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The last tax saloon

A parable illustrates the folly of higher-rate restrictions

HM Treasury has rejected proposals to simplify the restriction of higher-rate relief by reducing the annual allowance. The paper says: “A reduction in the annual or lifetime allowance would potentially apply to pension savers on lower incomes, particularly defined-benefit schemes.

Furthermore, it would allow high-income individuals to continue to benefit from a higher rate of tax relief than other pension savers.”

How can anyone “on lower income” be caught out by an annual allowance of, say, £60,000?
A little parable might be useful for Mr Darling.

Every day, 10 IFAs went out for a beer and the bill for all 10 came to £100. They paid their bill the way we pay our taxes, something like this – the first four IFAs paid nothing. The fifth paid £1. The sixth paid £3. The seventh paid £7. The eighth paid £12. The ninth paid £18. The 10th (the richest) paid £59.

They were happy until the owner made them an offer. “Since you are good customers,” he said, “I am going to reduce the cost of your daily beer by £20.” Drinks for the 10 now cost just £80.

The group still wanted to pay their bill the way we pay our taxes. So the first four IFAs were unaffected. They drank for free. Then, £20 divided by six is £3.33 but if they subtracted that from everybody’s share, the fifth IFA and the sixth IFA would each be paid to drink. The bar owner suggested they reduce each bill by roughly the same amount.

Now the fifth IFA, like the first four, paid nothing (100 per cent saving). The sixth paid £2 (-33 per cent). The seventh pays £5 (-28 per cent). The eighth pays £9 (-25 per cent). The ninth pays £14 (-22 per cent). The 10th pays £49 (-16 per cent). Each of the six was better off than before. And the first four still drank for free.

But the IFAs began to compare savings. “I only got a pound out of the £20,” declared the sixth . He pointed to the 10th IFA, “but he got £10.” The fifth IFA said: “I only saved a pound too.” The seventh IFA said “Why should he get £10 back when I got only £2?” “The first four IFAs yelled in unison. “We didn’t get anything at all. The system exploits the poor!” The nine IFAs beat up the 10th.

The next night, the 10th IFA did not show up for drinks, so the nine had beers without him. But when it came time to pay the bill, they discovered they did not have enough money between them for even half of the bill!

And that is how our tax system works. The people who pay the highest taxes get the most benefit from a tax reduction. Tax them too much and they just may not show up and might start drinking overseas.

David Trenner is technical director at Intelligent Pensions


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