Income tax
There’s lots he should do - mainly around simplification of income tax rules that are no longer providing the right incentives.
This could be the one opportunity he has to cut the top rate of income tax back to 40p. This would prompt a gale of protest but it would be the right thing to do. The disincentives created by high marginal tax rates more than outweigh the modest amount of extra revenue they raise.
The second income tax measure that the Chancellor should announce is the repeal of the tapering of the personal allowance for earnings between £100,000 and £121,000. The effective 62% tax rate (including national insurance) for earnings in this band is a ridiculous anomaly for a Government that professes to promote lower taxation.
The third measure around income tax will almost certainly not happen, which is a shame. The misleading distinction between income tax and national insurance should be abolished. Its only purpose is to make people think they pay less tax than they do and to maintain the pretence that there is a connection between what you pay into the system and what you get out. There is none.
Pensions
The second area that is likely to come under the spotlight is pensions. Here I am less hopeful that I will be cheering the Chancellor’s measures. That’s because, after the positive changes to the retirement landscape in recent announcements, I expect any new initiatives to be less about increasing freedoms for pensioners and more about increasing revenues for the Treasury.
With £35bn being spent by the Government on tax relief (80% going to higher rate tax-payers) and a further £15bn handed to companies in foregone national insurance on pension contributions, the incentive for the Chancellor to launch a raid on our retirement savings is too great to pass up, I suspect.
How he chooses to get hold of the money remains anyone’s guess. Options include: the already-announced tapering of the annual contribution allowance for higher rate tax-payers from £40,000 a year to £10,000; a reduction or total scrapping of the ability to take a quarter of a pension pot tax-free at retirement; the abolition of higher-rate tax relief on contributions; or something even more radical like the creation of a new Retirement ISA.
This might replace the current system, whereby a pension saver gets tax-relief on their contribution but pays tax when they take an income in retirement, with an ISA-style system in which you save out of taxed income but pay nothing later on. The principal advantage of this for the Government would be a big upfront boost to revenues (with a commensurate reduction in 30 years or so when it will be someone else’s problem).
Inheritance tax
A third area where I expect something to be pulled out of the hat is inheritance tax. The fudge in the last budget limiting relief to bequeathed properties was an unsatisfactory half way house. A no-strings-attached £1m IHT allowance would be hugely popular and would chime with the thinking behind the recent legislation to allow pension savings to be passed more easily down the generations.
It would be too much to hope that any changes announced by the Chancellor will make all savers and investors better off. A government battling a persistent budget deficit does not have that luxury. What we can demand of Mr Osborne is that whatever he does simplifies a complex system of taxation and introduces incentives to do the right thing. Let’s hope he rises to the challenge on Wednesday.
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