It’s heating up, again, pension tax reform.
The Conservatives seem to have ditched plans first proposed by the Centre for Policy Studies to remove up front tax relief for pension savings and replace it with back-end relief – when those savings are expended. And quite rightly too, because that otherwise fascinating CPS paper neglected the key question: whether such a change would encourage those who need to to save. It’s difficult to make the case that it will.
What has been mooted instead is replacing the iniquitous current system – which gives 40 of tax relief to a higher rate tax payer contributing 100 but only 20 to a basic rate payer making that same contribution – with a flat rate. Assume for the sake of argument, 33.
Such a change would provide further encouragement to basic rate payers to save – but diminish that for higher rate payers. And this has, in turn, sparked a row about whether the Financial Secretary to the Treasury, David Gauke MP, was right to tell the BBC:
“We need to ensure it is effective in terms of encouraging saving, and it is going in the right place”
And the arguments as to why a flat rate would or wouldn’t encourage saving are rehearsed in this typically thorough piece by Jim Pickard of the Financial Times.
Sadly, not surprisingly, it’s a typical political argument: under-evidenced, riven with sectarian division – and about completely the wrong thing.
The right thing is ‘what is the purpose of pension tax relief?’
If you proceed from the assumption – as I do – that its purpose is to encourage people to save for their old age so that they won’t become a burden on the State, you should really provide the greatest incentive to those otherwise most likely to become that burden. And that’s those on lower incomes.
The higher your income, the more likely you are to have surplus income – which, it being surplus, you will accumulate as savings even absent a tax incentive. And there is the closely related point – the higher your income the more likely you are to accumulate assets over your lifetime which you can liquidate during your retirement to provide for your then needs.
Putting the matter more acutely, what we shouldn’t be interested in is whether a flat rate pension tax relief would encourage aggregate savings. What we should be interested in is the change (relative to the present system) to the distribution of savings that a flat rate relief would effect. Will people more likely to be a burden on the state save more?
And the answer to that question, in the case of a flat rate pension tax relief, is indubitably yes.