Potential reforms to the tax relief on pensions could have a ‘significant effect’ on the future of UK finances, The Institute for Fiscal Studies has warned.

In its Green Budget, which assesses the potential impact of announcements likely to be made by Chancellor George Osborne in his Budget in March, the IFS said the impending changes to pensions tax relief could have a “substantial” impact on the headline public finances over the next five years.

The Treasury confirmed in the Autumn Statement last year that a decision about the future tax treatment of pension contributions would be made in the 2016 Budget.

Widespread rumours have since suggested the Chancellor is particularly toying with the idea of introducing a flat rate of tax relief, but the possibility of a TEE system still looms.

“Depending on which of the options is chosen, the effect on the headline public finances over the next five years could be substantial, but the true effect on the underlying and longer-term fiscal position may not be so easy to glean from the numbers that will be presented on Budget Day,” the think tank said.

But the IFS said exactly how much money each of these options would raise would depend on the behavioural impacts they would have. For example, under a flat rate, lower and middle-income individuals may or may not choose to save more, whilst those on higher incomes could save less.

“To the extent that the policy change only brings revenue forwards in time, the right response is to bank this money rather than use it to cut taxes or boost spending in the short term.

“But is it credible that the Chancellor or one of his successors – faced with a large surge in income tax revenues – would resist the temptation to give at least some of it away?,” the IFS added.

“In the longer term, when higher-income older people are enjoying their tax-free pension income, is it credible that a future, potentially cash-strapped, Chancellor will avoid the temptation to levy tax again on this income (i.e. TET tax treatment)?

“The first question suggests that future generations of taxpayers may not thank us if we allowed a Chancellor to take the tax revenue up front and spend it. The second question suggests that we might ourselves be wary of putting much into our pension funds in case a future Chancellor decides to tax us again.”

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