The TUC's Nigel Stanley, who is a nice enough bloke, but should probably stay away from tax policy work in future, has been writing about pensions tax relief in the Guardian ¹

Pensions tax relief is the pensions world's dirty little secret – a conveyor belt that shovels money in the direction of the better-off. While the government has put some limits on how much can be claimed – and that's worth at least one cheer – they have done nothing to reduce the fundamentally unfair nature of pensions tax relief.

Few understand how it works. If you put a pound into a pension, the tax authorities will take that pound off your taxable income, thus reducing your tax bill.

Standard rate taxpayers would have paid 20p on this pound – so for every pound they save they get 20p knocked off their tax bill. It therefore costs 80p to save a pension pound if you pay standard rate tax.

But as higher-rate tax is 40%, higher-rate taxpayers get 40p back for every pound they save, so it costs them just 60p to put a pound in their pension. Fair?

Tax relief does not come free. For every pound the government gives back in tax relief it has to collect in other taxes and the costs are staggering. Before the rules changed, tax relief on pensions cost more than £36bn a year. Three-fifths of this (close to £22bn) went to higher rate taxpayers, but 25% – nearly £10bn – went to the top 1% on more than £150,000 a year.

The new 50p tax rate for earnings over £150,000 gives us the ludicrous situation that the super-rich get 50p back for every pound they save. In other words we have a pensions "bogof", whereby the wealthy can buy one pension pound and get one free while the deal for standard-rate taxpayers is only five for the price of four.

In future no one will be able to claim tax relief on more than £50,000 a year of pension contributions. This will raise £4bn a year, and does come from the better-off. But the new rules do nothing to change the fundamental unfairness of tax relief.

This is because people can still claim at their marginal tax rate. The super-rich keep their pensions bogof, but there is now a limit on how many items they can take through the till. But there is no need for a whip-round for these distressed gentlefolk, for they can still buy £50,000 worth of pension for just £25,000.

He's falling into the Ritchie trap of presuming that all your money are belong to us and that what you get to keep is yours only by the divine mercy of the government.  Under this distorted, crackpot view of the universe, because we tax rich people at 50%, every £1 that you are permitted to pay out of pre-tax income costs you only 50p but is then topped up by a donation by the state of 50p.

This is of course mad, because if you earn £10, your tax would be £5, and you'd take home £5.  If you are allowed to pay £1 out of pre-tax income then your tax is £4.50 and you take home £4.50.  You're always taking home less than you would have done, and the state tolerates this because it's in the long term interest of the country.

If we imagine a much poorer person who earns only £2 but pays tax at 10%, they pay 20p in tax and take home £1.80.  For them to contribute £1 into their pension, they would pay 10p in tax and take home £0.90.

We should accept this settlement, even though Stanley and his nutty union buddies cry foul, because you will observe that the richer person still pays substantially more tax than the poorer one.  You will remember that the richest 5% of earners pay 45.5% of total income tax, even after taking account of the current tax relief arrangements.

And we should further accept pension contributions out of pre-tax income because it binds higher earners into a common settlement with everyone else over pensions.  Without this, there is the risk that higher earners will simply give up on pensions altogether, leaving everyone poorer.  To a certain extent we have already seen this with defined benefit pensions, as directors joining companies after their defined benefit pension plans have been closed to new joiners have a real incentive to close the schemes to future accruals as well.

There's also a profound unfairness that Stanley unsurprisingly overlooks.  As I mentioned a week or so ago, public sector pensions can cost in the region of £6.50 for every £1 contributed by the employee.  The £1:£1 that Stanley thinks is so unfair pales into insignificance compared to this largesse.

If he's serious about fairness, his union colleagues will demand that public sector pension schemes be scaled back significantly, given how grossly unfair they are for the taxpayers that fund them.

People who read this post also read:

• Pensions justice, but only if you work in the public sector
• Eoinomics and teachers’ pensions
• A tale of two employees
• Public sector pensions are gold-plated
• Our public sector pensions crisis

Filed under: Other blogs, Politics, Taxation with tags defined benefit, guardian, nigel stanley, pensions, public sector, tuc