Slashing pension tax relief could trigger a repeat of the infamous ‘Omnishambles’ Budget and unravel almost immediately, the Chancellor is being warned.
A raid on pension top-ups is among major changes Rachel Reeves might make to raise billions of pounds to plug a hole in the country’s finances.
Another is a cap on pension tax-free cash, fear of which drove a huge rise in withdrawals last year that is thought to be ongoing, despite retirement experts urging people not to make rash moves.
Overhauling pension tax relief to cut the amount going to better paid taxpayers would cause uproar and also harm lower paid workers, including in the public sector, according to a new study.
The practical difficulties and opposition would be so hard to overcome that the Government could be forced to row back swiftly, it suggests.
‘Reforms might raise far less than expected, break manifesto promises to workers or put additional burdens on employers who are already under pressure,’ says Steve Webb, a partner at LCP and co-author of its report.
Budget day is 26 November: The Treasury under Chancellor Rachel Reeves is looking to fill the hole in the country’s finances
‘The political backlash against such reforms could easily echo previous “Omnishambles” Budgets where a U-turn was made within a matter of weeks,’ adds Webb, a former Pensions Minister who is also This is Money’s retirement columnist.
This is a reference to the notorious Budget in 2012, when former Chancellor George Osborne made changes to VAT on some hot foods – which was dubbed the ‘pasty tax’ – and static holiday caravans that he swiftly amended.
Webb says: ‘Raiding pension tax relief may look superficially attractive for a cash-strapped Chancellor. But lying beneath the surface are multiple traps for the unwary.’
The net cost of boosting people’s pensions via tax relief is estimated at over £50billion, and most of it goes to higher earners because they pay the most tax.
But slashing the higher rate top-ups to the same level received by basic rate taxpayers, or somewhere just above, would require overhauling the whole pension system.
As well as higher earners it would affect salary sacrifice schemes used by lower earners – who exchange some of their wages for a boost to pension contributions – and less well paid public sector workers with long service records.
LCP says potential cuts to tax relief raise serious issues and are likely to be highly contentious. It highlights the following challenges.
– Public sector workers, including those on relatively modest incomes but with long service, could be particularly hard hit by the abolition of higher rate relief or the capping of tax-free cash.
Although public sector workers make up a minority of the workforce, the generosity of their pension arrangements and high level of pension membership mean they are expected to be disproportionately affected.
– Getting rid of salary sacrifice is the measure that has the most adverse effect on those on modest earnings, with over 3 million basic rate taxpayers set to lose out, and it would increase costs for employers.
It would also risk undermining the attractions to employers of providing high quality workplace pensions and could lead to a sharp downturn in pension saving.
– Abolishing higher rate relief would be a major structural change to the pension system, requiring lengthy consultation, complex legal changes, and time to change administration and payroll systems.
That means very little additional revenue is likely to flow during the current Parliament,
– Capping tax-free cash would be widely seen as ‘moving the goalposts’ for those approaching retirement who made plans based on the current rules, and so extensive transitional protections are likely to be needed.
That would mean extra revenue could be negligible in this Parliament.
‘Omnishambles’ Budget of 2012: Former Chancellor George Osborne had to u-turn on his so-called ‘pasty tax’
The LCP report, called ‘How to avoid an Omnishambles Budget’, says the five traps for the Chancellor Rachel Reeves are:
– Breaking the manifesto commitment not to increase tax on ‘workers’
– Hitting the public sector especially hard at a time of fragile industrial relations
– Not raising meaningful money in this Parliament, because of the time taken to implement change or because of the need for extensive protection for those losing out
– Putting extra burdens on employers, on top of the £25billion hike in employer National Insurance contributions in the last Budget
– Undermining pension saving when the Government estimates around 14 million workers are not saving enough for a decent retirement.
LCP created a red, amber or green rating for the three potential Budget changes it looked at on pension tax relief, tax-free cash and salary sacrifice.
LCP looked at how likely potential Budget changes are to fall into one of the traps listed above – the red rating indicates a serious issue the Chancellor would want to avoid
The LCP report concludes: ‘A previous Chancellor’s Budget has entered history – or notoriety – for its inclusion of measures which unravelled within weeks of Budget Day in a way which took the Treasury by surprise.
‘Our counsel to the current Chancellor is that she would do well to steer clear of major changes to pension tax relief if she is to avoid the same fate.’
Tim Camfield, report co-author and a principal at LCP, adds: ‘Millions of people on modest incomes benefit from various features of the tax relief system, including the ability to sacrifice salary and benefit from a reduced National Insurance bill.
‘If this measure was scrapped, employees paying basic rate tax and trying to do the right thing by saving for their retirement could well be losers, as well as the employers who try to provide good pensions.’
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