Time to axe tax breaks for affluent pensioners

We give large tax breaks to well-off pensioners when it is young people that need help with rising costs and debt levels – says think-tank

Everybody has times in their lives when they are a bit skint. For many, it is when they have left home but are still young. At this point they have yet to really establish their careers and so their incomes are not yet high. Renting in the private sector is almost always expensive and the first few years with a mortgage are tough. Then children come along and either two incomes become one, or childcare costs have to be paid. Many young people also have student loans to contend with as well. If you need a break at any point in your life, it is when you are young.

Yet instead of doing that, Britain gives big tax breaks to affluent retired people. They get to take a quarter of their pension as a lump sum, without paying a penny in tax. That is a £200,000 tax break for the richest people in the country, at the richest point of their lives. They also do not have to pay national insurance at all, unlike younger people. All this means that a pensioner on £50,000 pays a lower tax rate than Mitt Romney. That just is not right. It needs to change.

Britain must stop giving such a good deal to the richest third of pensioners. The government should do two things. First, it should lower the amount you can take tax free when you retire, to around £40,000. This would only affect those with very large pension pots, who can afford to pay more. Everyone else who was approaching retirement would still get exactly what they expected to get. To be honest, it is odd that anyone gets to take a chunk of money like this tax free, so it should be phased out altogether in the longer term.

Second, the government should end the national insurance exemption for pensions and pensioners. Pensioners should, however, get a double NI allowance - to protect poorer pensioners. There is no point charging them national insurance only to give it back in larger benefit payments. Overall, only a third of pensioners would be made worse off by these proposals. Yet they would raise £5bn a year in the short run, rising to £9bn a year in the long run. These are big sums; enough to raise the tax allowance by £1,100 in the short run and £1,700 in the long run.

This is the same as cutting taxes for the typical person by £230 in the short run and by £330 in the long run. These changes are strongly progressive. They take from the rich, and give to almost everyone. Some 87 per cent of households would be better off or unaffected, with people at the bottom and the middle of the distribution generally being winners. Of course, affluent pensioners are vocal and they vote. But policy-makers need to think about everyone, not just about those who shout the loudest.

Tim Leunig is chief economist at CentreForum, a liberal think-tank in the United Kingdom. He is also co-author of Tax justice: whatever your age