Thursday, 2 April 2015

Some Radical Ideas for Reducing the Deficit

We are now in the throes of the General Election campaign, and it will be one the closest races in living memory. The outcome of the election is far from certain. The next Parliament could see a majority Tory Government, a majority Labour Government, or pretty much any combination in between, with the Liberal Democrats, the SNP and even UKIP possibly acting as king-makers.

One thing is certain, though - with the public finances still showing a deficit of around 5-6% of GDP, further spending cuts will be required, on at least the same scale as we have seen over the last 5 years. The job is only half done, but the 'low-hanging fruit' has already been picked. Hard choices await whichever party (or parties) walks into Downing Street after May 7th.

So I thought I'd put forward some of my ideas for reducing the deficit.

1. State Pension Reform
The State Pension has already undergone significant reform, effectively simplifying it into a single tier system, where the level of payments is dependent on the number of years paying (or deemed to have been paying) National Insurance contributions. However, it still represents over half of all public spending on benefits, around the £100billion a year mark. With an ageing population and only slight increases to the State Retirement Age, the pensions millstone is set to get heavier and heavier.

A solution would be to gradually withdraw State Pension entitlement for pensioners who, by virtue of their other pension arrangements, are higher rate taxpayers. Now, you might think that it wouldn't save that much money, as there aren't that many pensioners who pay the higher rate of Income Tax. You'd be right on the latter count - about 2% of pensioners are higher rate taxpayers. Which means, on an annual State Pension budget of £100billion, we stand to save £2billion every year.

Some might put forward the argument that it's unfair to take those benefits away from people who have been paying into the system for years. However, I think there's some pretty solid counter-arguments to that:

  • Whilst many people presume that you pay National Insurance contributions for your own benefit, i.e. to fund your own healthcare and pension, the reality is that you don't. National Insurance revenue is not ear-marked for spending exclusively on pensions and healthcare - it simply goes into the melting pot along with everything else. It forms part of current expenditure - the historical contributions made have already been spent, on previous people's pensions and healthcare. If there were a giant fund over which pensioners held legal title, that would be a different matter;
  • The fairness argument also lacks credibility. You might argue that it's unfair to reduce benefits from people who have paid taxes all their lives. You may have a point. It's also unfair to expect young, poor people to pay taxes to fund the perks of older, rich people. Paying taxes to support people in need is one thing; paying taxes to redistribute from the poor to the rich is quite another;
  • The idea that means-testing acts as a disincentive for pension saving needs to be considered carefully, but the Government has already undertaken work which modifies the way some benefits are means-tested as to reduce disincentives to work. Put simply, as long as the withdrawal rate is not too high - thereby avoiding the 'cliff-edge' or 'slippery slope' effect, it won't act as a disincentive.
Further increases to the State Pension Age will also help to reduce the pensions liability in the long term, but it may take many years for this to come to fruition.


As well as the State Pension, pensioners are also entitled to a raft of other benefits such as free bus and train travel,  free TV licences and the winter fuel allowance. The answer to this is quite simple: abolish them in their entirety. Half of the savings can be used to increase the level of the State Pension, to compensate the poorest pensioners from the loss, and the rest can go towards deficit reduction.

2. Healthcare Reform
Currently, we have a healthcare system which guarantees free and universal healthcare at the point of need. Whilst this is a laudable aim, the reality of the situation is that, with an ageing and increasing population with radically changing and considerably more expensive healthcare needs, this is simply not affordable in the long term. The Government maintained a costly and generous ring-fence on healthcare spending during the course of the last Parliament, and even with healthcare spending rising in real terms (only just, but still), the NHS has still struggled with massively increased demand.

Part of the problem is organisational - the NHS is too big and bureaucratic to be able to cope with the changing and diverse healthcare needs of the population. Part of the problem is also funding, and changing the funding structure would help to put more resources in, and simultaneously contribute to deficit reduction.

The first step would be to require all foreign nationals, and British nationals paying higher rate Income Tax, to purchase private medical insurance. This would reduce the need for people to use NHS services, allowing the NHS to focus its attention on the people who need it the most, i.e. the people who cannot afford to pay for their own healthcare. This could be implemented on a sliding scale again, with some appropriate tax concessions and reliefs to incentivise people to make their own arrangements.

3. Tax Simplification
Currently, income is subject to two main taxes: Income Tax and National Insurance. Income Tax is applied to pretty much all forms of income; National Insurance is only levied against earned income, not investment income. Not only is this complex, it is also unfair - part of the problem with our economy is that it is biased too heavily in favour of financialisation - income arising from capital and ownership of assets is significantly more dominant than income arising from labour. Our tax system actively incentivises this, by effectively taxing earned income at a higher rate than investment income.

The answer is to abolish Class 1 Employee and Class 4 National Insurance and raise the basic rate of Income Tax by 10%. This would have the effect of a stonking great tax cut for working people, whilst simultaneously raising a significant amount of additional revenue from people who should arguably be paying it anyway. It also vastly simplifies the tax system. Again, part of the savings can be used to increase the Income Tax personal allowance, to offset the costs to poorer pensioners, whose income is not currently subject to National Insurance.

This would also address a huge imbalance in our economy, and go some way towards restoring parity between the earning capacity of labour and the earning capacity of capital, which should be at equilibrium for an economy to be fair and prosperous.

4. Council Tax and Business Rates Reform
Council Tax and Business Rates are some of the most complex, regressive, unpopular and inefficient methods of revenue generation in the Government's arsenal. Basing a tax on the value of the property 25 years ago, or on the assumed rental value of the floor space, is detrimental to almost everyone that pays it. These should be reformed into a local Income Tax and Corporation Tax, set by the Local Authority. And for those that argue that it's too complicated - well, Scotland is about to get devolution over both. It is not beyond the wit of man. Get it sorted.

5. Private Pension Reform
Whilst the Government's soon-to-be-implemented changes to private pensions are welcome, they don't go far enough. Pensions are still effectively a tool to allow the very rich to avoid tax, and do very little to provide ordinary people with retirement funds.

Firstly, the Annual Allowance (the amount one person can pay into a pension each year and still qualify for tax relief) should be modified, and simply changed to the amount one person can pay into a pension each year. No more. That's it. Carry-forward rules, which generally only benefit the wealthy, should be scrapped. The Annual Allowance should be set at twice the ISA allowance, and pegged to it.

Next, tax relief on new pension contributions should be limited to a flat rate of 10%. The vast majority of pension tax relief goes to higher and additional rate taxpayers. This would give a genuine credit to non-taxpayers and basic rate taxpayers, who need pension provision more than higher rate taxpayers.

But that represents a cut in tax relief for basic rate taxpayers, who currently get 20%, I hear you say. Not if the tax rate on benefits arising from new pension contributions is set to 0%. No tax at all to pay on future pension benefits, but a genuine tax credit to incentivise people to save, with limits on how much can be paid in to prevent abuse. Can't say fairer than that.