2  Background and Data Description

Before describing the income distribution trends and changes, in this section we first briefly outline the broad economic and labour market trends over the period since 1991, and then discuss the salient features of the data to be used in the analysis. Readers who are primarily interested in the distributional changes may wish to skip the discussion of the data in section 2.2.

2.1  Background

Figure A1 describes the pattern of the business cycle over the period since 1991, as measured by the unemployment rate and GDP per capita growth. A vertical line at 1997 marks the beginning of our observed sample period. This period can be split into three sub-periods. First, the early to mid 1990s (and before our sample period) was a period of substantial growth: the unemployment rate declined steadily from over 10.5 percent in 1991 to 6 percent in 1995-96, while per capita real annual GDP growth was between 2-6 percent over the 1993-97 period. Second, this was followed by a contraction in economic activity during 1997-98, and corresponding to the early part of our sample period: unemployment increased from 6 percent to 7.5 percent in 1998, and per capita annual GDP growth was negative for 5 quarters during 1997 and 1998. Finally, late 1998-2004 the economy expanded continuously: the unemployment rate fell steadily to around 3.5 percent by the end of 2004, and per capita annual GDP growth was always positive and averaged 2-3 percent over the period.

In our analysis below, we first describe the annual trends in various income distribution summary statistics over the full period 1997—2004, and then concentrate on the changes that occurred between the 1998 and 2004 years. We choose 1998 in preference to 1997 as the initial year for the analysis largely because 1998 is the end of period for much of the earlier literature on income distribution changes during the 1980s and 1990s. Note, also, that the bottom of the most recent business cycle occurred in 1998, so that our analysis may be viewed as a trough-to-peak analysis of distributional changes over this period.

Both the strong economic upswing and the absence of major policy change or economic shocks over the data period, suggests that distributional changes will flow through labour market outcomes. Largely for these reasons, our analysis focuses on working-age individuals, defined as those aged 15-64, as the unit of observation. The primary outcome of interest is individual total income. However, recognising that individuals tend to both share resources and also have obligations to dependents within their family unit, we also consider a measure of the “equivalised” household income associated with working-age individuals that takes account of both of these factors.[4] In particular, we adopt the so-called Luxembourg Income Scale (0.5), LIS(0.5), that divides total household income by the square root of the (total) number of persons in the household, and assign this value to each working-age individual in the household. Our analysis of equivalised income changes also incorporates more household-level information than the analysis of individual (non-equivalised) income changes.

There are some, potentially important, caveats to acknowledge for the analysis. First, our measures of income exclude family support and other tax credits that are becoming increasingly important components of the family welfare system, although the period of analysis predates the introduction of the recent Working for Families package of changes. Second, and related, except for a very simple estimate of post-tax income, our measures of income are essentially pre-tax gross income. Thus, in the context of equivalised incomes, it is important to recognise that the adjustment is in terms of gross and not disposable household income.