IFS Cautions Chancellor Against Hasty Pension and Capital Gains Tax Reforms

The Institute for Fiscal Studies (IFS) has issued a cautionary message to Chancellor Rachel Reeves regarding potential modifications to pension and capital gains taxes. The think tank emphasizes the possible detrimental effects on living standards, savings incentives, and economic growth.

As the October 2024 Budget approaches, the IFS advises against the "superficially appealing" option of limiting upfront tax relief on pension contributions. While this strategy might allow Reeves to maintain her pledge of not raising taxes on working individuals, the IFS argues it could negatively impact savings motivation and complicate the tax system further.

The IFS, established in 1969, has been a key player in analyzing UK fiscal policy for over five decades. Their warnings stem from a deep understanding of the UK's complex tax history, which includes the introduction of Capital Gains Tax in 1965 and the current income tax system dating back to 1799.

The think tank cautions that a broad-based increase in capital gains tax could hinder savings and investment. This concern is particularly relevant given that the UK's tax-free ISA accounts, introduced in 1999, have been a cornerstone of personal savings strategies for many Britons.

Reeves previously suggested restricting higher rate pension contribution reliefs in 2018, but has since distanced herself from these recommendations. The potential impact of such changes is significant:

• Capping upfront income tax relief for pension contributions at 20% could cost savers £15bn
• Introducing a flat 30% rate of pension tax relief would result in a £2.7bn bill
• Up to 6 million higher and additional rate taxpayers could be affected
• The wealthiest savers might lose around £2,600 each

The IFS notes that Reeves has limited her options by ruling out increases in income tax, National Insurance, VAT, and corporation tax, which collectively account for nearly 75% of all tax revenues. This self-imposed constraint echoes the challenges faced by previous chancellors since the establishment of the modern UK tax system.

"Measures that raise big revenue are few and far between and – assuming Ms Reeves intends to stick to her party's manifesto commitments – pensions taxation and capital gains tax are perhaps the most likely candidates. Both could be perilous."

While advising caution on major reforms, the IFS suggests some potentially positive steps. These include requiring companies to pay National Insurance on pension contributions to staff schemes and addressing the "absurd exemption" of certain pension pots from both income tax and inheritance tax upon the owner's death. The former policy could potentially raise up to £17bn.

As the UK approaches its Budget announcement, the debate surrounding these potential tax reforms highlights the ongoing challenge of balancing fiscal responsibility with economic growth and individual financial well-being. The discussion also underscores the importance of the UK's long-standing institutions, such as the PAYE system introduced in 1944 and the pension auto-enrollment scheme launched in 2012, in shaping the nation's financial landscape.