Tax cuts are great – but they don’t always make sense

The recent party conferences have thrown up several ideas on tax cutting that I now find – unexpectedly – that I don’t 100% approve of.

The first is the abolition of the tax on inherited pensions. It used to be 55%. Now it is to be nothing if you die before the age of 75, and the margin tax rate of the heir if you die after 75. I’ve written about this at length here and here, and I talk about the IHT implications in this week’s magazine (out on Friday).

The key point is that the 55% rate served a purpose. It was, as John Ralfe points out in a letter to the FT today, actually a neutral, serving to claw back the tax relief given on the pension in the first place (via income tax relief, the lost tax on the investment returns and on the 25% lump sum everyone takes on retirement).

The idea of pension tax relief has long been that it defers rather than cancels income tax: you don’t pay it on income you put in, but you do pay it on income you take out. Breaking this principle means that income tax can now be avoided on money put into a pension altogether. You can put it in, leave it to family members and, assuming they distribute it in the right way (£10,000 a year to each non-earning grandchild, perhaps), no tax is due. Ever.

How much will this cost the taxman? Ralfe has done some figures. If even 5% of pension cash is passed on this way, the total tax loss is around £10bn. The gains will go predominantly to the rich.

This might all need a bit more thought.

The other tax cut I’m concerned about goes to the poor – it is the pledge from David Cameron to raise the personal allowance to £12,500 so that none of those earning less will pay any income tax at all (they’ll still be paying NI, but that’s another blog). This sounds great. Why should the low-paid pay tax that is then, almost always, recycled to them in benefits? Better to cut the admin and leave them with their own money in the first place.

But there are problems. The first is that the cuts so far to the personal allowance have been expensive – they explain much of the fall in income tax receipts even as the economy has looked like it is recovering, and this most recent commitment is forecast to cost some £5.5bn a year. That’s real money.

But the second I’ve written about before. It is about democratic participation. If you don’t pay any tax, you have no interest in voting for policies that might keep taxes lowish or a nation solvent, and every interest in voting for high-spending governments and policies. It is better surely for everyone to “muck in” and so to have a least a degree of the same political interests, something I suspect that Gordon Brown was aiming for with his 10p rate: he wanted the low paid to pay less tax but still to pay tax.

Sweden is worth looking at in this context, says Ian King in the Times. There is very little allowance there – everything over £1,600 is taxed, something that may well play a part in its social cohesion: societies are more cohesive when everyone contributes.

I like the idea of tax cuts as much as everyone else – taxes are too high in the UK and state spending is too high in the UK. But not all tax cuts make sense.