Rishi Sunak has a problem.
The chancellor is under immense pressure, as today’s figures showed, to start restoring order to the public finances.
The government borrowed £53.4bn in just April and May alone. To put that into context, borrowing during the entire 2018-19 financial year, the last full year before the pandemic struck, was just £24.7bn.
Or, to put it another way, the amount the government borrowed in April and May alone exceeds the £48bn it expects to receive during the entire financial year from excise duties on tobacco, alcohol, petrol and diesel.
And the extra demands created by the pandemic will not go away immediately. Protecting jobs through the furlough scheme, for example, will continue until the end of September. Spending on public services has been raised by £55bn to help clear backlogs in the NHS and in the courts.
Adding to Mr Sunak’s problems is a prime minister yet to encounter a problem he does not think can be solved by throwing money at it.
Boris Johnson is not one of life’s savers and is also prone to blindsiding the Treasury by making unexpected spending commitments, such as his recent promise to build a new flagship to promote British trade, which is expected to cost at least £200m.
Meanwhile, an additional problem looms in the shape of the ‘triple lock’, the promise to raise the annual state pension by the highest of inflation, average earnings or 2.5%. With the headline rate of inflation forecast to hit 8% in July, the month the state pension is set, the cost of the ‘triple lock’ pledge this year is likely to be an extra £4bn.
That is the equivalent of just under an extra penny on the basic rate of income tax.
But Mr Sunak cannot raise income tax, or national insurance, or VAT. The Conservatives promised not to in their election-winning manifesto in 2019 and Mr Johnson has no intention of breaking that pledge.
Accordingly, the Treasury is scrabbling for other ways to raise money. Mr Sunak has already pledged to raise taxes on businesses, with the rate of corporation tax set to raise from the current rate of 19% to 25% in April 2023.
He has also frozen the sum Britons can earn tax free and the threshold at which the higher rate of income tax kicks in. These are a backdoor way of raising taxes known in the jargon as ‘fiscal drag’.
But these measures alone will not be enough to meet the extra cost of fulfilling the triple lock promise.
Which is why, yet again, the Treasury is looking at curtailing the ability of Britons to save for their retirement.
The Daily Telegraph reported on Monday that three options are under consideration. The first and most straightforward would be to raise taxes on the contributions employers make to the pensions of their employees.
The second would be to introduce a flat rate of tax relief on pension contributions. At present, workers can pay up to £40,000 a year into their pension, receiving tax relief as they do so. Because those contributions are paid in from gross earnings, a basic rate taxpayer receives relief at 20%, a higher rate taxpayer receives relief at 40% and an additional rate taxpayer at 45%.
The Treasury is discussing replacing these reliefs with a single rate – possibly around 30% – which would obviously benefit basic rate taxpayers but which would have the effect of squeezing more money out of higher and additional rate taxpayers. It would also make the tax system more complicated.
The third proposal under discussion is the most explosive. Once, over the course of their lifetime, Britons could save unlimited amounts in their pension pots. That changed when, in 2006, the then chancellor, Gordon Brown, introduced a ‘lifetime allowance’. He set it at £1.5m and anyone saving more than that would be hit with a hefty tax charge of 55%.
The sum Britons could save rose every year after that and hit a peak of £1.8m in the 2011-12 tax year. But in 2012 another former chancellor, George Osborne, launched another raid on savers.
The lifetime allowance was slashed to £1.5m. Mr Osborne went on to cut it again in subsequent years – although his successor, Philip Hammond, began raising it in line with inflation from 2018 onwards. Mr Sunak froze the allowance at £1.073m in his Budget in March this year – where it is set to remain until 2026.
Now, though, the Treasury is reportedly thinking of cutting the lifetime allowance to as little as £800,000-£900,000.
It would be a controversial move, to put it mildly, because it would hit the ability of hundreds of thousands of Britons to save for their retirement.
In theory, a pension pot of £1.073m sounds like a lot of money.
But it is not. At current annuity rates, it would buy a man retiring at the age of 65 an inflation-linked annual income of just £34,700 a year, little more than the average annual salary. Cut the annual allowance to £900,000, as the Treasury is reportedly considering, and it means that even someone with the maximum permissible amount saved would not be able to buy themselves a retirement income of more than £29,000 a year.
That is likely to provoke fury among millions of many middle-class savers and is why a lot of Conservative MPs, already twitchy after the party’s defeat in last week’s Chesham and Amersham by-election, are anxious about the proposals.
There are also at least two very good moral objections to cutting the lifetime allowance in the way proposed.
One is that the move would disproportionately hurt younger workers – who have not yet had the opportunity to save for their retirement in the way older workers, who built up their pension pots when the allowance was more generous, have been able to.
That will strike many people – and not just younger workers – as deeply unfair when it is the young who have had to make the greatest sacrifices, in terms of educational and career opportunities, during the pandemic. Especially if the extra money being wrung from them is being earmarked specifically for higher state pensions for older workers.
The other moral objection to cutting the lifetime allowance is that it punishes the prudent. Anyone who reaches the lifetime allowance will have done so not only by saving carefully but also by investing that money wisely. Cutting the lifetime allowance risks sending a message to younger savers in particular that there is little point in saving for their retirement.
Cutting the lifetime allowance also carries other risks. A few years ago, Mr Osborne introduced a deeply unpopular ‘taper’ on pensions tax relief, targeting higher earners. The Treasury ignored objections that it would hurt pensions savers on the grounds that just 300,000 top rate taxpayers – just one in every 100 taxpayers – would be affected.
Unfortunately, it soon turned out that among those most badly affected were doctors, surgeons and consultants. It led to thousands of them refusing to work overtime or even in some cases taking early retirement. It was for that reason that, in his 2020 Budget as the pandemic was erupting, Mr Sunak changed the rules to ensure most people no longer fell foul of the taper.
Cutting the lifetime allowance in the way being proposed risks all those problems emerging again – just as the NHS is in need of experienced healthcare professionals to help clear its backlogs.