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

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 ParetoI or ParetoII (generalized Pareto) models, and the choice of income threshold above which the Pareto models apply. The preferred specification is a ParetoII 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%.