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A cut too far

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Axing higher rate tax relief on pensions would fatally wound the Coalition says Teresa Hunter

When I returned from holiday to hear that the Government was contemplating scrapping higher rate tax relief on pensions, I found myself humming the theme tune of the M*A*S*H television series.

“Suicide is painless, it brings on many changes, and you can take or leave it if you please.”

In fact the more you think about it, the more the Government’s pensions strategy is looking like a Mobile Army Surgical Hospital casualty tent. Plenty of blood and chaos, as limbs and members are hacked away, while fighting rages all around.

Anyone would think the Conservatives had actually won the last election. Someone should have a quiet word in Chancellor George Osborne’s ear and point out that with no votes in Scotland, his party can never win a majority in the UK.

Support is pretty thin over swathes of the North of England and Wales too, and will be thinner still come the next election.

Antagonising core voters further, by slashing tax relief on their pension savings, at a time when many are struggling to come to terms with the loss of final salary pensions, would surely be electoral suicide.

Where is the logic anyway of slashing the deficit, only to hand the economy back to Labour in 2015?

But scrapping higher rate relief on pensions is by no means without its supporters. Former New Labour adviser, now director general of Saga, Dr Ros Altman has long argued that giving half of all pensions tax relief to the better off was unfair, and should be reformed.

More recently, former adviser to the Conservatives, Michael Johnson, research fellow at the Centre for Policy Studies, pointed out that the £30 billion cost of pensions tax relief was the same size as the defence budget and dwarfed other Government departments.

If scrapped, he suggested, it would go some way towards funding a 60 per cent increase in state pensions, which he put at £51 billion. Savers could then be encouraged to invest for retirement on top via a new beefed-up Isa.

Proposals from former Government advisers can be real killers. Plenty of sacred cows have been sacrificed on their altar. Take mortgage interest tax relief, which was chipped away at over the years, to a point where the impact of complete withdrawal barely raised a whimper.

Then again, our holiday villa was called Il Castagnello, so I know all about old chestnuts, and this is one.

Much of the debate around the cost of pensions tax relief is so much spit in your yoghurt, as M*A*S*H surgeon Corporal Klinger liked to put it. HMRC puts total tax relief for the year 2009/10 at £36.4bn.

Tax paid in retirement exceeds the cost of relief going into the schemes, which surely goes some way to proving the system works

Of this, admittedly gargantuan sum, less than £7bn was spent on giving individuals income tax relief on contributions into their pensions.

Employers saved £13.6 billion in tax on contributions into occupational schemes, and a further £8.3 billion through reduced National Insurance bills. In other words, companies, not employees are pocketing the lion’s share of the relief, and enjoying a £22 billion tax-break.

I wonder what their attitude would be towards their pension schemes, if this incentive were scrapped? I think we can all guess. Even Johnson accepts this could be counter-productive, and says firms should continue to receive relief. It should only be stopped for individuals.

Yet in 2009/10 these prudent savers paid £8.4 billion income tax on pensions in payment, dwarfing the £7 billion relief on the way in.

In other words, tax paid in retirement exceeds the cost of relief going into the schemes, which surely goes some way to proving the system works. HMRC deducts this figure from the gross tax relief cost of £36.4 billion, to give a more precise £28 billion net cost.

Even so, is it fair for half of all relief to go to higher rate taxpayers? When put like that, probably not. However, when you consider that 40 and 50 per cent taxpayers actually pay two-thirds of all income tax, it looks less surprising that they get most relief.

What are we talking about anyway? If half of all tax relief to individuals, or £3.4 billion to be precise, goes to higher rate taxpayers, less than £2 billion, or 5 per cent to total tax relief, relates to the top slice.

Would any Chancellor sign the death warrant for his party at the next election by hitting his most loyal followers hardest, and all for the sake of £2 billion?

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