Reeves warned of “dangerous” increases in pension and capital gains tax

Rachel Reeves has warned of the “dangerous” impact of rising pensions and capital gains tax, as economists say it would hit living standards, discourage saving and harm growth.

Ahead of next month’s Budget, the Institute for Fiscal Studies (IFS) has urged the chancellor not to be tempted by the “superficially appealing” prospect of restricting the upfront tax relief on pension contributions.

While such a policy would allow Ms Reeves to keep her promise to raise taxes on working people, the think tank said it would damage incentives for people to save and result in a tax system more “confused”.

It said launching a blanket raid on capital gains would also backfire, with tax hikes acting as an “increasing drag on saving and investment”.

Ms Reeves previously called for higher-rate pension contribution relief to be “restricted”, although she has since backed away from recommendations first made in 2018.

Capping the initial income tax relief on pension contributions at the basic rate of 20% would cost savers £15bn, while introducing a flat 30% rate of pension tax relief would result in a bill of £2.7 billion.

The cut in exemptions would hit up to 6 million higher and higher-rate taxpayers and cost the wealthiest savers around £2,600 each.

Inland Revenue analysis suggests that equalizing capital gains with income tax rates could raise as much as £6bn a year.

However, with just 369,000 people paying tax last year, the IFS warned that making major changes to a “relatively narrow tax base” meant revenues would be unpredictable.

“Mixed Tax System”

The IFS said: “Capital gains tax should be reformed carefully, otherwise tax increases risk acting as an ever-increasing limit on saving and investment. These are not orderly disputes.

“Badly designed taxes distort taxpayer behavior in ways that inhibit growth and ultimately harm living standards. Unlike across-the-board rises in income and expenditure taxes which Labor has ruled out, raising large sums of money from either pension taxation or capital gains tax would also mean a major change to a tax base relatively narrow.

“All else being equal, that will tend to mean more uncertainty about how taxpayers will respond.”

The think tank said Ms Reeves blocked herself by ruling out increases in income tax, national insurance, VAT or corporation tax, which she said “comprise only 75% of all tax revenue”.

The IFS said: “Measures that generate large revenues are few and far between and – assuming Ms Reeves intends to deliver on her party’s manifesto commitments – pension taxation and capital gains tax are probably the most likely candidates. Both could be dangerous.

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“Restricting the initial income tax relief on pension contributions is superficially appealing, but would create an increasingly confusing tax system and add economic distortions.

“While there is no reason to hold back on sensible reforms, this could make it difficult for the government to estimate how much revenue it can expect to get from any changes it makes.”

While the IFS warned Ms Reeves against hasty reforms to capital gains and pensions, it said forcing companies to pay National Insurance out of money contributed to staff pension schemes and ending the “absurd exemption of some retirement homes pensions from both income tax and inheritance tax on the death of the owner’ would be ‘positive’ steps.

The first policy could raise up to £17 billion, according to the IFS.

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