Ex-Chancellor Sajid Javid calls on govt to axe marginal rate pension tax system

The Centre for Policy Studies (CPS) and ex-Chancellor, Sajid Javid, have urged the government to axe the current marginal rate pension tax system in favour of a flat rate bonus, paid regardless of tax code.

A joint report entitled After the Virus: A plan for restoring growth, highlighted reforms around the taxation of pension contributions as “low-hanging fruit” when looking to recover funds following the current crisis.

It emphasised that that the reforms could “significantly increase” the incentive for lower earners and the self-employed to save for retirement, whilst also bringing “substantial savings” for the exchequer.

The report explained that under the current system, wherein relief on contributions is paid at the taxpayer’s marginal rate of tax, accounting for the fact that tax will be due when income is drawn in retirement, the cost of the relief “far outweighs” the tax paid by retirees on pension payments.

Furthermore, it also stressed that a marginal rate system means that the “vast majority of this money” will only benefit higher earners, whilst low earners who pay no tax see no benefit.

This follows a report by the Pensions Policy Institute, which revealed that half the value of the available pensions tax relief is claimed by the 15 per cent with the highest incomes (over £60,000).

Industry experts at the time supported the call for a simplification of the tax system, but remained divided by flat rate recommendations, warning of "unintended consequences".

The CPS, however, recommended switching to a flat rate bonus, rather than relief, to be paid on contributions up to a “generous annual allowance”, regardless of tax code.

It also reiterated a recommendation from a previous CPS report, which suggested combining such a flat-rate savings bonus with a broader shift to an ISA-style pension system.

The report noted that although CPS had previously argued in favour of comprehensive reforms to encourage saving, government had ”consistently baulked at the prospect of meaningful reform”.

Instead, the government made a number of "tweaks" to the existing system, ultimately leading to “controversial distortions” to the system, such as the impact of the annual allowance on NHS doctors.

It also emphasised that whilst CPS had “long been critical” of the state pension triple lock, it recognised that this was a “politically sensitive” area and that government “will be reluctant to set aside its manifesto commitments".

Industry has remained divided on issues around the triple lock, with recent reports that the government may be considering breaking its manifesto promise, due to concerns over the economic fallout following the current pandemic.

Part of the broader recommendations of the report included suggestions for a “system-wide” review of the UK tax system.

Commenting within the introduction of the report, Javid added: "Although the Covid-19 pandemic began as a public health emergency, it has swiftly developed into the most extraordinary economic crisis of our time.

"The threat posed to people’s livelihoods is superseded only by the threat to lives themselves.

"The purpose of this report is to support the efforts of ministers to instigate the strongest possible recovery.

"It was written in response to a shortage of off-the-shelf solutions to a challenge quite unlike any other.

"As the government puts together a stimulus package, it is essential that no stone is left unturned. Boldness, as well as out-of-the-box thinking, is the order of the day."

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