THE BLOG

Scrap Pension Relief - Help Cut the Deficit and Increase the State Pension

28/01/2014 11:34 GMT | Updated 29/03/2014 09:59 GMT

The picture has got a lot clearer. Following Ed Balls weekend announcement, all the main parties will go into the next election promising a budget surplus by the end of the next parliament. The Conservatives are pledging to do so by 2018-19, though on George Osborne's past record this will probably be pushed back a few years, with another 'rolling target'. Labour has said it will reach a budget surplus on current spending (excluding investment) by 2020. The Liberal Democrats plans, as usual, are in line with Osborne's, but will be, in some unspecified way, 'more fair'.

All parties hope that economic recovery will do most of the work for them. The more people in employment the greater the tax receipts and the lower the benefits bill. A bit more inflation wouldn't hurt either, decreasing the real cost of the national debt. Despite all this, there will probably need to be further savings/tax rises - and there will be increasing pressure on all the parties as we move towards May 2015 to spell out how they plan to do this. George Osborne has suggested he will balance the books purely by cutting spending. This is implausible - social security has already been cut savagely, leading to increased poverty and homelessness. Spending in non ring-fenced government departments has also been cut to the bone - it's hard to see how areas like local authority spending, justice and higher education can suffer further deep cuts without suffering disastrous consequences. Labour has put forward a few revenue-raising ideas, the most recent being a 50% tax rate for earnings in excess of £150,000 per year. Despite the howls from the super-rich and their defenders in the press this is perfectly sensible (and could even kick in at £100,000). Remember that the top rate was 60% for the first 9 years of Margaret Thatcher's premiership. The 50% tax is likely to raise considerably more than the Conservatives are suggesting - tax receipts from the previous 50% rate were distorted by the short time it was in place, as high earners organised their affairs to take bonuses and earnings in the years before and after it kicked in. But even if the rate raises the £10bn Ed Balls has suggested, this won't be enough to plug the fiscal hole.

So we need to look at other options. The most promising area is the assortment of tax exemptions that cost the government large amounts of money and mostly subsidise the wealthiest. Chief amongst these is Pension Relief - on which the government spends an extraordinary £48 billion a year. This is a subsidy that mostly benefits those who, after paying for their mortgage repayments (or saving for a deposit), bills and everyday spending can afford to put substantial savings into a pension pot. The government tops up their money by the amount of tax they've paid - up to 45% if a top rate taxpayer. The government has cut the annual amount they will top up from the previously astronomical £255,000 per year to £40,000 in 2014-15. But that is still a huge sum for an average earner on £26,000 - they would be doing well to save £2000-3000 in a year. The system also penalises those that save in other ways. Someone putting a monthly amount into an ISA (perhaps in case they needed to access their money before the age of 55) does not benefit from a government top-up at all. Pension relief is a massive state subsidy to the private pensions industry in the City of London, and encourages people to take out what may be risky investments rather than placing their savings in less lucrative, but much safer accounts.

Pension relief is one of the most common (and government-sanctioned ways) to avoid tax. Limiting it (especially if other exemptions and loopholes were also altered) could lead to further knock on gains for the public purse as higher earners find fewer simple ways to avoid taxation at their disposal. This is particularly important when putting up the top rate to 50% - the way to maximise income from this is to make it harder to for high earners to take their money out of the tax system. Of course there will always be a minority who prefer to relocate to a tax haven - but the majority will not want the inconvenience and the social upheaval such a move would entail.

Labour has dropped hints that they may reform pension relief - abolishing higher rate top ups and giving a flat rate top up of 30% or 26% to everyone. They could go further - and make much greater savings. Let's say we abolished pension relief all together - saving the full £48 Billion. The government could bank £18bn towards paying off the deficit. The remaining £30 billion saved could go towards increasing the state pension by around £2500 a year per pensioner. That would give a state pension of £158.23 a week in contrast to the current level of £110.15. That would make a real difference; it would significantly reduce pensioner poverty and would be of far more benefit to most people than the current system. If we want a policy to cut the deficit and give more help to people in their old age, we could do a lot worse than this.