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The pensions annual allowance debacle spreads beyond the NHS

The annual allowance that has wreaked havoc in the NHS has spread to the armed forces – and is a perfect example of how higher taxes can actually reduce the amount of tax collected.

Military parade © OLI SCARFF/AFP/Getty Images
The annual allowance debacle has spread to the armed forces

I've written here several times about the disaster built into NHS pensions (see here and here, for example). Thanks to the current annual allowance and taper system (see below for a brief explanation of how this works) large numbers of consultants and other highly paid staff are finding themselves not just caught in a hideous web of complicated admin, but also facing nasty upfront tax bills on money they won't (at best) see until retirement. That has led to them cutting the overtime they are prepared to do; going part time; or in the worst cases (for those needing medical attention at least) retiring early.

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But we've also noted for a long time that at some point the troubles would pop up across the public sector. And so they are. A freedom of information request from financial adviser Quilter to the Ministry of Defence shows that 3,840 members of the armed forces pension scheme breached their annual tax-free pensions savings limit in 2017/2018. That's four times more than in 2015/2016 and something that could in the end have nasty effects on the willingness of even middle-ranking officers to continue committing to the armed forces (not great if we really are at the beginning of a new cold war with China).

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Regular readers will know we have mixed feelings about all this. The taper and annual allowance were, we suspect, introduced specifically to claw back something from very generous public-sector pensions and to in part address the disparity between their pension provision and private-sector pensions. It's also true that in many cases the "scheme pays" option (where your pension scheme pays the taxes for you and you just get a slightly lower pension later) works pretty well.

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But we also feel that a lower lifetime allowance could do the job in a rather more simple manner. And, absolutely crucially, we feel that when a change in tax regime starts affecting the way people behave in a bad way that change should be looked at again. If the taper means fewer NHS consultants, we have to see the disincentives provided by the taper as the problem and, if we are sensible, get rid of it.

However, this whole mini disaster should also act as a neat reminder to policy makers of something else the Laffer Curve (the idea that if you make tax rates too high you will reduce rather than raise the revenue from those taxes). It turns out that, in the case of pensions and doctors at least, it really is true that higher taxes disincentivise work and hence reduce the income gained from those taxes.

Something for all governments planning more taxes on "the rich" to note particularly perhaps the Indian government, which has just proposed a "super rich tax" on the income of those earning over $275,000 (see this week's magazine for more on this).

How the taper works

Then in 2016, in an attempt to show that he was as keen to make the well paid suffer financially as everyone else, George Osborne introduced a taper to this. It sounded simple(ish) at first. But it is anything but simple. Anyone earning over £150,000 would gradually have their allowance cut until, at £210,000 it would be a mere £10,000. But there are complications around what makes an income of £150,000 earn more than £110,000 (the threshold income) and you are automatically in the firing line for the taper.

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