Fine bread- or just the crumbs?
A tired (and possibly emotional) actuary sends me a late night mail which starts..
What is the tax relief deal? Govt in effect borrows money over 40 years on average to invest in whatever DC investors invest in and gets something like 2/3 back, at a guess. (Allowing for tax free and band slippage).
What is the point of that ? What exactly are the other policy gains?
The argument is along the lines of the pre RDR “what has commission ever done for us?” thread. But unlike the Romans, who brought lasting improvements to society, neither commission or tax-relief have radically achieved the aim of a strong second pillar of retirement savings.
Tax relief, like commission, is a crutch that keeps the established order in cakes and ale. Without tax-relief we would have fewer conferences, less corporate sponsorship at Twickenham and the “no-brainer” culture of saving into occupational and personal pensions would be stalled if not de-railed.
Thomas Phillipon, the notable American academic, reckons that the Financial Services industry has operated a 2% pa rake on people’s savings over the past 150 years. That is 20% of the growth on a fund when growth is good and around 50% of the anticipated return in the “new normal of 4-5% anticipated growth rates.
My friend’s estimates of the tax retrieval from an EET system, reckon without the financial services tax (which puts George Brown’s 10% dividend tax raid in the shade.
If I was to be as cynical as I ought to be, I would answer my friend’s question by pointing to the quality of bread on his (and my) table. It is made of fine flour and purchased from fine shops.
Tax relief cannot be justified as putting fine bread on our table
The creation of debt to fund tax-relief to put fine bread on the table of the pensions industry, is not- by any measure a “policy gain”.
What is more, Osborne is in a strong enough political position (and ambitious enough) to shoot the lights out.
If you really want to crack the systemic weakness in the British Economy, the enormous fiscal support of the financial services industry, you make that industry stand on its own two feet and compete for savings on a level playing field with direct investment in housing, investment in small business and dis-intermediated participation in the prosperity of listed companies through work-place share save.
This is certainly not what the financial services industry wants to hear but it may be what the country needs to hear – if Osborne is to pull a “killer rabbit” out of the budgetary hat.
Deckchairs on the Titanic
Another person I greatly admire, Paul Lewis, asked me recently why the ABI had converted to a flat rate of tax-relief from its long-held belief that the loss of higher rate tax-relief would spell the end of pension saving.
My answer was that maintaining a credible system of wealth distribution to those paying taxes was preferable to a progressive system of wealth re-distribution – at least for the insurers.
The canny insurers who have pulled up the drawbridge on auto-enrolment and stopped staging new schemes – recognise that shareholders have to wait a long time to see a return on investment in small pension pots. That is why we see nothing of Fidelity, Black Rock and Zurich when looking to place schemes for SMEs and Micros.
There is nothing wrong with cherry-picking. It is what shareholders want and – so long as there is competition at the bottom end of the market- the withdrawal of these insurers from providing new workplace pensions is of little consequence.
But the ABI know that the market in which their members make their money, is highly dependent on the huge injection from both the income tax and national insurance pools, associated with tax-relief and national insurance.
Without commission to incentivise savings, insurers and fund managers would have no lever- were the conventional tax-tilts to be removed – to attract the long-term savings into pension policies.
But the ABI may be doing no more than re-arranging deckchairs on the Titanic
It is extremely hard to argue for tax-relief on any “policy” grounds.
Pension tax-relief is regressive, rewarding the rich at the expense of welfare.
It is partisan, rewarding the financial services industry at the expense of other parts of the economy.
It is wasteful, encouraging inefficiency in the financial services industry itself.
There are – as people like Con Keating point out – other ways to provide people with a firm second pillar to their post retirement savings. Con would point to the German Book Reserve System and David Pitt-Watson would point to the Dutch CDC approach. Neither are perfect, but both are a lot less dependent on state support and less dependent on the services of the City.
What should be done?
Pension PlayPen argued in its submission to the consultation on tax-relief, that nothing short of a wholesale shift away from tax-relief by right would do. In a world where Government knows who is paying what (through RTI), the option to target savings incentives exists (as never before).
A fairer consensus can be built around Government borrowing money to pay people to save – WHO WOULD OTHERWISE BE A BURDEN ON THE STATE.
That is the point of auto-enrolment, a pensions system that – while not as efficient as S2P/SERPS, does have the grudging approval of the nation.
The cost of incentivising the savings of up to 10m new savers will be immense. We cannot afford auto-enrolment and tax-relief (as we now know it).
We should prepare for radical reform and for some severe belt-tightening.
Have you yet again forgotten that it is NOT tax RELIEF, it is tax DEFERRAL?
If you use the correct terms the current private pensions framework makes good sense. But I suppose that presenting this in a fair way wouldn’t suit your agenda…
I’ll have to re-think what my agenda is supposed to be- can you explain?
Henry this article is a polemical giggle, but really is missing the point. The primary purpose of the tax relief system is to ensure that people who are saving for the long term do not experience their income being taxed twice ( on the way in and on the way out of their pension ). This type of double income tax would deter any rational person from saving as in effect saving ( deferral of consumption ) would be taxed more harshly than immediate consumption. The vast majority of tax relief is simply a matter of maintaining the tax neutrality of saving. If your actuarial friend doesn’t get this perhaps he should take a basics course in economics.
In principle both EET and TEE regimes can achieve the goal of making saving tax neutral. In a EET world the provision of tax relief is not a subsidy, it is simply the deferral of taxation to match the deferral of income by the saver. It provides great certainty that your saved income will not be taxed twice. In a TEE world savers have to pay tax up front and then wait for 30-40 years with their fingers crossed to see if a future chancellor will actually honour the promise not to tax it again when they draw an income from their pension. Hence the likelihood that long term saving will be lower in a TEE / Pension ISA world, due to the greater uncertainty over future returns.
There are two major ways that the current EET system delivers incentives to save over and above basic tax neutrality. One is the tax free lump sum, which is an intentional incentive, but since it is uncapped it is of greater absolute value to those with the highest pension pots / deferred incomes. The second incentive is unintentional and arises from the fact that a high proportion of those people who receive higher rate tax relief only pay basic rate tax in retirement as their incomes are lower than when they were working and saving. This is where the proposal to move to a flat rate of tax relief comes in, although like all reform of the system it has pluses and minuses.
I do completely agree with you that maintaining a tax neutral system for long term saving that gives certainty to savers is in the interests of the pension providers, but it seems to me it is also in the interests of those well paid consulting actuaries and everyone trying to help people get better results from saving. This doesn’t feel like a conspiracy to me, just a sensible common interest.