How the Single Income Tax would secure a better deal for pensioners

An actuary, so goes an old joke, is someone who thought the sheer thrill of chartered accountancy seemed like too much excitement. The problems with pensions may be huge in scale and almost universal in their impact, but facing up to them often just seems too dull and uninteresting for all but a select group of doughty actuaries and pensions professionals who have been pointing out the alarming consequences of issues such as a rapidly aging population and permanently sluggish trends for economic growth.

The Single Income Tax, the 2020 Tax Commission’s proposal to radically simplify and reshape direct taxes, tackles these problems head on. But fairness is at the heart of the proposals, and the report warns that without careful planning some groups might be caught in the transition from the current system to the Single Income Tax. The TaxPayers' Alliance is firmly committed to opposing every tax rise as one of our core principles. Pensioners paying the basic rate of Income Tax are one such group the report cautions governments not to disadvantage in the transition.

“there would need to be a delay before the introduction of some of the recommendations, so that individuals and businesses that have made decisions based on the current tax system do not face too much disruption.” - p.30, The Single Income Tax

Generally, pension funds would enjoy a substantial boost from our proposals. Now, asset values are hit by transaction taxes which gum up markets, hit by corporate taxes when they make a profit, and then hit again by Capital Gains Tax when they are sold. And all that’s before Income Tax on dividends. We propose to abolish all those taxes and reform Income Tax into our Single Income Tax. A recent study indicated that abolishing Stamp Duty alone, which then raised about £4 billion a year, might increase the value of shares by £150 billion, which are largely owned by pension funds. Capital Gains Tax and Corporation Tax currently raise almost £50 billion. Their abolition would be likely to increase share values by a substantially larger margin than Stamp Duty.

But share values are also significantly influenced by expectations of economic growth. The Centre for Economic and Business Research has calculated that our plan would boost trend growth every year by 0.4 per cent. It doesn’t take long for this to make a big difference. They calculate that after just 10 years, the economy would be 5.9 per cent larger than it would otherwise be, and 9.3 per cent larger by 2030. That would mean higher expected profits and dividends which would in turn lead to higher share values now.

So beleaguered defined-benefit pension funds, including many suffering worrying deficits, would receive a major boost from our plan. In addition, our reforms exempting UK companies from tax when they transfer money to other UK companies would free up pension contributions, so employers could pay pensions contributions directly into pension funds tax free, sweeping away complex and unnecessary rules and restrictions.

In addition, pensioners are considerably more likely to directly own property and shares than the population, because they have had the time to build up assets. So not only will pensioners benefit from the gains to asset values owned by pension funds from the abolition of Stamp Duty, Capital Gains Tax and Corporation Tax but they will also gain directly when they sell their own assets.

Despite these huge gains for pensioners in general and the more generous personal allowance under our proposals (the Government plans to freeze the more generous personal allowances for people born before 6 April 1948 so that inflation will make them gradually less valuable), some would still be at risk of losing out from the merger of Income Tax and National Insurance to a Single Income Tax rate of 30 per cent, because pensioners currently enjoy the advantage of being exempt from National Insurance. So instead of the combined rate falling from 40.3 per cent to 30, as it would for basic rate taxpayers under the pension age in work, it would mean a rise from 20 per cent.

Because it would be too late to expect pensioners to adjust their plans accordingly or fully benefit from the wider reforms, it would be unfair if the Government did not account for this. So we would suggest the Government consider two options. Firstly, pension funds could be mandated to increase pension payments to ensure everyone receives at least the same income after the new 30 per cent tax rate. However, once personal allowances are factored in, funds would need to raise their payments by up to 10 per cent to ensure every pensioner would be better off. For example, if all payments were increased by 10 per cent, a 70 year old pensioner paid £15,000 by a fund would have received £13,988 after tax, last year. Under the Single Income Tax, that pensioner would have been £562 better off. Meanwhile, a pensioner paid £40,000 would have been £305 better off.

While ensuring pensioners benefit from the increase in values in their funds, this might not be possible as funds covering annuities tend to hold assets such as Treasury gilts which would be less likely to rise in value as much as shares. It would therefore require detailed study by the Government.

The second option would be to let pensioners whose pensions had already been settled retain the 20 per cent rate for the first £33,000 of taxable pension income. This could be combined with a one-off tax on settled schemes where the other tax reforms have increased their value, to ensure everyone benefits from the reforms. As with the first option, this would require detailed technical study that was beyond the remit of the 2020 Tax Commission.

The British tax system is a complicated mess that requires radical root-and-branch reform to help restore incentives and growth into the economy. The Government must not shy away from this challenge. But it must also protect pensioners and others who have made decisions and arranged their affairs according to the current system. The 2020 Tax Commission’s Single Income Tax can achieve both of these objectives.

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