How to understand Brown's pension tax change. Now, stick with this people

If you want to be able to understand Gordon Brown's pension tax change, I have a blog post that is just the ticket.

Evanomics, the blog of BBC Economics Editor Evan Davis provides a superb (and mercifully concise) explanation. He describes the shift from a classical corporation tax towards an imputation system and back again in a way that you can actually follow.

And in the process he concurs with my view (always a sound thing to do, I feel) that the real "crime" the Chancellor committed was to fail to spell out the possible downsides of his reform. Davis argues that if he had done, Brown would have encouraged people to top up their pensions. 

Comments

[Richard Young]

I'm no pensions expert, but...

"The chancellor may have put an obstruction in the pensions road, but he wasn't driving the car that crashed into it. That was in the hands of employers who were free to increase contributions but chose instead to accelerate the closure of final salary schemes."

Without checking the stats I can't be sure about the DB scheme closures, but I'm pretty certain that didn't really kick in until the whole thing had already gone "phut" after the stock market collapse in 2001-2003. In any case, closing schemes was (and is still) one of the few options companies had if they were to prevent fund liabilities spiralling out of control.

Davis's other mistake is to assume that companies helped cause the problem by failing to invest more in their schemes. When the stock market was booming in the late nineties - after Gordo's daring raid - I spoke to several company finance directors who complained that the rules prevented them "overfilling" pension funds - and if I recall correctly, there were major headaches if your pension fund was worth more than 105% of the liabilities. (Again, I stand to be corrected on the figures.)

In fact, whatever the economics of the situation or the Chancellor's historically justifiable intentions, the 1997 decision is still blamed by many FDs and pension fund trustees as a major cause of the collapse of DB schemes. You simply can't take that much money out of the system and expect it to withstand the shock of a stock market collapse.

But the *real* villains of the piece are the actuaries... in other words, the private sector. Utter failure on their part to provide meaningful predictions pre-2002 for scheme liabilities - compounded by their decision after 2002 to over-compensate for their earlier error with new, ultra-conservative estimates - is what really created the current pensions black hole.

And since we're pointing fingers, let's have the NHS (for helping us live longer), the MPC (for keeping interest rates low - killing the returns on fixed income investments) and the dot-com brigade (for falsely inflating the value of quoted companies). But Gordo certainly does take some of the blame - regardless of whether or not he ought to have warned us that the value of our investments might go down as well as up.

[David Andrews]

Both you and Evan Davies have overlooked one central fact. From the 1920s on until Brown`s tax, there was an explicit agreement between the Inland Revenue and pension funds that income deferred and paid into a pension scheme, and the investment income thereon, should not be liable to tax until it was paid out as a pension.

Two undeniable consequence of the Brown pensions tax were:
(1) pension fund trustees either had to find £5 billion a year to replace Brown`s tax - now cumulatively estimated as a £50 billion+ hit - or face up to the certainty that funds could not meet their future obligations; and
(2) pension fund members now suffered double taxation on their savings.

In the circumstances it is no surprise that final salary schemes are closing down and will become a thing of the past. Brown`s measure otherwise becomes another tax on the companies that funded the shortfall.

It is also no surprise that anyone receiving or anticipating a pension is livid about this measure. This will run and run.

[Simon Stephenson]

David Andrews' analysis is quite correct, but it needs to be said that a system of tax deferral is not neutral in the hands of the pension recipients. It is in normal circumstances massively in their favour, leading to nett-of-tax pensions far greater than would have been gross pensions purchased from the proceeds of a fund that did not enjoy tax deferral. The reasoning behind this is that the part of the closing fund that has been generated from the deferred tax, and the compound growth thereof, will in any normal situation be far greater than the amount needed to fund the tax on the pension, and may be applied therefore to increase the amount of pension actually received.

What also needs to be pointed out is that the 1997 changes did not impose an across-the-board tax on pension fund investments. What it did was to prevent funds from reclaiming imputed income tax on dividends. The income from all other forms of investment continued to be free of tax. Why were the funds not able partially to offset the loss of the tax credit by switching their investment into other areas from which the return would be free of tax?

I appreciate that this business was not handled very well at the time, but this was, surely, only to be expected when the Chancellor and his entourage behave in such a sociopathic way. But it is, I believe, incorrect to contend that what was done was unjust. In many ways the injustice was in the previous arrangements, which unfairly favoured those with occupational pensions over those without.

[John Feldman]

What Gordon Brown has created is a divided community where a large part of the pensioner population has been forced below the poverty line whilst there are increasing numbers of the public sector who are enjoying gilt edged pensions paid for by the rest of us.

But the crucial question now is how do we get out of this pension mess. There are two areas that need to be corrected. An article in the Times a couple of years ago showed that the UK is paying the lowest state pension amongst the major members of the European Union at 17% of average earnings. The next lowest is Denmark at 40% of average earnings. However the value of the UK state pension decreases year on year since it only increased by the rate of inflation.

The taxation of pension funds introduced by Gordon Brown must be abolished. It is quite immoral for the Chancellor to tax the pension savings of the private sector.

The important question now is not to talk on and on about these obvious defects but to determine when and how they are to be corrected. Clearly for many pensioners the sooner the better. We also need to know the attitude of the three major political parties and what steps they are prepared to take.