The following is a blog from Professor Michael Bromwich, speaking from a career in economics , a statesman for the London School of Economics.It appeared earlier in a truncated version, this is the blog in its entirety.
Mrs Reeves and Pensions
Mrs Reeves and Pensions
The media makes it impossible to forget that Rebecca Reeves the Chancellor of the Exchequer is in difficulty meeting her self-imposed rule that government revenue must cover expenditure excluding investment by 2029/30 continuing for future sessions. Government borrowing for investment is intended to decline by the end of the forecast period (2029/30).
This blog sets out the changes already made to pensions and in closely related areas in the Pensions Schedule Bill and those which could come in the forthcoming budget. In sum we seem to face substantial taxation, some first shots at abolishing some long-standing conventional reliefs, possible substantial behavioural effects, an even more complex system with few obvious catalysts for economic growth. The monetary rewards from each of these pension changes seem small when looking for billions of pounds.
When I first started on this blog in mid-October, to satisfy the Reeves rule in her budget statement on 26 November Mrs Reeves needed to find an extra £20bn to £30bn, tending towards £35bn with low forecast productivity compensated by some favourable changes and a reasonable buffer (£15bn-£20bn). Satisfying the rule requires increasing taxes or cuts in expenditure (or both) or a smaller more favourable deficit.
From then suggested new options for her have continually appeared with indications that many of these were Treasury based and a surprising number of leaks suggesting the Chancellor was often changing her stance. As the days to budget shortened this machine accelerated. Much time was devoted to finding options to combat the deficit without increasing income taxes as the Labour’s manifesto pledged that the rates for the two major taxes: income tax, Vat and for National Insurance Contributions (NICs) would not increase for workers.
In contrast, many commentators felt that the deficit required a breaking of this promise while warning that neither the party nor the electorate would stand for it. This meant the Treasury scabbling around for alternative funding sources.
In an unusual and unusually early morning speech on 4th November the Chancellor all but said taxes were going up and on the 7th of November she informed the Office of Budget Responsibility (OBR) prior to their final prebudget forecast that income tax will increase by 2p in the pound yielding £20bn with a countervailing decrease of employee NICs for working people yielding a net £6bn. This approach to increasing tax was suggested by the Resolution Foundation, a think tank focussing on households with low and middle incomes.
Mrs Reeves said that those with the broadest shoulders should bear the cost-not all of whom are wealthy. Indeed, most in the UK seem to be rather skinny. The Office of National Statistics estimates median household wealth as around £300,000 with wealth of around £3.5mn for the top one percent of households.
Estimates suggest that to satisfy her rule in her budget statement on 26 November she needs to find an extra £20bn to £30bn, tending towards £35bn with low forecast productivity compensated by some other favourable changes and a reasonable buffer (£15bn).
However, in her early morning address Mrs Reeves implied she would with at least ostensible reluctance follow the almost unanimous advice from commentators to break manifesto promises and increase at least one of the main taxes-income tax is the favourite. It is inclusive capturing all with taxable incomes, progressive and allows higher charges to those more able to bear them. 2p in the pound seems be in mind yielding £2bn thought saleable to the party or on the doorstep.
Where are we now?
In April 2006 income tax relief on pension contributions was severely reduced. At that time pension payments were liable only to income tax. Pensions were assumed to be exhausted at the time of death, as is the case with DB pensions and was the case with DC pensions when pots had to converted into annuities. Pension freedom was granted from April 2016 enabling pensioners to cash in all or some of their benefits at the age of 55 depending on their scheme’s rules. The allowance which capped lifetime pension contributions was abolished from April 2024 and the 25% tax free cash allowance was limited to just over £250,000.
In her first budget in October 2024 Rebecca Reeves, introduced IHT on the passing on of family farms and businesses and combinations of them commencing in 2027. After the first million pounds, IHT is at a reduced rate of 20 % rather than 40%. These businesses are often seen as a substitute for having a pension while allowing continuation over generations.
The Chancellor is also concerned that wealthy people are building up very large pension pots to pass on free of IHT. Although not part of legal estates non-exhausted DC pension pots will therefore be liable to IHT from 2027 as will some discretional DB awards such as death benefits. An important benefit of DC schemes is the ability to pass on benefits so there is a danger of revivifying the media’s claims of a ‘death’ tax. Both changes were highly controversial. These two changes, and a new similar charge on shares on the AIM market will save around £2.8bn without incentivising growth.
The next section reviews a few of the changes relative to pensions that have been suggested to the Chancellor. Far fewer leaks have addressed cuts.
The good, bad, and ugly
With the tax increases there are eight suggestions related to pensions that could generate substantial savings by the2029/30. Most are self-descriptive, and others are familiar from newspaper descriptions.
- Increase in income tax 2p/ decrease in NICs.
- No reductions in the relief from income tax on pension contributions
- Reductions on the size of the tax-free lump sum allowable from
pension payments
- Salary sacrifice
- Freeze on tax thresholds
- Charging national insurance to pensioners
- Mansion/ wealth tax
- Charging capital gains tax on family houses. Too unlikely to be further considered.
Regarding increasing tax by 2p in the pound yielding £20bn and a countervailing decrease of £14bn in NICs of working people. This approach to increasing tax was suggested by the Resolution Foundation, a think tank focussing on households with low and middle incomes. No figures are given for this but calculation suggests that the claimed results are correct. Protecting working people from the tax rise satisfies to a degree the government’s claim of no tax increases on this element of the community and applying this deduction to only those below the first threshold for national insurance payments satisfies the broader shoulders claim. Higher earners do not get any national insurance deductions.
This is however an unsuccessful exercise seeking to hide something in not so plain sight. Can Mrs Reeves sidestep accusations of manifesto breaking by only making a small but essential increase in tax whilst protecting working people to a degree but generating only a small deficit reduction? Surely it would be more efficient and transparent to stand up for the full 2p increase freeing the government from scrabbling around for several further small deficit reductions. Both possibilities will clearly draw behavioural responses both in Parliament and in the economy. Two questions are the problems arising from any breach of trust any greater for the full 2p increase than that which protects working people and would the full increase make people question more intensely the government’s whole programme.
Once again, a group of people is being privileged, previously it was hard working families now it is workers-those who have payslips. Workers is not a clearly defined term. One possibility is those earning up to the first threshold on national insurance of £50,270 but another is the equivalent rate for income tax of £37,700.
Those who do not pay national insurance do pay income tax which would include the full 2p increase. This taxable group is mixed, including non-pensioned self-employed, including some landlords, pensioners and those relying on investment income.
The Institute for Fiscal Studies in their Green Budget indicate that the Chancellor could for example cap income tax relief at 20% rather than 40% saving some £22bn. This would make a major contribution to shrinking the deficit at the end of the Parliamentary session. Any dropouts are unlikely to be large for DB pensions because of the considerable employer contributions but it could affect DC ones especially at the lower end. In the longer run people may find themselves paying tax at 40% of income when receiving only 20% relief earlier. This was not pursued as it would breach the promise of no extra taxes on workers.
The Green paper highlights that employers do not pay tax on all NICs for employee pensions and wonders whether relief overall needs to be so large especially as it provides no incentive to save for the self-employed who tend to avoid pensions or are unable to set up a pension. Similarly, it can be argued with existing arrangements pensioners who pay income tax are supporting this relief for current workers. Not necessarily a bad thing if the government has carefully considered this.
Reductions on the size of the tax-free lump sum allows pensioners to take a 25% tax free sum from pensions life subject to a cap of £268,275 usually on retirement but it can be spread over the pension life. This extremely popular option gives considerable flexibility to meet finance contingencies, such as paying off outstanding mortgages or funding the banks of ‘mum and dad’. Scrapping this option has been estimated to save some £5bn (estimate Institute for Fiscal studies) but reduces one opportunity for the ‘personalisation’ of pensions.
Salary sacrifice occurs because employers do not pay tax on NICs but employees do pay tax on their salaries so there is an opportunity for arbitrage by employees taking a lower salary in return for higher NICs. However somehow these additional NICs can be used to buy expensive bicycles and to avoid this salary sacrifice is to be limited.
The table below shows in the second column the increases in tax required to allow the initial deficit of £20bn-£30bn to be reduced to a viable amount and the third column indicates the situation where the deficit is reduced by the OBR and allowing some possible changes to be withdrawn. 
Sources from reports of think tanks, professional firms, ONS and HRMC and are in general use in the industry.
The total for the second column with the tax rise is surprising as this does not cover the deficit or permit a larger buffer though the Chancellor has other non-pension options. The third column does permit additional buffering. This relies upon the OBR’s brighter future which will considered carefully by the market when details are available. Given the deficit is the difference between two very large and variable sums it is not clear their current view maintained.
The rushed ‘pick and mix’ approach to the budget needs to be replaced by a regular reappraisal of strategies leading to considered budget changes. This will help to avoid the behavioural effects of the ‘P&M’ approach which has frozen the housing and new project markets and caused an increased demand for lump sums.
The gaming approach to information transmission should be abandoned as should the floating of possibilities that may be considered or may be ruled out. Those interested in fiscal strategy should not be treated as a very large focus group.
Ignoring politics its worth noted that the 2p increase yields £17bn and the more favourable view of the OBR is worth £10bn, this all that needs to be done.
