Chancellor risks new ‘Omnishambles’ Budget if she raids pension tax relief – LCP

As the Chancellor searches for additional sources of tax revenue, there is often pre-Budget speculation that she may find it by cutting back on pension tax relief. But new analysis from pensions experts LCP finds that although the Chancellor may think that pension tax relief represents ‘low hanging fruit’, she could find out that it turns out to have a bitter after-taste politically and economically. The analysis concludes that a Budget decision to cut pension tax relief could bring back memories of the 2012 ‘Omnishambles’ Budget, where high-profile measures created a storm of opposition and had to be watered down within weeks.

The new report, ‘How to avoid an Omnishambles Budget,’ looks at areas typically highlighted as potential areas for Treasury savings.

These are:

• Getting rid of the higher rates of tax relief enjoyed by those who pay tax above the basic rate
• Capping (or even scrapping) the ability to take 25% of a pension as a tax-free lump sum

In addition, following the publication this year of HMRC research exploring employer attitudes to potential cuts in ‘salary sacrifice’ for pensions, the report also looks at the scope for capping or scrapping this element of the system.

The report then identifies five potential ‘traps for the unwary’ which could be associated with some or all of these changes.

These 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 losers
• Putting extra burdens on employers, coming on top of the £25bn hike in employer NICs in the last Budget
  Undermining pension saving, at a time when even the Government estimates that around 14 million workers are not saving enough for a decent retirement

The authors then ascribe a red/amber/green rating to each of the three potential Budget changes on which there has been recent speculation against these five ‘traps’, with a red rating indicating a serious ‘trap’ that we expect the Chancellor would want to avoid.

The results are shown below:

The chart shows that all of the potential cuts to tax relief raise serious issues and would be likely to be highly contentious.

Key points include:

• 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 the high level of pension membership in the public sector mean we expect they would be disproportionately affected by such changes.
• 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 if the change went ahead; in our view this would be a clear breach of the manifesto pledge not to increase tax on ‘workers’, as well as increasing costs for employers.
• Abolishing higher rate relief would be a major structural change to the pension system, requiring lengthy consultation with pension schemes and providers and employers, complex legal changes to implement a new system and considerable time to change administration and payroll systems to reflect the new rules; all of this means very little additional revenue would be likely to flow during this Parliament.
• Capping tax-free cash would be widely seen as ‘moving the goalposts’ for those who were approaching retirement and had made plans based on the current rules; in our view extensive transitional protections would be needed, and these would mean that extra revenue from this measure could be negligible in this Parliament.

Commenting on the analysis, Steve Webb, Report Co-author and Partner at LCP said: “Raiding pension tax relief may look superficially attractive for a cash-strapped Chancellor. But lying beneath the surface are multiple traps for the unwary, meaning that reforms might raise far less than expected, break manifesto promises to workers or put additional burdens on employers who are already under pressure. The political backlash against such reforms could easily echo previous ‘Omnishambles’ Budgets where a U-turn was made within a matter of weeks.”

Tim Camfield, Report Co-author and a Principal at LCP said: “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. Any such change could undermine pension saving and confidence in the system and should be avoided.”