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Sunday 12 February 2012

Do the Liberal Democrats seriously want to be elected ?

On Wednesday 8th February, the Daily Telegraph reported that the Lib Dems were seeking a pre-budget assurance that the tax relief on pension contributions would be limited to the basic rate of income tax. The Telegraph goes on to state that "the Treasury estimates that scrapping the 40 per cent relief would cost workers £7 billion per year".

Yesterday, Saturday 11th February, the Daily Telegraph further quoted Danny Alexander, the Liberal Democrat Chief Secretary to the Treasury as stating "if you look at the amount of money that we spend on pensions tax relief, which is very significant, the majority of that money goes to paying relief at the higher rate". This could turn out to be one of the most inept statements of this parliament, and, the policy which it espouses, the one that ensures there are less Liberal Democrat MPs next time around.

So why is not only the policy, but also the premise for change so unavoidably flawed?

Apart from a serious loss of contact with the electorate, referring to the Treasury 'spending' on a relief is utter nonsense. A potential reduction in income, maybe; a matter to be treated as expenditure; absolutely not.

The £7 billion refers to the difference, ceteris paribus (which you will recall means all other things being equal or constant) between the amount of tax that would have been paid if the tax relief on pension contributions were limited to 20%, rather than at the effective rate of tax. The fact is that all other things are most definitely not equal. People frequently increase their pension contributions, precisely so that their income is taxed at the lower (20% rate). Removing the higher rate relief would ineluctably lead to lower pension contributions.

At first sight, this would seem to be even more of a bonanza than the Lib Dems had been waiting for; not only would the rate of relief on contributions be reduced but the size of the pool would also diminish, leading to yet more tax intake. The £7 billion additional revenue would be even higher; what a master stroke... except that life is not quite that simple.

The whole reason behind the huge pensions industry is that it was realised, some time ago, that it was financially impossible for the government (in its role of redistributor of tax revenues) to dole (sorry, couldn't resist) out pensions to everyone as an exercise in bountifulness. The solution was to encourage each and every one to save for their pension, on an individual basis... unless they were in government or the civil service, of course. This very much helped the financial services industry, on which the UK relies so much (possibly excessively).

So the actual effect of a reduction in pension contributions, which is the unavoidable corollary to reducing the tax relief, would be a reduction in income for the financial services industry. This, in turn, would lead to reduced profits and job losses; hardly the desired effect.

And now for two lessons in very basic economics; the sort of common sense that seems to be so sorely lacking in the political class. The fact that they seem necessary reflects appallingly on the quality of our 'leaders':

Lesson No. 1 - Increased demand leads to higher prices.
The very fact that there is more money going into pension funds increases the price of the individual component shares. This benefits everyone in a fund, regardless of the rate of tax relief they are receiving. Reduce the demand and the value of the funds will fall.

Lesson No. 2 - Propensity to save is not equal.
If you have £10,000 left over after your expenses, you are much more likely to save some, or all, of it than if you have a residue of £100. It is self evident that one is more likely to have a larger amount left over if one has a larger amount to start with. Therefore, higher rate taxpayers are more likely to be larger contributors to pension funds. Now read lesson No. 1 again and see how this has a multiplier effect.

The UK, in common with many countries, has a progressive tax system, where higher incomes are taxed at a higher marginal rate. Most countries (actually, all that I am aware of) have various deductions to income which can be made, in order to arrive at a net (taxable) income. The Lib Dem proposal would effectively be at odds with this system, thereby differentiating the rate at which a deduction were allowed, based on a political whim.

If one believes in a market economy and fairness, which I thought were Liberal Democrat values then, the proposal, or demand, as it seems to be, would be a nail in the Lib Dem coffin.

The last Liberal Prime Minister was Lloyd George, who left office in 1922, having been at the head of a coalition government backed by more Conservatives than Liberals. The closest that the Liberals have come to having any real political power since then, is with Nick Clegg's appointment as Deputy Prime Minister, under the current coalition agreement. If the Lib Dems want to be electable, I would suggest that a return to traditional socialist (squeeze them until the pips squeak) ideals is suicide.

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