Tax Credits: saved at a stroke

Cut the ‘benefits’ of the wealthy instead!

By Russell Bruce

George Osborne has to find savings of £4.5bn to reinstate his proposed tax credit cuts as the House of Lords, being unusually populist, decided to throw out his changes to Tax Credits.

I thought I might be helpful and suggest where the money could be found. Nothing revolutionary – except perhaps to Daily Mail readers. The idea has been around for some time about one area where the tax system can be reformed, simplified and savings made.

“Today’s tax-based incentives to save for retirement are hugely expensive

and, worse, ineffectively deployed. Skewed towards the wealthy,

they do far less that they should to minimise pensioner poverty.”

Centre for Policy Studies, 2012

The welfare state was set up to make our society more equal. Benefit has become a dirty word in a right-wing controlled state, like the UK. But there are two sides to state benefits. On one side is the cost of the range of payments made to families and individuals, including Tax Credits. On the reverse there is the tax credit, or tax relief, only the wealthy are in a position to fully benefit from.

Two sides of the coin – completely separate – never spoken about in the same terms. Yet, both are in effect, transfers from which recipients ‘benefit’.

Tax credits cost around £30[1] billion a year and the tax relief on pensions cost the Treasury £34.3 billion[2], disproportionally benefiting higher earners. Encouraging people to save for their retirement is a good thing and has many advantages for the state in the longer term. Retirees will have more money to spend in retirement and some of that spend will come back in tax revenues.

George Osborne planned to save £4.5bn by cutting Tax Credits to those on low incomes in the tax year starting April 2016. At a stroke, the tax credit cuts can be reinstated, just by cutting the cost of pension tax relief by a mere 13.1% to find that £4.5 billion[3]. What is more, we can make the system of tax relief on pensions more efficient and fairer.

Currently tax relief is based on the amount of tax you pay at 20%, 40% or 45%. Pension providers claim tax relief at 20% on your behalf from the Treasury. Higher rate, 40% and 45%, taxpayers have to claim the additional relief of 20% or 25% on their tax return. By introducing a flat rate of relief this will reduce the cost to the Treasury, simplify administration and reduce the cost of collection.

Everyone up to the age of 75, even if they do not pay tax, can put up to £2,880 a year into a pension and the Treasury will top it up by £720 to £3,600. So 20% of the total, but actually 25% more than you contributed.

Table 1 shows how higher rate taxpayers contribute less to achieve the same total pension investment that basic rate taxpayers obtain. The higher your income and tax rate, the less money you need to find as the rest is paid for by the government.

Tables 2 and 3 show the effect of a new flat rate relief at 33.3% and 25%

Pension tax relief.numbers

Under the present system higher rate taxpayers get an extra bonus from George Osborne. Indeed, as they also got from Gordon Brown and Alistair Darling. 40% taxpayers get twice the amount of Treasury cash as basic rate and non-taxpayers, whilst those on 45% get back an extra £1260.

Moving to a flat rate relief system will never create a truly level playing field because the more you earn, the more you can invest in your pension and the more the Treasury shells out to keep you in the lifestyle you have become accustomed to, in your later years.

This is a reasonable compromise because the more you earn, the more you pay in tax and the wealthy never tire of telling us how much they pay of the total tax take. By investing more in a pension and getting more tax relief, but at a flat rate, rather than your marginal rate of tax, still enables the wealthy to keep more of their earnings advantage, but no longer at the expense of those on low and middle incomes.

For the 2015/16 tax year there are an estimated 29.7 million taxpayers. Of those 24 million pay at the basic 20% rate, 4.65 million at the higher 40% rate and just 332,000 pay the additional rate at 45%.[4]

As I wrote at the beginning, the proposal for a flat rate of tax relief on pension contributions is not revolutionary. What is different in this proposal is the linkage of tax allowances and tax relief to welfare payments including Tax Credits. All constitute ‘benefit’ transfers to citizens by the state.

The Centre for Policy Studies (CPS) produced a paper in 2012 showing how costly and ineffective pension tax reliefs are[5]. In the conclusion to their report the CPS said, “Today’s tax-based incentives to save for retirement are hugely expensive and, worse, ineffectively deployed. Skewed towards the wealthy, they do far less that they should to minimise pensioner poverty. Furthermore, they do little to catalyse a savings culture amongst younger workers, thereby exacerbating the looming generational inequality.”

Most readers will be familiar with statements indicating how welfare spending rises year on year. What never gets a mention is how the bill for pension tax relief also rises year on year. In 2001/02 the cost to the Treasury of pension tax relief amounted to £17.5 billion. For the current tax year it has doubled. For the 10 years from 2001/02 to 2010/11 the total cost came to £262 billion.[6]

A flat rate of pension tax relief would not be a tax rise per se, Because the relief comes before the final calculation of revenue, it is not classed as spending, but all tax allowances and reliefs are, none the less, a means of reducing revenue and a cost to a nation’s revenues.

Tax allowances are justified as part a progressive tax policy. Extended higher rate relief, on the other hand, is not a progressive measure but a benefit extension to those on higher tax rates.

Those on high incomes with high net worth have access to an annual tax free Capital Gains Tax Allowance of £11,100, can obtain pension tax relief for significant contributions (subject to the lifetime allowance) and are best placed to take full advantage of their annual ISA tax shelter allowance, currently £15,240.

Introducing flat rate pension relief at 25% or 33% would actually benefit and improve access to pension saving for 24 million basic rate taxpayers and voters. Only the wealthy lose. Whist I have no wish to see another Conservative government in 2020 this is something, I would have thought would appeal to George Osborne, a man known to have future political ambitions.

All that is required is to run the numbers to determine a flat rate that will save £4.5 billion to restore the Tax Credits cuts to the low paid.

Why are you dithering George?

 

References

[1] http://www.independent.co.uk/news/uk/politics/tax-credits-what-they-are-and-how-the-cuts-could-affect-you-a6707591.html

[2] Hargreaves Lansdown, Investment Times, December 2015, p.22

[3] http://www.bbc.co.uk/news/business-34572807

[4] https://www.gov.uk/government/statistics/number-of-individual-income-taxpayers-by-marginal-rate-gender-and-age Table 2

[5] http://www.cps.org.uk/files/reports/original/121123104830-costlyandineffective.pdf p

[6] ibid p.5

 

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About russellbruce

Writer, journalist and blogger. Worked in advertising and publishing. Former board member Loch Lomond National Park Authority, Chair of Borders Writers' Forum
This entry was posted in Austerity, Benefits, Economy, Tax Credits and tagged . Bookmark the permalink.

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