Trouble ahead if tax relief on pension contributions abolished
Press release issued: 29 September 2015
Tinkering with the pension system to make short-term savings would be a major long-term error, historians at the University of Bristol warned the Chancellor today.
In a consultation paper HM Treasury has outlined proposals to change the basis of pension taxation. It proposes to abolish the present system in which people saving for a pension are given tax relief on their contributions but the pension, when it is eventually taken, is taxable. Instead the Treasury proposes to tax contributions but for the pension in payment to be tax free. (A move from a so-called Exempt-Exempt-Taxed or EET system to a Taxed-Exempt-Exempt, or TEE, system).
History suggest the proposed change is likely both to reduce tax receipts and result in lower pensions for consumers over the long-term (in turn producing pressure for higher state spending). The short- to medium-term tax revenue gained by the shift will be vastly outweighed by the long-term costs to the state and to individuals.
Dr Hugh Pemberton, Reader in Contemporary British History in the Department of History at the University of Bristol, said: “Unfortunately there is a long history of politicians tinkering with UK pensions for short- to medium-term gain. Those changes often proved disastrous over the long-term.
“Of all areas of policy, pensions are the most long-term and the proposals set out by the Treasury risk repeating such mistakes.”
Take the Conservative government’s 1980 decision to link increases in state pensions to the rise in retail prices instead of the rise in average earnings, for example. This alteration, made entirely for reasons of short-term economy, looked small at the time but over the long-term the change, compounded annually, served to slash the value of the state pension from an already meagre 26 per cent of average earnings in 1979 to just 16 per cent within 20 years.
The present proposals will have similar long-term consequences.
- The loss of tax relief will remove an important incentive for people to save into their pension and so we can expect levels of pension saving to fall.
- Because contributors will lose the capital growth on the value by which the tax relief raises their contributions their final pension pot will be 17 per cent smaller.
- Receiving the pension tax free will not make up for this shortfall. A 25-year old today will find their pension will be seven per cent lower.
- Over the long-term the initial tax gained by removing initial tax relief on contributions will be significantly less than the tax revenue lost by paying the pension tax free (in our modelled example the total tax taken from this individual drops from nearly £40,000 to just £8,600).
- Finally, the promise of simplification held out by the Treasury consultation document is an illusion. Like virtually every change to the UK system since 1945 implementation of this proposal would complicate not simplify the system – because pension contributions pre-dating the proposed tax reform will continue to yield a taxable pension and so there will actually be two parallel tax regimes.
The academics conclude that the Treasury’s consultation documents is an attempt to dress up a policy aimed at bolstering tax revenues over the short- to medium-term as a long-term reform to incentivise pension saving and improve the level of income replacement in old age. It is inconceivable that it will achieve either long-term aim.
Historians, Dr Hugh Pemberton and Professor Roger Middleton, who are researching Thatcher’s Pension Reforms for the Arts and Humanities Research Council, recommend that government should look to the long-term security of British pensioners and resist the temptations of a short-term boost to public finances from abolishing tax relief on pensions. If the Treasury is determined to reduce the cost of tax relief on pension contributions it should instead consider removing higher-rate relief, a costly subsidy to those least in need of an incentive to save into a pension.
The response to the Treasury’s consultation is a product of research into the Thatcher Pension Reforms and their Consequences that is being conducted at the University of Bristol for the Arts and Humanities Research Council (further details on the website of Research Councils UK and on the project’s website at http://pensions-history.uk/).
The full response to the consultation is available at: http://pensions-history.uk/?attachment_id=326
Dr Hugh Pemberton is Reader in Contemporary British History at the University of Bristol and Principal Investigator on the AHRC project.
Professor Roger Middleton is Professor of the History of Political Economy at the University of Bristol and Co-investigator on the AHRC project