The pensioner paradox

28 Nov 13

If we’re all in this together, why are pensioners given special treatment? The government should ensure that older workers are no longer exempt from National Insurance Contributions and that pensions tax relief is reformed

Pensioners have largely escaped austerity. Shielding this entire age group from these changes, irrespective of need, is a mistake.

To explain why, it is important to consider how the link between taxation and spending has been broken. Although current retirees may have contributed income tax and National Insurance Contributions (NICs) all their working lives, they can still expect, on average, to receive more in services and cash benefits than they have put in.

This may have been affordable when the population was young, but as the number of people of retirement age rises it has become increasingly unsustainable. To quote former Treasury Chief Secretary Liam Byrne, ‘I’m afraid there is no money’.

Hard decisions need to be taken. These will apply not only to public spending, including the budgets for health and pensions, but also revenue, where taxation will have to rise to help plug the fiscal gap. Under projections from the Office for Budget Responsibility, non-interest revenue will rise from 37.2% of GDP to 37.8% of GDP over the next 20 years. This means that the average tax burden will rise by £380 per family by 2033.

As the country ages, the screws will inevitably tighten, making it increasingly difficult to put the public finances back on track. Not only will the state have greater pension liabilities and health and care costs, older taxpayers will represent an ever-increasing proportion of the tax base.

Currently, over-65s make up just 4.5% of the tax base. Even under existing policy, the percentage of the tax base represented by this age group is predicted to increase by a third by 2033.

Historically, pensioners have not paid NICs, as this was seen as a contribution during working life towards a state pension at retirement. Yet, in practice, they have been little more than a clumsy extension of income tax. Further, many people now choose to work beyond 65, particularly following the removal of the default retirement age.

Reform estimates that ending the exemption from employment and self-employed NICs would raise £735m and only affect the richest (by income) 6.3% of people aged over 65. These are people who have earned incomes above current NIC thresholds.

Another area for reform is pension tax relief. This is expensive, poorly targeted and fails to achieve its policy objectives. It tends to mostly benefit higher and top-rate taxpayers, and is unlikely to increase national savings rates, as much of the savings it encourages are redirected from other forms of saving.

However, care needs to be taken, as any changes will impact most heavily on younger taxpayers. Sixty-one per cent of pensions tax relief is received by people aged 35-55.

Yet this does not mean government should have no role in supporting pensioners. Rather, it means that when thinking about how to help this group it is important to be realistic. The direct tax system is a blunt policy tool. A desire to account for the specific needs of pensioners may more appropriately be pursued through reform to the state pension, not through broad changes to direct taxes.

The risk is that, rather than facing up to these hard choices, future governments will simply raise tax burdens on the mid-aged group. This would place a heavy burden on people at the key productive stage of their lives and could have serious knock-on effects on incentives and economic growth.

If the government is serious about lowering public debt, it must restore the link between taxation and expenditure, and not duck the hard decisions.

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