Should the Office for Budget Responsibility also forecast inequality?

Published on Incomes and Inequality

The strengths and weaknesses of economic forecasting are under scrutiny, perhaps like never before. How might GDP perform under different Brexit policies compared to a world with no Brexit? Is unemployment now likely to rise or fall? What will public borrowing in 2022 be? Whatever your politics, such modelling and forecasting is indispensable – so long as its limitations are appreciated. But whose job is it to forecast inequality?

We have just released our own projections for household disposable incomes. These are not based on new modelling of economic fundamentals but, rather, combine the latest official forecasts from the Office for Budget Responsibility (OBR) with the default tax and benefit system that will exist unless policy changes. Crucially, this allows us to explore not just aggregate figures like average income but how different groups might fare and the outlook for income inequality. It is a projection not just for growth but for the distribution of growth.

For example, while in our projection average household incomes (after housing costs) rise by a fairly weak 3 per cent between 2016-17 and 2020-21 after accounting for inflation, this hides an increase of 4 per cent for the richest third of the population and growth of zero for the poorest third. As shown below, we therefore project an increase in inequality after 2016-17 – maybe even to record highs on some measures.

Figure 1: Various measures of inequality (after housing costs), with RF projection

There are a number of reasons why the OBR might do well to go beyond mean averages to give at least some distributional element to economic forecasts – potentially ranging from giving medians to full growth distributions all the way to explicit inequality and poverty forecasts (the latter being a recommendation of the Joseph Rowntree Foundation).

First, for most people a forecast for the actual finances of typical households is more meaningful than aggregates like GDP. Second, for a lot of voters and politicians inequality and poverty are important societal metrics just as overall levels of income are. Indeed, thirdly, in some cases the UK has formal targets to meet, where it is especially useful to have forecasts. Previously this included goals (now abolished) to reduce child poverty. Now, there are the international Sustainable Development Goals to which the UK is committed – which include domestic targets for reducing poverty and delivering above-average growth for the poorest 40 per cent of the population. Finally, the OBR might reasonably be concerned that the distribution of income (and debt) matters for demand or economic stability.

While our distributional forecasts (and those done by the IFS) have taken a lot of work, replicating this process would be well within the ability of the OBR and government departments with only minimal extra resource.

You might think inequality is hard to predict. And indeed there are many inputs: employment, the pattern of wage growth, demographics, taxes, benefits, even expected housing costs. But for the most part we already know what future tax and benefit policy will be (in the absence of policy change); policies like the National Living Wage are relatively easy to model; and demographics too are relatively predictable. The most uncertain part of forecasting inequality is the underlying economic forecast (prices, productivity, unemployment etc.).

As with any economic projections, we shouldn’t expect to be able to make super-accurate inequality forecasts. But nor does it take a super-computer to work out that £14 billion of working-age welfare cuts will apply great upward pressure to inequality and poverty. As our projections below show, the bottom part of the working-age income distribution may as a result be facing several years of falling real incomes. In comparison to such intuitive and mechanical tax and benefit impacts, forecasting how rapidly productivity will grow (which is a central part of the OBR’s existing projections) is essentially guesswork.

Figure 2: RF projections for real household disposable income growth (after housing costs) by working-age income percentile

So, in among the OBR’s many, many forecasts – from house prices, to the balance of trade, to landfill, tax revenues and BBC expenditure – there is a case and the potential for it to include projections for the distribution of household income growth and/or income inequality.

There is a strong counterargument: that the OBR’s primary role is to produce independent forecasts about public borrowing – a ‘fiscal watchdog’ – and that to do more would be to distract it from this goal. Similar arguments have been made about other proposals for the OBR to extend its remit: such as to look at the fiscal plans of opposition parties, or to “include the impact of climate change and environmental damage in its long-term forecasts”. Certainly nobody should want the OBR to become politicised, with each administration changing its remit to reflect their own priorities: any amendment – which would likely require legislative change – should only be done after careful consideration.

In addition, there are lots of ways of measuring ‘inequality’ with no single right answer. These include judgement calls about which parts of the income distribution matter most: whether what really matters is poverty, or perhaps even the economic power of the top 1 per cent. There is a choice about whether it is relative gaps (e.g. one household having five times the income of another) or absolute gaps (e.g. one household having £50,000 more than another) that matter. There are concerns about the quality of household income data. And there is a big question about whether ‘income’ is the best measure of living standards at all. But these are important debates to have, and the very process of producing forecasts (and explaining when they change) would contribute to economic science and discussion.

It is true that inequality is inherently political. But then so are projections for borrowing, employment and growth. And just as the government and public find it useful to have projections for these latter measures – as a basis for discussing further policy changes –forecasts for inequality are equally important for informing debate about what kind of country we want to become.

The Resolution Foundation will continue to do projections of income and inequality – in large part based on OBR economic forecasts – and I certainly don’t wish to put myself out of a job. But given that it would be possible for the OBR to do the same, the question that remains is whether it should.