The March 2016 budget is surpassing all before in pensions tax speculation. Some commentary has verged on the melodramatic! Context is required. This article sets out the context: it is intended to be policy-neutral.
Let’s acknowledge the true problems with further changes to tax relief: it would disrupt the system at a delicate time after a whole raft of changes in the recent past. It may interfere with auto-enrolment (AE) take-up. Long-term financial planning is impossible with an ever-changing system. If people save less there is more future state benefit reliance.
Nonetheless, let’s acknowledge other truths: the UK’s budget deficit is shocking at still over £1 billion per week. It is coming down too slowly (if at all at present) and tax rises or further spending reduction measures (or both) are needed. The alternative of an ever-increasing national debt is either bankruptcy or the devaluation of the value of money. Neither seems attractive! Reducing pension tax relief is one of many possible legitimate measures: even if we don’t like it.
Perhaps a diagram of possibilities would illuminate:
This is not exhaustive – there are other possible changes or a mixture of some of the above.
The “un-squeezed” middle?The idea of the “squeezed middle” was coined in 2010 by Ed Miliband: how various changes in the employment market, social spending and tax disadvantaged middle income earners compared to others. The truth in pensions has been the opposite: a squeezed top and bottom and a relatively “un-squeezed” middle.
At the top end of the income scale, tapering of annual allowance and the ever-reducing Lifetime Allowance are taking away the ability to utilise pensions, especially the latter.At the lower end: Auto-enrolment (AE), for all the positives, acts as a squeeze on the low paid – even if rarely acknowledged as such. AE combined with the long-term phasing out of means-tested pensioner benefits will become what I term “PYOMTI”: pronounced “peee yom teee.” (“pay your own means tested income”): or more accurately, you and your employer pay for it, with a little help from HMRC. This is not a criticism of AE – merely an observation of what it does at the lower income end. This is true even if you allow for tax “relief at source” for non taxpayers. Previously, the government paid 100% of the state pension top-up and these top-ups were set to rise considerably. This trumps tax relief plus employer contributions.There are, of course, many other tax and benefit changes affecting all income scales positively or negatively, I am being selective on pensions.In this context, if the chancellor removes higher rate tax relief, he will be squeezing pension tax relief further down the income scale to circa £42,000 per annum, leaving those earning less (including median earnings) untouched, or even better off if the rate comes in higher than 20 per cent. Let’s remember everyone earning up to £100,000 benefits from the much higher personal tax allowance. Let’s also remember non tax payers can still benefit from tax relief if their scheme operates “relief at source.” In effect it is a social measure.
The chancellor giveth and taketh away in various measures. What the heavily trailed reduction in higher-rate tax relief would do is alter the relative attractiveness of pensions and other savings for higher earners, and re-distribute a little from higher earners to lower earners. The median earning middle would still remain un-squeezed. It would also disrupt the system and add a cost of change.
This is not to defend any particular change, just to observe what it does.
If the Chancellor chooses to save tax at the same time rather than a cost-neutral change, then that is a legitimate action for a Chancellor, because the budget deficit needs addressing. After the budget, those criticising a reduction in overall tax relief, if it happens, may wish to opine their own remedy for the deficit bearing in mind that all tax rises and all spending cuts are unpopular. Normally, that is too holistic for commentators – whereas simply criticising is easy.
As for EET to TEE (taxed, exempt, exempt): that would be transformational. More complex arguments apply: the annual budget deficit would be transformed but at a cost to future generations of tax payers (as noted by Steve Webb, amongst others). It would be directly in line with the general drift of policy of the western world of “living for today and forgetting about tomorrow” – and as such hard to defend. We should remember that this is the MAIN problem with TEE.
TEE would disrupt pensions severely, and indeed upend the entire system - I agree. Can we trust the last E of TEE to remain E? – I agree with the doubters. But all of these pension points are secondary to the multi-generational tax issue. Let’s always remember the bigger picture….