Fabian report – Expensive and Unequal by Andrew Harrop

The chancellor of the exchequer is considering how to raise taxes in October’s budget in ways that do not breach the 2024 Labour party manifesto. The Fabian Society’s new report Expensive and Unequal explains why the government should reduce and redistribute pension tax relief as part of this package. It also presents a menu of possible reforms.

Today pension contributions and investments are largely exempt from tax. This is called pension tax relief. Private pensions in payment do incur some tax, however almost all workers receive far more in tax relief on their pension contributions and investments than they can expect to pay in tax on their pension income. This is especially true for high earners.

Findings

• Tax relief on pension contributions was worth £66bn in 2022/23, an increase of 55 per cent since 2016/17. Only one third of pension tax relief was offset by tax revenue from pensions in payment (£22bn in 2022/23).
• More than half of tax relief (an estimated 53 per cent or £35bn in 2022/23) went to upper and top rate taxpayers who make up just 19 per cent of employee taxpayers.
• Only an estimated 35 per cent of tax relief on pension contributions went to women.

Proposals

The report presents a series of options for reform – a selection of which could raise at least £10bn per year for the exchequer. Key proposals include:

1.      Create a single flat rate of tax relief for individual and employer pension contributions for all tax bands (eg 25p or 30p per pound of gross income).

2.      Levy employee national insurance on employer pension contributions in exchange for a higher government top-up on the first £7,500 of annual pension saving

3.      Reduce the maximum tax-free lump sum to the lower of £100,000 or 25 per cent of pension wealth

4.      Fairly tax the inheritance of pensions by subjecting pensions to inheritance tax and levying income tax on all inherited pensions

5.      Charge employee national insurance on private pension incomes (with an allowance to exclude small pensions) in exchange for cancelling the forthcoming cut to winter fuel payment

Andrew Harrop, Fabian Society general secretary and report author said:

“Pension tax relief is very expensive and very unequal.  It costs the exchequer over £60bn per year and more than half this money goes to higher and top rate taxpayers. With huge pressure on the public finances the UK cannot afford to maintain such a costly and badly targeted system.

“Rachel Reeves needs to raise revenue while also safeguarding family living standards and sticking to Labour’s manifesto pledges. As part of her tax-raising October budget she should introduce reforms to pension tax relief that save money and redistribute taxpayer support from the wealthy to low and middle earners.”