Rachel Reeves has been warned of the “perilous” impact of increasing pensions and capital gains taxes, as economists claimed this would damage living standards, discourage saving and harm growth.
Ahead of next month’s Budget, the Institute for Fiscal Studies (IFS) has urged the Chancellor not to be tempted by the “superficially appealing” prospect of restricting upfront tax relief on pension contributions.
While such a policy would allow Ms Reeves not to break her promise of raising taxes on working people, the think tank said it would damage incentives for people to save and result in a more “jumbled” tax system.
It said that launching a blanket raid on capital gains would also backfire, with tax increases acting as an “ever-greater drag on saving and investment”.
Ms Reeves has previously called on higher rate pensions contribution reliefs to be “restricted”, though she has since backed away from recommendations first made in 2018.
Capping upfront income tax relief for pension contributions at the basic rate of 20pc would cost savers £15bn, while introducing a flat 30pc rate of pension tax relief would result in a £2.7bn bill.
Restricting reliefs would affect up to 6m higher and additional rate taxpayers, and cost the wealthiest savers around £2,600 each.
Internal Treasury analysis suggests that equalising capital gains with income tax rates could raise up to £6bn a year.
However, with just 369,000 people paying the tax last year, the IFS warned that making big changes to a “relatively narrow tax base” meant revenues would be unpredictable.
‘Jumbled tax system’
The IFS said: “Capital gains tax would need to be carefully reformed or else tax rises would risk acting as an ever greater drag on saving and investment. These are not tidy-minded quibbles.
“Poorly designed taxes distort taxpayer behaviour in ways that hamper growth and, ultimately, damage living standards. Unlike the broad-based tax rises on income and spending that Labour has ruled out, raising large amounts of money from either pensions taxation or capital gains tax would also mean making a big change to a relatively narrow tax base.
“All else equal, that will tend to mean more uncertainty in how taxpayers will respond.”