Pareto Models, Top Incomes and Recent Trends in UK Income Inequality

• Published in: Economica (London) Vol. 84; no. 334; pp. 261 - 289
• Main Author: Jenkins, Stephen P.
• Format: Journal Article
• Language: English
• Published: London Blackwell Publishing 01.04.2017; Blackwell Publishing Ltd
• Subjects: Economic models; Income inequality; Income tax returns; Pareto optimum; Tax returns; Taxation; Trends; United Kingdom; United Kingdom > UK
• ISSN: 0013-0427; 1468-0335
• DOI: 10.1111/ecca.12217

I determine UK income inequality levels and trends by combining inequality estimates from tax return data (for the 'rich') and household survey data (for the 'non-rich'), taking advantage of the better coverage of top incomes in tax return data (which I demonstrate) and creating income variables in the survey data with the same definitions as in the tax data to enhance comparability. For top income recipients, I estimate inequality and mean income by fitting Pareto models to the tax data, examining specification issues in depth, notably whether to use Pareto I or Pareto II (generalized Pareto) models, and the choice of income threshold above which the Pareto models apply. The preferred specification is a Pareto II model with a threshold set at the 99th or 95th percentile (depending on year). Conclusions about aggregate UK inequality trends since the mid-1990s are robust to the way in which tax data are employed. The Gini coefficient for individual gross income rose by around 7% or 8% between 1996/7 and 2007/8, with most of the increase occurring after 2003/4. The corresponding estimate based wholly on the survey data is around −5%.