Osborne must not tax pensions more
WANT to add some money into your pension? You’d better hurry up, as there is intense pressure on the chancellor to slash tax relief on pension contributions. If Lib Dems gets their way, 40p and 50p taxpayers will lose their tax relief, which would fall to just 20p for everybody. This would be a further, massive blow to pension savings: the annual allowance has already been slashed to £50,000 (from £255,000) and the lifetime allowance from £1.8m to £1.5m.
There are several reasons why chancellor George Osborne must resist reducing tax relief on pension contributions, or further slashing the allowance. I write this with some reluctance, as I would much rather have a simple, flat income tax system without the current very high marginal tax rates, with a large zero-taxed personal allowance and with no tax reliefs of any kind at all. Imagine a single tax rate of 30 per cent, with no tax payable on the first £10,000, and with no allowances, exemptions or loopholes. It would be much better than what we have today.
Tragically, such radical tax reform is not on the cards – so the second best solution is to maintain the existing reliefs. Abolishing them would be a massive attack on aspiration and hard work and would penalise savers.
Within the current system, there is a good reason for the tax relief: it is to avoid double-taxation. People pay income tax on the annuity they purchase with their pension pot on retirement (though they are able to extract 25 per cent as a tax free lump sum). Without any tax relief, they would be putting in income that has already been taxed – and then see it taxed again on the way out.
Tax relief on pensions is a partial shield from Britain’s very high marginal rates for the millions of people on the top two income tax bands. This has blunted their negative impact on incentives and hence on the UK’s competitiveness. Abolishing the relief would be equivalent to a substantial increase in the tax rate faced by millions – it would cripple the UK’s supply-side at the worst possible time.
It would also devastate the pensions industry: with just 20 per cent relief, it would barely be worth it for anybody to contribute to pensions. After all, the money is locked away for decades and even then cannot be used in a flexible manner; Individual Savings Accounts (ISAs) would become a far superior tax-efficient savings vehicle.
Last but not least, stripping pension contributions of their tax advantage would be political suicide for George Osborne: taxpayers in the 40p and 50p bans – who live disproportionately in London and the south east – make up a very large chunk of the Conservative Party’s core vote. Declaring war on them – anybody who earns £42,476 or more – would be madness (it would also hurt Boris Johnson’s reelection campaign).
Such voters are unlikely to forgive the Tories if they succumb to Lib Dem pressure on this – and especially if this is also accompanied by other anti-wealth policies, such as introducing higher rates of council tax for those with more expensive homes.
If the chancellor wants to increase the personal allowance to help the worse-off – a good policy which would increase low earners’ incentives to work – he needs to find more savings in his Budget. This shouldn’t be too difficult. But it is absolutely vital that he resists the urge to increase the tax burden yet further.
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