The shrinking pound in your pocket
Nearly everyone's feeling squeezed these days, and for good reason. New research published today in association with the BBC shows that after tax, the real income of the median household in the UK, right in the middle of the income distribution, will be 1.6% lower in 2011 than it was in 2008. That's a loss of around £365. Usually, they could have expected their income to have risen by nearly £1140 over that period.
This represents the greatest 3-year squeeze in real living standards since the early 1980s. Looking at the likely prospects for the next few years, the IFS reckons that the real income of the median household will still be lower in 2013 than it was in 2008 - meaning the largest 5 year drop in living standards since the early 1970s.
As we all know, it's not just the recession that has hit household incomes - there's been a triple whammy of slow or no growth in the economy, above-target inflation and tax and benefit changes to cut government borrowing. In advance of the Budget, I asked the IFS to try to estimate exactly what had happened to real household incomes as a result of all these different factors - and which had done the greatest damage.
The result of that work is the research published today. Here's what I found most interesting in these figures.
First, for most households, low interest rates and high inflation have had a much greater impact on their real incomes than either unemployment or tax and benefit changes. If you break down that £365 loss in post-tax income for the median household, only £79 is directly attributable to loss of employment. About £203 has been lost as a result of earning less interest on savings, and another £203 has been lost as a result of their wages not keeping up with inflation.
You might wonder why those losses add up to more than the total loss of £365 a year. The answer is that changes in benefits and direct taxes over this period have actually raised the income of the median household between 2008 and 2011, by about £120. This includes the changes coming in April.
That's the second striking element of these findings. Only households in the top fifth of the income scale or the bottom tenth, on average, have lost out from changes in direct taxes and benefits over this period. Everyone else, on average, has gained.
How can this be true? One part of the answer is that the VAT rise is not included in this heading, because it is already included in that £203 loss of real earnings, due to inflation rising faster than wages.
If you think about the way we pay for that VAT rise, we pay for it in higher prices - and the increase in VAT is a large part of the reason why the target measure of inflation is now running at 4%. It would be double-counting to measure the impact of higher VAT directly as well as taking inflation into account.
These numbers don't take account of the benefit cuts that are coming after 2012, many of which, like the cuts in housing benefit, will cut the income of many households. Inevitably, the indirect effects of public service cuts are also excluded here. But we often forget that the government is also raising the personal tax allowance by £1000 from April. That will boost real incomes for a large part of the income distribution, even if the government will be taking it away in other ways.
That brings me to another point: These figures show that by far the tightest squeeze on incomes, in percentage and absolute terms, has been to the richest households. A family in the 95th percentile - right in the middle of the top tenth of households will be 3.8% worse off, in real terms, than they were in 2011. That's a fall in their annual income of around £2230. Nearly £600 of that is due to the loss of benefits or higher direct taxes, with around £815 due to lower interest on their financial assets or other savings.
I suspect few will shed tears for this group. There will be more concern that the household in the 5th percentile - in the middle of the bottom tenth of the income distribution - will have lost around £35 a year from tax and benefit changes, compared with a gain for the median household of around £120. (Although, as ever, the IFS would note that the bottom tenth contains a lot of students or self-employed people with highly variable income, whom we would not necessarily consider poor).
The other group that has lost relatively more than other groups has been pensioners. The median pensioner household will have seen their real annual income fall by 2.4% since 2008, or £456. In more normal times, the income of this "typical" pensioner household would have risen by nearly £960 over that period. Unlike most other groups, tax and benefit changes have also left pensioners slightly worse off - with a net loss for the median pensioner household of just under £13 a year.
That brings me to the final point to note: the relative importance of low interest rates in squeezing real household income. That is responsible for the lion's share of the loss in pensioner income - more than £350. But even the typical household with kids has lost about £77 a year as a result of lower interest income.
You might think it strange that the IFS has included the negative impact of low interest rates for savers - and not the direct benefit of lower borrowing costs for households with mortgages. The measure of household income they use is after taxes, but before housing costs. But, once again, the impact of lower rates is included in the RPI measure of inflation that they've used in calculating the change in real earnings.
If interest rates had not fallen so far, then the loss in savings income would have been smaller, but the loss of real earnings from employment would look a lot larger, because the RPI measure of inflation would have been even higher than it actually was. For that reason, the IFS believes it has fully taken into account the fall in mortgage rates.
As anyone with a mortgage will tell you, mortgage rates have not fallen nearly as far as the official base rate. There are households who were on tracker mortgages when rates were slashed, who have seen a massive boost to their net income, but they are not the majority. (And many of them will have had to re-negotiate their mortgage by now, because that particular deal has run out). By contrast, savings rates have generally fallen in line with official rates.
That is how loose monetary policy is 'supposed' to work after a financial crisis - low interest rates help banks rebuild their balance sheets by widening the gap between what they charge borrowers and what they pay to savers. That will be little compensation to families who feel they are being squeezed on all sides. For most, they would be right in their suspicion that the recovery has been more painful so far than the recession.