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The IFS partly attributed the fall in average income to the tax and national rises in the 2002 Budget.
The report also said that the biggest above-inflation increases in council tax to date under the current government reduced average incomes by a further 0.3%.
However, the IFS found that the incomes of poorer households were boosted in 2003/04, largely due to the introduction of child tax credit and working tax credit, which the report described as "more generous" than the credits and benefits they replaced.
The report found that the new tax credits had helped to reduce income inequality for the third successive year. The IFS reported that the incomes of the poorest fifth of households rose by around 1% in 2003.04, while the income of the richest fifth of households fell by around 1%.