Right in principle – wrong in practice. Ros Altmann’s tax reforms need more work

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Ros Altmann is bang on the money when proposing we link healthcare and pensions in her most recent blog

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The big picture policy issue for the UK is how to afford a healthcare system that is free at the point of delivery for everyone, including those who suffer chronic health problems in later life.

It is not impossible to see a realignment of Government departments so that we have a department of work and savings and another for health and pensions. If work is how we save, then health is what we spend those savings on. That goes for private individuals who transfer through their pension pots , as much as it does for Government which uses the mechanism of taxation.

Bravely, Altmann is confronting the biggest elephant roaming the state rooms.

  • Could Government commitment to sort out NHS pensions herald radical pension reform? 
  • NHS problems are canary in the coalmine showing need to urgently change pensions tax rules. 
  • Tapered Annual Allowance and Lifetime Allowance should be changed or abolished. 
  • Reforming the £50billion annual cost of pensions tax reliefs (which gives top earners most help) could raise much-needed revenue AND improve pension outcomes.

Most people in the NHS and in pensions are aware of the local problem the Annual Allowance taper is giving high-earning clinicians in the NHS, a broken pension tax system is creating a drop in productivity amongst our most valuable doctors.

The Government has proposed a fix to the AA-taper issue which will be announced on budget day- March 11th

2019/20. The majority (£132.3 billion) of this is revenue funding for spending on day-to-day items such as staff salaries and medicines. (source Kings fund).

This cost of the NHS is set to escalate and part of that escalation will be the cost of refunding monies to doctors who – because of pensions – are finding themselves paying tax on slices of their earnings in excess of 80%.

The elephant that roams the state rooms is bellowing that if we want a world-class national health system, we are going to have to find more money to pay for it. It is also bellowing that the way we are organising pension incentives does not result in alleviating the problems of old age. It results in massive wealth accumulation for the richest in society and it results in low and middle earners finding they have to sell their houses to live in residential care homes.

In short, tax-relief isn’t working and the funding of chronic care for the elderly isn’t working either. We should kill two birds with one stone.

What Ros Altmann is proposing

In her blog, Ros Altmann discusses three options for the Government to reform pension tax-relief to make it less regressive and to free up resources for other things (the NHS is clearly another thing).

The first isn’t controversial, it involves changing  complicated tax -reliefs to a flat rate “one nation” savings incentive where the top-up is set by the Government . A variant of this is simply to abolish higher-rate tax relief though this still poses problems as there are still two rates of tax for the lower earners (20% and 0%).

The second is controversial as it converts auto-enrolment into a compulsory pension contribution system. This would render pension contributions  a tax on earnings – albeit highly hypothecated as we bet the tax back with interest later in life. It would mean that Government could do away with tax-relief – reducing the £50bn considerably.

For either of these measures to work, the tax reliefs would have to be abolished not just for savers, but for sponsors, otherwise savers would just elect to have their sponsors pay their pension contributions (as happens with salary exchange).

This simple avoidance measure has stood  in the way of partial tax-reforms.  It also stands in the way of Ros Altmann’s proposals for it effectively makes pensions a business tax, it is far easier for an employer to pay salary and write it off against corporation tax than pay pensions and not.

To counter this problem, Ros suggests that it is only the auto-enrolment levels of contribution that need be made compulsory (5% from savers and 3% from sponsoring employers). Above those levels Ros Altmann proposes a voluntary incentivised system with a flat rate incentive for all.

But even here, the temptation will be for the contributions to come solely for employers,  even if salary sacrifice/exchange for pension contributions were to be abolished, it is hard to see how scheme rules or employment contracts could be barred from offering non-contributory pensions which would effectively reduce tax-bills (and tax-revenues) to what was paid before the changes.

The third way is Ros’ worst way!

Ros Altmann accepts that there is a third way and she isn’t afraid to talk about it in her blog. She dismisses it as the “worst way”

Turning pension incentives into ISA-style saving would be hugely damaging: Importantly, it would be damaging to replace the current tax relief incentives structure with an ISA-style regime

The biggest issue for Government is not the popularity of ISA style pensions (people like the certainty of ISA taxation) . It is the unpopularity of what they’d do to people’s salaries.

If we were to tax pensions as a benefit in kind – as we tax corporate sponsorship of ISAs, then every pound paid into a pension would reduce take-home by between 0 and 45% of the pension contribution. While it might be argued that this would result in tax-free pensions (under a Taxed- Exempt – Exempt) formulation, the damage this would do to people’s immediate standard of living would be unacceptable.

This is why Osbourne and Cameron were unprepared to put forward such a radical measure before the Brexit vote in 2015/16.

Pension contributions taxed at source?

There is a way to soften the blow and to introduce TEE in stages, it involves an extension of scheme pays to all pensions and would mean that  pension administrators would be sending back to HMRC the part of the contributions they received that were deemed to have arisen from tax relief. This would be a major change and could only work with Real Time Information from HMRC, informing pension administrators and real time payment systems meaning that pension contributions were taxed at source.

It would mean that people’s take home would remain unaltered , but that their investable contributions would be reduced at their marginal tax-rate – whether they came from employer or from them.

Having mulled this idea for four years, it is the only solution that I have seen to the fundamental issues faced by the Government.

TEE would change our taxation system from one where around half is allocated to the top 10% of earners, to one where the pension contribution system favoured the low-earner. There would be minimal impact on DB pensions for the poorest, but future accrual for those in higher tax-brackets would be curtailed. Many high earners would prefer to be paid salary than pension though there could still be marginal advantages for the TEE system, based on national insurance savings which could still prefer pension contributions.

I don’t propose that this mechanism should las for ever, it is artificial and will be messy. It’s purpose would be to transition us from EET to TEE and it should be phased out in a decade. Like MIRAS in reverse, pension contributions should begin to be taxed at a lower rate and gradually direct taxation on “contributions as pay” should be phased in. As direct taxation increases, secondary taxation through the scheme pays mechanism should reduce.

In ten years time, we might barely remember the days of EET, as we have forgotten the days of LAPR , MIRAS and other unnecessary fiscal incentives.

Radical change in pensions must mean radical improvements to the NHS and Long Term Care

I am so close in my thinking to Ros Altmann, that I do not want this blog to seem critical of her position. As always she is saying the things that others do not dare. She is pointing to a new contract between workers, Government, pensioners and the NHS and demanding that the rampaging elephants is tamed. The neglect of successive Governments to reform pension taxation is only making the matter worse.  Reform must come , but it must be true and simple and it must be reform that can survive the attempts of tax-specialists to get round it with complicated avoidance systems,

We must not give way to arguments that say that if we move to a more progressive tax-system, we simply drive the rich offshore. The rich will stay onshore provided they see that there are real societal benefits to this approach. The quid per quo for giving up the current taxation system must be a commitment to reform the funding of long term healthcare so we move towards what has happened in Scotland where people do not fear extreme old age as taking from them their house, their savings and their dignity.

The only acceptable solution to the problems we have with an ageing society is to spend massively on keeping the old comfortable and in dignity in their final years. This can best be achieved by requiring us to pay more while at work for this benefit.

The £50bn a year we lose in tax revenues so that rich people get wealthier in retirement is regressive. We need to move to a system that is progressive and I don’t think that Ros’s first two/three proposals do this in a meaningful way. They will simply be a charter to employee benefit specialists to circumvent the rules.

The fundamental reform that I favour (and Ros does not) is as firm as the blockchain. TEE is black and white. The means of dealing with the cashflow implications of transition from EET can be dealt with contribution taxation using the scheme pays methodology.  All that is missing is the sharp intake of breath that is needed when a Government really goes for it.

This Government is in a better position than any other this century to make these changes . I have no voice like Ros Altmann’s , so I will ask her to join this debate with me. Ros , you are very welcome to my platform, please feel free to tell me why I’m wrong!


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About henry tapper

Founder of the Pension PlayPen,, partner of Stella, father of Olly . I am the Pension Plowman
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2 Responses to Right in principle – wrong in practice. Ros Altmann’s tax reforms need more work

  1. Ros Altmann says:

    Dear Henry I always enjoy reading your thoughts and agree on many occasions. However, on the point of pension-ISAs and TEE, I’m afraid I am absolutely opposed.
    The aim of my paper was to encourage people to think about pensions tax relief reform, rather than set out fully-fledged proposals. This was a high-level thought leadership piece, that can hopefully spark more detailed thinking.
    Specifically on TEE and EET, I believe it is vital to warn of the dangers of turning pensions into ISAs. This is an existential threat to the whole idea of pensions.
    Indeed, the 2015/16 reforms almost concluded that this was the best radical solution, but failed in the end because it would have been the death of pensions. If withdrawals are tax-free, then the behavioural benefits of pensions as currently constructed will disappear. Without some reason to avoid taking money out too soon, the pension fund will be gone before it is most needed. ISAs are mostly popular as a way of saving in cash without tax, or as an addition to pension tax relief for the wealthy. But pensions are for your 80s and 90s, not for your 50s and 60s. Turning them into ISAs would see people take their entire tax free pension pot out as soon as they could. Look at the current situation where almost everyone takes their 25% tax free lump sum early, way before their older ages. This is driven partly by having planned to spend some of it, partly by fear that a future Government reform could remove the tax-free status of this lump sum if it needs to raise revenue! Imagine in the coming years that people can take 100% of their fund tax free – there will be so many who will do so just in case. If they received taxpayer incentives on the contributions, that money will have been pretty much wasted, since it is supposed to help people have more money to live on in retirement, not have a tax-free spending pot around age 60. The current position is behaviourally sound – incentives on the way in are provided by employer and taxpayers (E), investment returns are tax exempt (E) and then the income withdrawn in later life is only taxed when taken out (T) – thus meaning those who understand the benefits of pensions would do best to keep money inside their pension fund for as long as possible. They are better off spending their ISAs or downsizing their house, and leaving their pension for much later on, without fear of doing so now that the 55% death tax on remaining funds has been abolished and the rest of the fund can pass on to the next generation tax-free if unused.
    Turning pensions into ISAs destroys this behavioural soundness and effectively means the long-term impact of pensions would be lost – there will be far more poor pensioners in future, a future Government would find it presides over lower spending power in the economy, more people needing support (the new State Pension and Pension Credit do not avoid the later life means-testing of Housing and Disability Benefits, so people will still fall back on the state). And that future Government will have no means of recouping taxpayer funds that were given to people’s pensions upfront many years previously by past taxpayers.
    Pensions need to retain a tax ‘brake’ on early spending, that is vital because it is part of what pensions are for. ISAs can give you a tax-free spending pot, but that is not a pension.
    Sorry Henry, but I feel this would be a classic example of dangerous policy reform, that might be portrayed as radical tax-revenue saving and levelling of opportunity, but will have disastrous long-term consequences that today’s policymakers will not be around to take responsibility for. Leaving problems to future Governments is not good pension policymaking and has been done so many times in the past. Too often, pension policymakers fail to think of the longer term consequences and focus on the short-term only – think of ‘A-day’, removal of dividend tax relief, MFR, TAA……
    My paper was really designed to propose potential ideas, and warn against the risks of pension-ISAs. To the extent that is has encouraged debate, I am really pleased. Let’s see what happens next.

  2. henry tapper says:

    Thanks Ros, I still disagree; the cat is out of the bag with the Pension Freedoms and people can self-harm with no brake applied. Tax brakes or tax breaks!?

    I don’t think low earners are incentivised by tax breaks and I know they object to paying tax on 75% of their savings – because over 37 years talking to ordinary people, that’s what they say!

    I don’t think that people will withdraw money from tax priviledged accounts (pensions) to put into accounts where they have to pay tax on interest (banks). Making pension accounts as taxless as ISAs will encourage those who need to save most – to save most.

    But, as you say, it’s not how we reform that is the main point of your paper, it’s that we have the debate.

    Your paper has encouraged debate and I see Pension Buzz has given itself over to discussing tax-reform – I’m sure because of you.

    As we know from work of the Net Pay Action Group, good can come from putting like minded people in the same room with a common purpose.

    It’s good to see you leading the same debate on the wider issues raised in your article – even if I think you’re wrong in your solutions!

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