Delivering a speech about inequality to the Resolution Foundation on 6 September, Sir Vince Cable said that increasing income tax rates for high earners becomes “counterproductive” once they get much above 50%. He saw “greater merit” in eliminating opportunities for “legal tax avoidance and arbitrage,” including by “equalising rates of tax relief on pension contributions between high and low earners”. Of course, a policy proposal can have “greater merit” than something that is “counterproductive” and still not be very good…
Sir Vince is not the first politician to praise a flat rate of upfront tax relief on pension contributions, however faintly, without spelling out how it would be implemented. Nor is he likely to be the last. So here’s a cut-out-and-keep checklist of half a dozen practicalities that policymakers would need to be clear about if they made firm proposals in this area:
- Two taxes and a top-up: Operating a flat rate of upfront tax relief would mean taxing income saved through pensions both on the way in and on the way out, and adding a Government top-up in between.
- How do you communicate it without mis-selling? Describing the top-up as a Government “bonus” would overstate its generosity: to get it, savers would have to agree to have the same income assessed for tax twice over.
- Taxing employees on employer contributions… Currently, employees do not pay a benefit-in-kind tax on employer contributions (because most of the resulting retirement income will be subject to tax). That would have to change: otherwise, higher rate taxpayers could still get de facto 40% relief where contributions come via an employer. For 40% taxpayers, the charge would be bigger than the corresponding top-up, leaving a net tax bill. Would this be siphoned off the employer pension contribution or collected through PAYE?
- …and on defined benefit accrual: The Government would need to value each employee’s defined benefit accrual and tax the part not financed through employee contributions; again a net tax bill would be due from 40% taxpayers. How would these tax bills be calculated, and how would they be collected from the (overwhelmingly public sector) employees affected? For basic rate taxpayers, the top-up due in respect of employer-financed accrual would exceed the tax: would this augment their benefits, or boost their take-home pay?
- Would employer contributions affect an individual’s tax band? If employer contributions are to be taxed (and topped up) at the time they are paid, will they be allowed to tip some people into a higher tax band? Will thresholds be adjusted in response?
- Does it end here? If this model works by taxing the same income twice and topping it up, there is an obvious challenge: why not just tax the income once and make the top-up smaller? Perhaps flat-rate relief ultimately collapses into the Pension ISA model.
The Liberal Democrats appear well aware that equalising rates of upfront relief is easier said than done: using identical words, their last two manifestoes promised only to “establish a review to consider the case for, and practical implications of” a shake-up along these lines.
If the “case for” such a policy is to reduce inequality, changing upfront tax relief on pensions contributions would take from 40%+ taxpayers to the extent that they save in pensions (where those with the very highest incomes are already constrained) and give to basic rate taxpayers to the extent that they do (noting that the poorest can’t save much). As such, it is only half on target as a way of reducing income inequality and does nothing about the wealth inequality which Sir Vince’s speech identified as a bigger issue.