, it had risen to 102:1. Not only did executive pay greatly outstrip average earnings growth up to 2007, apart from a slight blip in 2009, it has continued to do so.

There has been much talk about the need to tackle growing inequality, but little real action. Ending the present crisis and building a sustainable global economy requires a much more fundamental leap that accepts that there is a limit to the level of inequality – one that is still being breached in a majority of nations – that is consistent with stability.

The successful management of economies depends especially on securing a more equal distribution of market incomes, before the application of taxes and benefits. Tackling the unequal “pre-distribution” of incomes means elected governments taking more responsibility for both the distribution of factor shares and of relative levels of pay.

It is a role that most, if not all, governments have been and remain reluctant to play. For most national governments – and global institutions from the IMF to the OECD – reducing inequality has not been a central economic goal alongside say, controlling inflation, or tackling fiscal deficits.

In the US, the UK and most rich nations, the economic role and impact of inequality has been at best a side-issue in economic decision-making. Too many governments have, by default, allowed the relationship between wages and output to become dangerously imbalanced. They have permitted remuneration practices to emerge that have distorted incentives and sanctioned business activity geared more closely to wealth diversion than wealth creation.

Translating talk into action requires governments to set clear targets for a number of key economic relationships. These should include the balance between wages and profits, the pay gap between top and bottom and the degree of income concentration. In a majority of countries, the wage share is too low and heading lower; the pay gap, already at historic highs, is heading higher while income concentrations are above the limit consistent with stability.

Meeting these targets means ditching many of the failed economic shibboleths – that inequality leads to faster growth, that allowing the rich to keep more of their own money boosts growth and tax revenue, that a larger pay gap reduces unemployment – of the last thirty years. It will require much tougher policy measures aimed at keeping economic elites in check. National governments need to develop a new contract with labour that raises the wage floor, bolsters the middle and lowers the ceiling. This means the taming of excessive corporate power and a rebalancing of bargaining power in favour of the workforce. It means moving towards more progressive tax regimes with much tougher global action on tax havens.

None of this will be easy. Despite the accumulated evidence that fairer societies and economic success go hand in hand, and the mounting pressure for change, the political and economic consensus remains rooted in the past. Radical change will be heavily opposed by those with most to lose. Yet a model of capitalism that fails to share the proceeds of growth more proportionately is not sustainable.

This article originally appeared on the ‘OECD Insights’ website.

The driving force behind the widening income gap of the last thirty years has been a shift in the distribution of “factor shares” – the way the output of the economy is divided between wages and profits.

In the first two decades after the Second World War, a transformed model of capitalism emerged – across the rich world – in which it was accepted that the fruits of growth should be more evenly shared than they had been in the pre-War era. In the US, the share of output allocated to wages rose and stayed high. In the UK the “wage-share” settled at between 58 and 60 per cent of output, a higher rate than achieved in the pre-war era and the Victorian age. It was this elevated wage share that helped drive the “great levelling” of the post-war decades.

From the late 1970s, the capitalist model underwent another transformation, one characterised by a backward shift in the way the proceeds of growth were divided. By 2007, the share of output going to wages had fallen to 53 per cent in the UK. In the US, the fruits of growth became even more unevenly divided, with the workforce ending up with an even smaller share of the economic cake. There were similar, if shallower trends in most rich nations.

This process of decoupling wages from output has led to a growing “wage-output gap”, with a very profound, and negative, impact on the way economies function. This is for three key reasons. First, by cutting the purchasing power needed to buy the extra output being produced, the long wage squeeze brought domestic and global deflation. Consumer societies started to lose the capacity to consume.

The solution to this problem – which would have brought a prolonged recession much earlier – was to allow an explosion in private debt to fill the demand gap. In the UK, levels of personal debt rose from 45 per cent of incomes in 1981 to 157 per cent in 2008. In the US, debt reached a third more than national income by 2008. This helped to fuel a domestic boom from the mid-1990s but was never going to be sustainable. Far from preventing recession, it just delayed it.

The same factors were at work in the 1920s. The 1929 crash was preceded by a sharp rise in inequality with the resulting demand gap also filled by an explosion in private debt. In 1920s America, the ratio of household debt to national income rose by 70 per cent in less than a decade.

Second, the intensified concentration of income led to the growth of a tidal wave of global footloose capital – a mix of corporate surpluses and burgeoning personal wealth. According to the pro-inequality theorists, these growing surpluses should have led to a boom in productive investment. Instead, they ended up fuelling commodity speculation, financial engineering and hostile corporate raids, activity geared more to transferring existing rather than creating new wealth and reinforcing the shift towards greater inequality.

Little of this benefitted the real economy. Of the £1.3 trillion lent by British banks between 1997 and 2007, 84 per cent was in mortgages and financial services. The proportion of lending going to manufacturing halved over the same period. It was this combination of the erosion of ordinary living standards and the accumulation of massive global cash surpluses that created the bubbles – in housing, property and business – that eventually brought the global economy to its knees. Again there are striking parallels with the 1920s when swelling surpluses in the US were poured into real estate and the stock market creating the bubbles that triggered the 1929 Crash.

Third, the effect of these trends has been to intensify the concentration of power with wealth and economic decision-making heavily concentrated in the hands of a tiny minority. In the US, such is the concentration of income, 5 per cent of earners account for 35 per cent of all consumer spending. A new elite has been able to exercise their muscle to ensure that economic policies work in their interest. Hence the inaction on tax havens, the blind-eye approach to tax avoidance and the scaling back of regulations on the City and Wall Street, policies that have simultaneously accentuated the risk of economic failure.

Not only did the growing income divide help to drive the global economy over the cliff in 1929 and 2008, it is now helping to prolong the crisis. UK wage-earners today have around £100 billion less in their pockets (roughly equivalent to the size of the nation’s health budget) than if the cake was shared as it was in the late 1970s. In the bigger economy of the US the sum stands at £500 billion. In contrast, the winners from the process of upward redistribution – big business and the top one per cent – are sitting on growing corporate surpluses and soaring private fortunes that are mostly sitting idle. This is a perfect recipe for paralysis.

The economic thrust of the last thirty years – greater reliance on markets, the weakened bargaining power of labour and hiked fortunes at the top – was aimed at dealing with the crisis of the 1970s, a mix of “stagflation” (stagnation and rising inflation) and falling productivity. It succeeded in squeezing out inflation but replaced these fault lines with an equally toxic mix – global deflation, rising indebtedness and booming asset prices – that eventually brought economic collapse.

Part 3 looks at the lessons to be drawn from these trends.

Read Part III here.

This article originally appeared on the ‘OECD Insights’ website.

There is one key reason for this lack of interest. For the last thirty years, the economic orthodoxy has been that inequality is a necessary condition for economic success. We can have greater equality or faster growth but not both. That orthodoxy emerged out of the global crisis of the 1970s when, it was claimed, the move towards more equal societies in the immediate post-war decades had gone too far and had led to economic sclerosis. What was needed to put economies back on an upward and sustainable path was a stiff dose of inequality.

Since the late 1970s that theory – for theory it was – has been put to the test in a real life experiment in both the US and the UK, and more latterly in a number of rich countries. As a result, the income gap in America and Britain has grown to levels last seen in the inter-war years. So has the experiment in “unequal market capitalism” worked in the way predicted by the theory? The answer appears to be no. The income gap has surged but without the promised pay-off of wider economic progress.

On all measures of economic success bar inflation, the post-1980 era of rising inequality has a much poorer record than the egalitarian post-war decades. In the UK, growth and productivity rates have been about a third lower since 1980 than in the post-war era, while unemployment has averaged five times the level of the 1950s and 1960s. The three post-1979 recessions have been deeper and longer than the shallow and short-lived ones of the two post-war decades. The main outcome for the countries that have embraced the post-1980 model of market capitalism most fully has been economies that are both much more polarised and much more fragile, culminating in the great crash of 2008 and today’s increasingly prolonged and intractable crisis.

So does this mean the theory is fundamentally wrong? Do high levels of inequality lead to economic collapse? Was rising inequality from the 1980s onwards in fact a central player in driving the global economy over the cliff in 2008, and in the dogged persistence of the current slump?

The official view is that inequality played no part in the present crisis. The report of the bipartisan US Financial Crisis Inquiry Commission into the causes of the 2008-9 Crash, published in January 2011, for example, failed to mention “inequality” once in its 662 page report.

Two years ago the handful of economists who argued that inequality was the real cause of the current crisis were easily dismissed as an insignificant and heretical minority. The political consensus remained that inequality was not an economic issue. Yet gradually, opinion is beginning to turn. At the 2011 World Economic Forum in Davos, Min Zhu, former Deputy Governor of the People’s Bank of China and a special adviser at the International Monetary Fund, told his audience: “The increase in inequality is the most serious challenge facing the world.” In his economic address in Kansas last December, President Obama attacked the long period of stagnant earnings facing most Americans, or what he called the erosion of the “basic bargain that made this country great”. “But this isn’t just another political debate”, he continued, “this is the defining issue of our time.”

At the OECD’s annual conference in Paris last month, the packed agenda was dominated by the issue of the growing divide, while the IMF has produced several reports that question the orthodox explanation of the role of inequality. In one study, two IMF economists, Andrew Berg and Jonathan Ostry, argue that the 1970s theory – by Arthur Okun in his highly influential book Equality and Efficiency, The Great Trade-Off – has failed to stand up to real world application: “When growth is looked at over the long term, the [efficiency/inequality] trade-off may not exist. In fact equality appears to be an important ingredient in promoting and sustaining growth.”.

Not only has the rise in inequality failed to deliver on faster growth, history shows a clear association between inequality and instability. The great crashes of 1929 and 2008 and the deep-seated recessions that followed were both preceded by sharp rises in inequality. In contrast, the most prolonged period of economic success and stability in recent history – from 1950 to the early 1970s – was one in which inequality fell across the rich world and especially in the UK and the US.

Of course, association is one thing, causation is another. In part 2, we will look at the reasons why the link may run from inequality to crisis, and at why economies that allow a small minority to colonise an increasing share of the economic cake raise the level of economic risk and the likelihood of implosion.

Read Part II here.

This article originally appeared on the ‘OECD Insights’ website.

Professor Ruth Levitas at the University of Bristol has called it a ‘factoid’ – an apparent fact but one without substance.  The figure originates from an eight-year old study which found that about two per cent of families surveyed suffered from five or more of seven characteristics: no parent in work; lives in overcrowded housing; no parent has any qualifications; mother has mental health problems; at least one parents has a long-standing limiting illness or disability; has low income (below 60% of median income – the mid-point of the distribution); cannot afford a number of food and clothing items.

As Levitas shows, we cannot even be sure that there are 120,000 families with these difficulties. ‘Since it is a sample survey, the actual figures may be substatially lower or higher, possibly as high as 300,000.’ But the key point is that these are households experiencing multiple deprivation, with no evidence at all that they are involved in crime or anti-social behaviour.

Despite this, the government goes on to make a big and entirely unjustified jump. Families suffering from multiple deprivation are suddenly transformed into ‘troubled families’ with the implication that they are dysfunctional, cause trouble and, another oft-repeated figure, cost the state an alleged £9 billion a year.

The government is misusing statistics compiled by civil servants in order to defend an ongoing and high profile government campaign, one that is being couched in increasingly immoderate language. In December 2011, the Prime Minister talked of a ‘shameless culture’, on of ‘disruption and irresponsibility that cascades through generations.’ In his interview with the Independent on Sunday, Pickles went further: ‘Sometimes we’ve run away from categorising, stigmatising, laying blame.’

There is now an apparently growing trend towards greater intolerance to the poor and those on benefits. In a recent study of a sample of 1,750 newpapers from three different countries, the UK, Sweden and Denmark, it was found that in the UK, 19 per cent of stories about the poor were related to abuse, whereas such stories were almost absent in Sweden and Denmark. Stories about people in poverty were twice as likely to be negative in the UK. Take these from the comments section of the interview with Pickles: ‘scum’; ‘pointless lives’; ‘layabouts and spongers with their feral kids’; ‘stop them breeding’.

The likelihood is that such attitudes are fuelled by other popular myths about benefits and welfare. Speaking on BBC’s Question Time last week, the editor of the Spectator magazine, Fraser Nelson, announced that ‘our benefits are some of the most generous in Europe’. In fact, as the global club of rich nations, the OECD, has shown, benefits in the UK are typically much less generous than in other rich countries, especially when it comes to benefits fro the newly unemployed. Indeed, the value of Jobseeker’s Allowance has fallen by half in relation to typical earnings over the last thirty years.

The government – and its backers – it seems, have been preparing the ground for a weakening of the commitment to tackling poverty embraced by the 2010 Child Poverty Act, despite gaining all-party support. The Work and Pensions Secretary, Iain Duncan Smith, has repeatedly asserted that generous benefits are not the way to reduce poverty.

A report recently published by the Centre for Social Justice, a right-of-centre thinktank, has voiced ‘serious concerns’ with the poverty measures contained in the Act. The Centre claims, for example, that a relative poverty measure is ‘methodologically flawed’ in that ‘the poor will always exist statistically’, making the 2020 child poverty targets ‘almost impossible to achieve’. An identical claim has also been made by both the government’s poverty czar, Frank Field and the Work and Pensions Secretary. As Duncan Smith put it, ‘You get this constant juddering adjustment with poverty figures going up when, for instance, upper incomes rise.’

Yet this is complete nonsense. If the rich get richer, as they have, there is no effect on the median- the poverty line stays exactly the same. If all households below 60% of the median were to rise above it, poverty would be eliminated. Both Iain Duncan Smith and Frank Field are, inexcusably or deliberately, confusing the median with the mean, which is the average income calculated by dividing the sum of all incomes by the number of people in the distribution.

The new statement on the ‘120,000` families and its attempt to create a culture of blame is thus part of a wider pattern, one contributing, wittingly or otherwise, to an increasingly hostile climate towards the growing numbers forced onto benefits.

But despite this pressure, tax revenue has often lagged well behind. Take the UK. Between 2001 and 2007, spending as a share of GDP rose by four percentage points from 36.8 per cent to 40.9 per cent, largely as a result of improved health, education and welfare programmes. Although this was quite a jump, it did little more than reverse the fall in spending over the previous two decades. Tax revenue, in contrast, remained static at 38.6 per cent of the economy over the period. As a result of this rising fiscal gap, the national debt rose from 30 to 37 per cent as a percentage of GDP.

Chart: UK tax revenue as a share of GDP, 1976-77 to 2010-11

The share of tax revenue in the economy peaked in the UK in the early 1980s at over 45 per cent. It then fell sharply over the next decade and since the early 1990s has settled at the much lower average of 37-38 per cent. Although cutting tax was a deliberate policy, this has meant that tax revenue has fallen short of public spending for most of the last 20 years (though some of this shortfall is explained by the use of borrowing to fund capital spending).

Ultimately, of course, such shortfalls are unsustainable. Either governments need to moderate their public spending plans, or they must find ways of raising the tax-take. So what explains the apparent long term stagnation in revenue? Three main factors have been at work.

• First, the reforms of the tax system introduced by the Conservatives in the 1980s. The top rate of income tax on the rich was cut from 83 per cent to 40 per cent while the share of taxation taken from indirect taxes like VAT was increased. Up to the mid-1980s, the tax system had been progressive – those on the highest incomes paid a higher proportion of their incomes in tax than those on low incomes. In 1979, the top fifth paid 37.6 per cent of their incomes in tax and the poorest fifth paid only 30.5 per cent. The effect of these reforms was that by the mid-1980s, the tax system had moved from being progressive to regressive – these shares where reversed.
• Second, the rising share of the national cake in the hands of the rich. The share of net income held by the top one per cent has nearly tripled in the UK, standing at over 15.4 per cent in 2009 compared with a low point of 5.6 per cent in 1978.
• Third, the explosion of tax avoidance amongst the highest earners over time.

The combined effect of these three changes has been that since 1979, the share of earnings paid in tax by those in the top one per cent has fallen from over a half to around a third, while the average tax rate on most of the rest of the population has risen to over 35 per cent.

Supporters of the 1980s reforms have long argued that by boosting economies, lowering tax rates would actually increase revenue – the so-called Laffer curve. This is the argument used by the Republicans in the United States to cut taxes on the rich and by George Osborne to cut the 50p tax rate in the last budget. But the evidence has long been clear. Cutting tax rates does not increase revenue. Along with many contentions of market advocates, the ‘’dynamic effect’ from lowered taxes at the top is a myth.

The policy strategy of the last 30 years – making economies more unequal while cutting tax rates on the rich – neither leads to a larger economic cake nor to boosted tax revenue. Instead it simply shrinks the tax base. The latest evidence for this comes from a significant paper from Thomas Piketty , Emmanuel Saez and Stefanie Stantcheva.

They show that the optimal rate of tax on the rich – the rate which maximizes revenue – is well above current rates. Indeed, it has recently been disclosed in an interview with the former cabinet secretary, Lord O’Donnell, that George Osborne was advised by the Treasury that the optimum tax rate is 48p, higher than the 45p rate introduced in the last budget. Piketty and his colleagues suggest it is a good deal higher than this.

The lesson is clear. To maintain high levels of public spending without increasing the level of public debt requires steering economies in the direction of more progressive tax systems with a much larger contribution from the very rich. Although Labour eventually raised the top rate of income tax to 50p, they could and should have done more – and earlier – to increase taxes on the very rich. Even the secretary-general of the OECD, Angel Gurrí, has called on rich nations to reform ‘their tax systems to ensure that wealthier individuals contribute their fair share of the tax burden’.

Stewart Lansley is the author of The Cost of Inequality: Why Economic Equality is Essential for Recovery, Gibson Square, 2012.

Faced with the impact on living standards of a rise in the extent of low pay – which almost doubled in the 20 years from the late 1970s – governments have two options. First to let relative incomes at the bottom sink and poverty rise. This was broadly the policy response of Conservative governments from 1979. As a result, the level of relative poverty doubled between 1979 and the mid-1990s. One of the main causes of this surge in poverty was a sinking wage share and the decline in relative pay below the middle.

The second option is to intervene to raise income levels at the bottom. This was the one adopted by Labour. Yet because pay inequality continued to rise from 1997, the three Labour governments had to work much harder merely to hold the line on poverty and inequality. Just to stabilise the level of poverty, Labour poured public money into anti-poverty programmes, raising the incomes of the low paid, notably through the introduction of a generous tax credit system. Without this extra support, the level of in-work poverty and the extent of inequality would have risen even more sharply.

One of the consequences of these wider labour market trends and the adoption of the second option has been an extension of the social and economic obligations of the state. Over the last fifteen years, governments have chosen to do more heavy lifting to protect the workforce from the impact of a more market-orientated economy. Without this extension, poverty levels and the income gap would have been even higher. This applies not just to income support but also to jobs. As unemployment levels mounted from the early 1980s, settling at around five times higher than in the 1950s and 1960s, job opportunities in the most de-industrialised areas of the UK became increasingly dependent on an expansion in local public sector jobs. In some parts of the UK, purchasing power has shrunk to a level that cannot sustain much private sector activity, leaving the state with the lead economic role.

In the process, these trends have had important implications for the health of public finances. Under Labour, public spending on welfare support rose from 12 to 15 per cent of GDP. A good deal of the rise in public spending was to limit the social impact in increasingly jobless communities This meant higher taxes while putting pressure on work incentives. In the UK, the rising cost of anti-poverty and state job creation programmes has put greatly increased pressure on public finances and may well have contributed to a structural fiscal deficit, albeit one that was largely hidden in the artificial boom of the post-millennium era.

Moreover, because Labour did not make simultaneous moves to undo the regressive character of the tax system, most of the burden of the rising taxes to fund these programmes was felt by those on middle incomes – ‘the squeezed middle’ – a group already under pressure themselves from the changing nature of the British model of capitalism that had brought declining opportunities and falling relative earnings compared with those at the top.

These trends raise a vital issue for the appropriate role for the state. Is it best to leave the market to work relatively freely in determining job opportunities and wages and then intervene with a more pro-active income support system and job creation programmes? This was the option adopted by Labour. By the end of their time in office, for example, the UK stood close to the bottom of the league table of rich nations when it came to employment protection.

Alternatively, is it better for the state to intervene more directly in the market process, through polices aimed at modifying what economists call ‘pre-distribution’: the way rewards are distributed by markets before state income support comes into play? The answer has to be yes. By adopting the minimum wage, Labour accepted the need for some intervention in labour markets. But this was about as far as it went. It is now becoming clear that a much more balanced twin-approach is required, one that attempts to modify the distribution of incomes arising under markets, as well as intervening to change the distribution of post-market incomes. This is now set to become an increasingly important part of the debate about how to fashion a society in which rewards are more fairly distributed.

Stewart Lansley is the author of The Cost of Inequality, Gibson Square.