Tax relief on pension contributions

There's a bit of speculation that Alistair Darling may use the forthcoming Budget to play about with the tax relief on pension contributions. Currently tax relief applies in bands, meaning that high-rate taxpayers get more bang for their buck of pension saving than lower rate taxpayers.

This is quite an interesting issue as it gets at the question of whether tax incentives actually work to boost savings. This is something we had a look at when I was at the TUC, and were pretty sceptical of the impact of incentives on saving. But before I'm accused of bias, let me point you in the direction of the Pensions Policy Institute report (PDF) on this subject. Here are their conclusions:

• There is no evidence that tax incentives increase the overall level of saving. They are complex, do not appeal to their target group, and do not solve the basic problem for most low income people; that they do not have the money to save.
• Tax incentives can encourage pension rather than other types of saving.
• But tax incentives appear not to have been effective in generating enough pension saving for future pensioners.
All taxpayers pay for the tax incentive system, but it benefits higher earners most:
• Tax relief is often described as tax deferral, but there is also an element of tax advantage.
• Most tax relief is paid to higher (male) earners.
• Almost £20 billion a year of tax revenue is foregone each year due to tax relief on pension contributions. After taking account of other pension tax advantages and the tax paid on private pensions in payment, the net annual cost to the taxpayer is more than £19 billion (1.8% of GDP). This is significant, being 25% of the cost of state pensions and retirement benefits.
• The proposed tax simplification is likely to increase the cost of tax relief on private pensions.

Not much equivocation there really. So there is a good case in theory for at least tweaking tax relief - what about a standard band for all savers? The ABI claims that getting rid of higher rate relief would be "a direct attack on the hard-working people of middle Britain", but how many people are in that box, less than 1 in 5 and falling. This isn't Middle Britain, it's well-off Britain and it's dishonest to claim otherwise.

To be honest I could see tax relief being phased out altogether in the future. As of 2012, with the introduction of Personal Accounts, we'll have a quasi-compulsory pension scheme in any case. So why will we need incentives (which don't work very well) to get people to save? We could spend the money better elsewhere. If we really want to spend smart on pensions, rather than overly-reward the already well-off, why not phase out tax relief and use the savings to increase the state pension? Just a thought, like.