George Osborne spoke yesterday to the BBC in China warning that “storm clouds” over the global economy were holding Britain back and “our own economy is not as big as we had hoped”.
“We may need to undertake further reductions in spending because this country can only afford what it can afford and we will address that in the Budget,” he told the BBC in Shanghai, where he is attending a G20 finance ministers’ summit.
“We’ve just had figures that show the economy is smaller than we thought in Britain, and we also know that global risks are growing and Britain is not immune to those things.”
Europe's most respected think tank has told Osborne to lay off cuts and there are some who hope that the Chancellor may spare pensions as to reduce pension tax-relief would contract our economy still further. In my opinion , they are underestimating the craftiness of Osborne's solution.
It is not just me is flagging the scale and audacity of the Chancellor's approach to pensions. Willis Towers Watson have flagged to their clients precisely the same approach. The FT has also hinted at a more radical solution to the Treasury's consultation than those commonly discussed in pension circles.
There's a problem with pay
Osborne's central problem is that any attempt to reduce upfront tax-relief through conventional means has three negative consequences
- It requires payroll to co-operate. Payroll has been co-operating over RTI and auto-enrolment but the CIPP and other bodies are saying "enough is enough", we have our hands full.
- It requires those who see a reduction in tax relief to take an immediate cut in take home. While Osborne might take on those with high net disposable income (as he does with changes to the annual allowance), collecting tax against employers contributions and forestalling national insurance avoidance could hit basic rate tax-payers.
- Reducing take-home plays into the hands of those (like the OECD) for whom austerity measures are seen as creating a vicious deflationary spiral.
I simply don't see a conventional cut in tax-relief as working.
If you can't beat them- join them!
To get what he wants, Osborne needs more than to nibble the cheese, he needs to move it. The paradigm shift in thinking, comes when you move from thinking of tax as something that payroll collects out of income, to something that pension schemes -either out of contributions or out of accumulated funds. If you can't beat pension funds, join them! HMRC have found a way of becoming the default fund manager that can demand a share of contributions or a portion of existing funds while leaving people's net disposable incomes untouched. It's as simple as asking a pension scheme to pay whatever tax (and national insurance) the Chancellor wants back, as a payment to the Treasury. If there is no fund to raid (as is the case with the majority of state-run occupational schemes, the money comes from contributions, otherwise pension schemes can choose to pay tax , on our behalf from contributions or from the pension pot. Note "on our behalf". This is not a raid on corporate profits or the budgets of Government offices. The people who will be paying this tax will be you and me- ordinary citizens. The impact of these tax payments now, will be a cut in the amount in our pension pots when we take our benefits, a charge against the defined benefit pension - when they come due.
It is crafty and elegant and devilishly destructive. The HMRC are the enemy within, demanding pension administrators treat them as another fund manager. If you can't beat them - join them.
Guess what - it works!
If the Treasury want to raid pensions from the outside, they use payroll, corporation tax and self-assessment. Collection isn't easy, the impact of payment is immediate and the capacity to "have a go" limited. By "having a go" , I mean having a go at the big targets. The big targets are not the higher rate relief enjoyed on personal contributions. Employee contributions amount to only a fifth of the tax-reliefs granted to pensions. Although higher-rate tax payers currently account for a high proportion of this tax-relief, this is not the problem (especially with auto-enrolment kicking in properly in 2018-19). The problem is the £20 bn of employer contributions paid to staff as deferred pay. On top of that there is a second problem of £14bn of lost national insurance contributions on employer payments. It is this £34bn pa tax and NI loss that is keeping the Chancellor's eye on the pension prize. If he could recoup a proportion of that though taxes collected by the Pension Schemes themselves - and ease the pain of this pensions austerity by deferring it to retirement, George has his rabbit.
It works? - How?
It works for payroll- who have no further duties, the administration of all this passing to pensions. It works for the tax-payer, who continues to take home as he or she did prior to any changes It works for public finances which can benefit quickly from massive inflows from these new taxes and it works for short-term economic growth, as it does not stop the man in the street spending his income and growing the economy.
Will the Office of Budget Responsibility buy it?
We can reasonably expect a fair bit of scrutiny on our behalf from the Office of Budget Responsibility. Some cynics call the OBR a rubber-stamping machine but I'm not one of them. The OBR have made it clear that we cannot go on providing the current incentives to private pensions. They have also made it clear that - relative to other OECD countries, we over-pay on tax-relief. Measures to curb and reduce these incentives, especially where they are targeted towards those with large existing entitlements, are likely to be met with approval.
The end of tax-relief is nigh
For generations , we have linked the amount of tax-relief we get on private pensions with our marginal rate of taxation. This "yours by right" model looks set to go, instead we will have a model based on Government incentives- targeted at those who the Chancellor feels the public purse reckon are most deserving (those who have lost in the past), or least deserving, the feckless non-savers who are being culled into long-term investment through auto-enrolment. These definitions, as the Institute of Fiscal Studies point out, point at the same group of people- it just depends on your point of view! So I see a budget that strengthens not weakens auto-enrolment, reduces the benefits of defined benefit schemes (but does not attack its funding) and is a full-on attack on the wealth management industry (at least in their use of pension wrappers as a means to protect wealth). This is not necessarily a bad thing for pensions. The overall impact of the reforms will be judged ultimately by outcomes. If more save , if those who save, save more , then the Chancellor will have achieved another pensions hit. If those who see their pensions being cut by stealth taxes rebel, then the Government run the risk of civil insurrection, Brexit, famine plague and associated problems. I think it more than likely that Osborne will be able to raid pensions, as Gordon Brown did in years gone by - from within. There is no easier way of making money than from pension management charges!
About Henry Tapper
I'm best known for helping small employers and business advisors with their problems with pensions. These are typically over choosing the right pension for auto-enrolment though through my work with First Actuarial, I get involved with big occupational schemes too.
I'm on this site as I see accountants as the missing link between the pensions industry and the business community - especially small businesses.
I've a Cambridge MA and 30 years in finance behind me, but I'm looking forward to the next ten to twenty years (my flexible "corridor to retirement") to help restore people's confidence in pensions.
Director- First Actuarial
Writer- www.HenryTapper.com and many magazines and papers,
Manager; Pension Play Pen linkedin group, Pension Auto-Enrolment Linked In Group
Choices Champion; Friends of Auto-enrolment