You might not like the thought of paying tax on your pension contributions, but it’s coming
They’ve done it once and they could do it again. The Treasury could change pension saving as radically as they changed pension spending. The temptation for a new Chancellor to showboat at the budget on March 11th is something that’s worrying Ros Altmann in her latest blog on pension tax reform
Perhaps out of political loyalty, Altmann looks back not to George Osborne’s pension freedoms but to Gordon Brown’s abolition of dividend tax credits in 1997, as the bete noire of Treasury behaviour. The comparison is of two new Chancellors arriving with a recently achieved thumping majority from the electorate.
Although I think Ros is wrong in her solution, I think her right to be cautious. People have no idea about how pensions tax relief works and can be bamboozled into thinking that a £10bn raid on pensions (as flagged in the Times and other papers) is somehow good for us.
True the Government needs a kicker if its going to stick to its fiscal guidelines, but taking £10bn a year out of pensions amounts to a 20-25% cut in the Government’s incentive to save. Like Ros Altmann, I don’t think this is a plan, I think it’s a jerk of the knee.
So what is at stake?
Well we know from the Office of National Statistics where the £40bn , pensions lose HMT in tax and national insurance revenues, goes.
It goes in income tax foregone, national insurance foregone and investment taxes foregone and income tax and national insurance are the big two.
We also know from work done by various bodies that about half of the money foregone benefits about 10% of savers – the 10% who pay the most tax.
What is at stake is not just the £10bn pa that might be lost from pensions by moving to a mooted 20% flat rate incentive but a collapse in saving amongst the savings classes – the 10%. Ros Altmann is not the only one who thinks that a radical change from tax relief to flat-rate tax incentives could destroy pensions, there are deep-thinkers like WTW’d David Robbins, who are also advising caution.
The “keep calm and carry on” school of thought is based on there being no consensus for change and no proper discussion about the impact of change either on public finances or on savings rate as a whole or on whether change would result in a fairer system
In as much as I agree that we are “in the dark”, I side with those like Altmann and Robbins, who warn against fundamental change in this budget. There is too much at stake for us to repeat the “hit and hope” strategy of pension freedoms (or of the Brown tax raid)
But change is going to come
I remain a radical when it comes to tax reform. I think the current system is a subsidy for those who have spare cash to save and too little an incentive for those to whom saving not spending is a tough choice.
I certainly think we need to rid ourselves of the complexity of two tax-relief systems so that everybody who doesn’t pay tax gets the 25% bonus of those who do.
I don’t think that it’s right that top rate tax- payers get 82% (and tax -experts will tell you that -because of the taper they don’t).
I am also unclear just who is benefitting from the lost revenues the ONS relate to national insurance but i suspect that relatively few higher rate tax payers are actually contributing at all to pensions. The 13.8% corporate NI rate makes it stupid for companies to pay people salary which goes on pensions when they can pay the pension contribution instead of the salary and shave 13.8% (and 2% from the staff member).
If you cost of losing national insurance and tax revenues together, you can see the subsidy for top rate taxpayers is close to 60%.
This goes way beyond incentivising. This is why change is going to come.
Merryn Somerset Webb, fresh from a week on the ski-slopes thinking about these things agrees.
…. the current system with its lifetime allowance of over £1m seems ridiculously generous.
And scrapping the higher rate tax relief system — as it is rumoured the next Budget will address — isn’t spiteful, self defeating, an act of fiscal hooliganism or part of a war on wealth.
It is just a way to prevent the better off effectively hypothecating their own tax revenues back to themselves.
Think of it less an unkindness than a rational response to a rising level of state pension entitlement and a need to deploy tax revenue elsewhere — or in my dream world, to find a way to cut taxes. It isn’t entirely straightforward — this kind of change is hard to implement in the public sector in particular.
But unless we dump the relief system altogether (perhaps in favour of a much higher state pension) or shift to a pure Isa-style system for pensions, it is definitely coming.
Plan or jerky-knee?
We’ve only got to wait a couple of weeks to answer this question. The Treasury will, I hope prove they have a plan – if it’s only to pledge to radical reform in the Autumn budget or perhaps the spring 2021 budget. If they have a plan that is pre-baked from the 2015 consultation, then I think it should be consulted on and not shoved into the 2020 Finance Act.
Even if the plan is good – it will be considered knee-jerk if we are bounced into reform as we were bounced into pension freedoms. Osborne may think he got away with his “rabbit” but he’s not having to deal with the problems it left an unprepared public.
Jerky-knee isn’t good, plans are. Ros Altmann is right to urge caution and the Treasury would be wise to listen to her.
I am a radical, but I am a cautious radical in this.
I think it will be hard to change. The problem is that we have two systems, DC and DB, and employers pay most of the contributions overall.
I am not saying that the actual system is good, just that is very hard to change, without introducing a tom of complexity.
Scrapping the 45% tax band and limiting pension tax relief to the basic rate would be a good start.