From the TUC

Pensions tax relief

12 Sep 2009, by in Economics, Pensions & Investment

There’s been a lively debate over at Liberal Conspiracy on my post on public sector pensions. Many of the points are from the small-state right and entirely predictable and have been effectively rebutted already, but there have also been some others that deserve a fuller response than one can put in a comments thread.

First many people question whether the state is really spending money on pension tax relief, and some ask how it works.

Tax relief works by reducing what the taxman sees as income by the amount that you put into a pension.

If you don’t pay income tax it costs you one pound to put an extra pound into your pension. If you pay basic rate tax it costs you 78p. This is because basic rate tax is 22 per cent – if your taxable pay is reduced by one pound you will pay 22p less tax.

If you are a higher rate tax payer it costs 60p to put a pound in your pension, because higher rate tax is 40 per cent.  That’s why it’s legitimate to talk about spending money on tax relief.  Other tax payers are effectively contributing that 40p.

Pensions are a uniquely privileged kind of savings in their tax treatment. If you put money in a bank savings account, you do not get any relief and still pay tax on the interest. There is tax relief on savings in ISAs but they are limited – going up to £10,900 a year next year. Currently there is no limit on the tax relief on pensions savings made in a year (though you can’t build up your pension pot indefinitely).

The rationale for providing tax relief is that it is in the state’s interest for people to build up a pension so that there is less pensioner poverty and people do not require means-tested benefits. But the way it works at the moment means that the well-off don’t just get more relief because they earn more, but also because they get relief at the higher tax rate.  

Let’s look at one particular post  from Mac 3, as it represents much pensions world orthodoxy. I’m sure he won’t mind me reposting it here and commenting on each point he makes. He’s welcome to come back in the comments of course.

Mac 3> It has been a longstanding principle of UK pensions planning for years that pensions are regarded as deferred pay. As the eventual pension will be taxed as income on receipt, it has always been considered perfectly fair to grant full tax relief on an individual’s contributions to pension schemes. If – as the TUC seem to be proposing – pension contributions have to be paid out of taxed income (e.g. at 40% or 50%), and then some years later the pension derived from such contributions is taxed at say, 40% or even 50%, then the individual has effectively been taxed twice-over on the same monies!

NS> We are not opposed to the principle of tax relief on pensions. The question is at what rate the relief should be and how far up the income scale it should go.  If you look at the HMRC tables we used for our work (which we based on Pensions Policy Institute methodology) they show that the cost of tax relief is £36 billion, while the income from taxing pensions is around £10 billion. If they were more in balance Mac 3’s argument would have a point.

Mac 3 >So Mark M is quite correct in challenging the irresponsible claim that high earners, by enjoying full tax relief on their contributions, are somehow being subsidised. They are not. They are simply deferring their liability to income tax until they come to pick up their pension in retirement.

NS> But they are also juggling their tax rates, and of course the super-rich are in the forefront of those demanding that they should not have to turn their pensions savings into annuities so that they can leave it to their dependents and thus not pay any kind of income tax on it. 

Mac 3 >Do not forget that the proposed measures that arose out of the 2009 Finance Act aim not only to restrict tax relief on a high earner’s personal contributions to a pension scheme, but to impose hefty Benefit in Kind tax charges on the value of the employer’s contributions as well.

NS> And quite right too. This is one area of tax fairness where the government has made some welcome moves. If you look at the TUC’s PensionsWatch report into top pensions, it is clear that top directors are frequently not in the same scheme as their staff and negotiate their pension contributions as part of a tax planning/avoidance scheme. (I wonder if the Longbridge report looks at the pension arrangements of the directors.)

Mac 3 >It is highly disingenuous for the TUC, in its next breath, to lament the decline of private sector pension schemes. Just what does it imagine will happen when the senior directors of good occupational pension schemes no longer find it tax-effective for themselves to remain in those schemes? If the senior directors opt out (and frankly who could blame them) of such schemes, then there will be even less incentive for the sponsoring employers to keep such schemes going.

NS> But this has not worked. Generous tax relief has not stopped huge numbers of employers closing DB pension schemes, while keeping very generous pensions schemes in the boardroom. Spending £10 billion on an ineffective bribe strikes me as rotten politics. And hard as it is for some in the pensions world to accept the best defence of good DB schemes is effective union organisation.

Mac 3 >Unfortunately, this type of bash the rich mentality will only hasten the decline of good private sector schemes.

It is inevitable that any call for great fairness gets dubbed the politics of envy. Let me turn this round against all the public sector scheme bashers (which to be fair Mac 3 doesn’t mention in his post).  

Unfortunately, this type of bash the public sector mentality will only hasten the decline of good private sector schemes.

6 Responses to Pensions tax relief

  1. Tim Worstall
    Sep 12th 2009, 7:38 pm

    “Today the TUC publishes the first comprehensive rebuttal of the arguments used against public sector pensions and instead shows that for every pound that taxpayers spend on public sector pensions this year, they are giving £2:50 to subsidise the pensions of the richest one per cent who earn more than £150,000.”

    It would be interesting to see you rebut the point I made over there. That the above is so wrong as to be deliberately misleading.

    The £ 4 billion (ie, the £1 in the above) is only what the taxpayer is paying to fill the unfunded gap between contributions and payouts this year from those schemes which do not run a funded operation.

    That is, it is only the gap between contributions collected this year from members of pay as you go schemes (plus, of course, the taxpayers’ contribution to the employers part of such contributions) and the money paid out to current pensioners of such schemes.

    What you’ve entirely left out is the following: the taxpayers’ contributions to such pay as you go schemes which appear as the employers contributions (a very large sum indeed) plus also any deficits in those schemes which are supposedly funded by investments but which, like almost all current pension schemes, have deficits.

    Sorry, but your playing with the numbers here is tantamount to lying.

    There’s one number that I’m hugely interested in. There’s, as you say, £10 billion going in pensions tax relief to the top 1%. There’s also £10 billion being raised in taxation on pensions….for pensions are as you agree taxable.

    So, what percentage of that £10 billion in tax raised is coming from those fat cats in the top 1%? I would assume that it’s most of it actually, as it will be those fat cats that have pensions high enough that they pay the full 40% whack on it, no? (Compared to the say, 47% including NI relief they’ve had when they pay in).

    If, say, 90% of the £10 billion in tax raised is coming from those who in years past were the same people who were getting the £10 billion in reliefs (and of course with inflation etc they would have got less than that) then it all seems to be a very minor problem.

    If only 1% of the tax raised is coming from those fat cat pensions that got the £10 billion reliefs then of course this is more of a problem.

    So, what is the number? What percentage of the tax paid comes from the pensions of those top 1%?

    And yes, I do think you owe me an answer.

  2. Nigel Stanley

    Nigel Stanley
    Sep 13th 2009, 4:55 pm

    The Treasury has always defined the net cost of pensions as the difference between the cost of pensions in payment and income received from contributions. Our report simply follows the same methodology – and the common sense view that pension contributions are best seen as part of the wages bill.

    Your logic leads to seeing that part of pay going to the pension scheme as a pensions subsidy from tax payers. It isn’t – just as when a nurse buys a bar of chocolate it is not a tax payer’s subsidy to the chocolate industry.

    But, unlike any of the attacks on public sector pensions that I have seen we discuss, the difficulties of measuring the cost of pensions commitments that go into far into the future, including the limitations of the “net cost of pensions” measure. We also look at estimates of the total cost of pensions in payment as a share of GDP going into the future. Treasury estimates show some increase through to 2017 but then stability.

    I know of no source showing any breakdown by income of the tax paid on pensions in payment. I’d like to see one too.

    But I suspect that many pensioners will find it hard to accept that only those who were in the top few per cent of income earners when working are the only ones who pay tax on their pensions.

    As I said there is a strong case for some tax relief on pensions, but given that they are the only form of savings uniquely privileged with full tax relief it seems perfectly reasonable to ask whether it is all justified or well-targetted.

    It may be that the best approach comes from the TUC proposal for minimum tax rates for those earning more than £100,000. This would work by saying that those earning between £100,000 and £150,000 could not use reliefs and tax planning to reduce the tax they pay below a minimum rate of perhaps 32 per cent. There would be higher minimum rates for higher income bands. This, a sort of graduated progressive flat tax if you like, would massively simplify the tax system and make it much more fair.

  3. Tim Worstall
    Sep 13th 2009, 5:30 pm

    “Your logic leads to seeing that part of pay going to the pension scheme as a pensions subsidy from tax payers. It isn’t…”

    Of course it is: it’s certainly a cost paid by the taxpayers.

    Especially when (as I very strongly suspect but can’t be bothered to google up) the employer’s contribution to a public sector pension is very much higher than the private sector employers contribution to a pension.

    “The difference is even more stark if one calculates how much the government should be charging departments for their pension schemes. At the moment, this charge is 18% of payroll;”

    “Furthermore, employers tend to pay in less: around 6.5% of payroll.”

    http://www.economist.com/displaystory.cfm?story_id=13983688

    Sure looks like a subsidy to me.

    “As I said there is a strong case for some tax relief on pensions, but given that they are the only form of savings uniquely privileged with full tax relief it seems perfectly reasonable to ask whether it is all justified or well-targetted.”

    It’s tax deferment, not relief. And as such, if you reduce the relief to basic rate (say) then there’s a very strong moral case that the tax on what comes out of the pension pot should also be limited to basic rate.

    A suggestion which would no doubt shake out of the Treasury that number we’re both interested in.

    However, a much more interesting point now arises.

    “I know of no source showing any breakdown by income of the tax paid on pensions in payment.”

    You mean that you and the TUC are suggesting changes in hte taxation of pensions without actually having any clue what the actual amount of the subsidy to top pensions is?

    Way to go, proposing policy in such an uninformed manner.

  4. Tom P
    Sep 13th 2009, 10:53 pm

    “Especially when (as I very strongly suspect but can’t be bothered to google up) the employer’s contribution to a public sector pension is very much higher than the private sector employers contribution to a pension.”

    According to the NAPF the average employer contribution to a private sector DB scheme is 15.6%.
    http://www.napf.co.uk/Policy/KeyFacts/Workplace_Pensions.cfm

    The Taxpayers Alliance reckon the equivalent in the local govt scheme is 12%. (I actually think it’s more like 14%, but hey)
    http://tpa.typepad.com/home/files/council_spending_uncovered_3_pension_contributions.pdf

    In fact if you think about it you ought to expect the average contribution in many private sector DB schemes to be higher, because many of them are winding up and have to pay off the deficits they are facing whereas open schemes have a bit more leeway.

    Obviously the average employer contribution to a private sector DC scheme is much lower. But all that tells you is that much less generous schemes have lower costs.

  5. Tim Worstall
    Sep 14th 2009, 7:49 am

    “Obviously the average employer contribution to a private sector DC scheme is much lower. But all that tells you is that much less generous schemes have lower costs.”

    Quite: and that the public sector nearly exclusively now has those higher cost schemes is something that the taxpayers are paying for, no? So would usefully be counted as a cost to the taxpayers over and above the DC schemes which now prevail in the private sector?

    To start from the beginning again. The TUC figures point to the cost to taxpayers of the current tax subsidy that must be paid for currently unfunded public sector pensions. That gap between current contributions (employer and employee) amassing future pension rights and the pensions currently being paid of £4 billion a year.

    This is of course the lowest (which is why it was picked) of all the possible numbers we could use to determine the cost of public sector pensions.

    More enlightening numbers would include perhaps what is the current value of future such unfunded pensions. And also an interesting figure would be, what is the higher cost to taxpayers of DB pensions in the public sector as opposed to the DC pensions now overwhelmingly what is available in the private sector.

    That last is definitely a cost to the taxpayer of public sector pensions, is it not?

  6. TPA concede higher rate pensions tax relief is ‘problem’ | ToUChstone blog: A public policy blog from the TUC
    Sep 16th 2009, 3:50 pm

    […] is a rationale for tax relief on pensions as I set out here and here.  And of course, a tax incentive to save will provide more help if you choose to save two pounds […]