The pensions triple lock plus is a no-brainer

Labour will adopt Rishi Sunak’s triple lock plus policy in office. It needs to have a more honest conversation about tax now, or it will not have a mandate for the things it will inevitably need to do

“Is the Labour Party going to tax the state pension for the first time in history?” This is the question Rishi Sunak asked Keir Starmer at last week’s debate.

The answer is no. The introduction of the pensions triple lock plus, like the general election, is a foregone conclusion.

But that’s not what the man who will be Prime Minister in less than a month said: he dodged it. I understand why. The triple lock plus has a theoretical price tag, and Labour needs to be a lot more cautious about spending commitments than the Conservative Party; partly because it is actually going to be in government soon, and partly because Labour invariably finds it more difficult to persuade voters that it can be trusted with the public finances.

Nevertheless, a Labour government will introduce the triple lock plus (unless it goes on an immediate and unlikely tax-cutting spree and raises personal allowances for all age groups). The fact that it has put itself in the position of not being able to acknowledge this – and get some political credit for doing so – is frustrating.

It is easy to conclude that this will not make much difference electorally, in the grand scheme of things. However, it is emblematic of an election campaign in which neither party is facing up to the major fiscal challenges the next government will face.

Why the plus

The benefits of the state pension triple lock are much misunderstood. It guarantees that the state pension’s value will increase each year by inflation, earnings, or 2.5% (whichever is higher). It protects the income of today’s pensioners, but its main beneficiaries are tomorrow’s.

The value of the UK state pension remains lower than almost any other OECD country. The triple lock guarantees that the state pension entitlements that younger cohorts are currently accruing are creeping, slowly but surely – well, a little more quickly in the last few years of high inflation and earnings growth rebounding after the pandemic – towards the international average.

It is an expensive policy, but only because we are paying the price for generations of under-spending on the state pension. Labour has vowed to retain it.

Entirely independently of the triple lock, the government has frozen the income tax personal allowance: a classic stealth tax whereby over time a greater proportion of our income becomes taxable, without rates ever changing in cash terms. A Labour government would retain this freeze. Given its promises not to raise any of the more noticeable tax rates, it cannot afford not to.

In 2027, these policies will collide. The personal allowance will still be frozen at £12,570, but the annual value of a full state pension is forecast to rise to £12,578. The gap – i.e. the taxable amount – would be only £8. But it would grow rapidly: after only a single year, and even if the state pension were minimally uprated by 2.5%, the gap would grow to £322.

The triple lock plus means the personal allowance for anyone above state pension age would always match the value of the state pension. The policy would nominally cost £2.4 billion a year by 2029/30 (this is the amount of tax revenue that would have been received had the anomaly been allowed to materialise).

Contradiction

It is absurd, as a matter of principle, that the state pension would be subject to income tax.*

Those arguing in the wake of the announcement that £2.4 billion could be better spent on other priorities simply have not thought this one through. This is not a case of money being taken out of another area of spending in order to fund a tax cut for pensioners. Instead, it is a decision not to introduce a new tax by default in three years’ time, an unintended consequence that would unfairly punish poorer pensioners who have only the state pension to rely upon in retirement.

If your plan to, say, abolish the two-child limit rested upon the accidental introduction of a tax on a different social security benefit, not enacted until more than halfway through the next parliament… then I would respectfully suggest that you aren’t really committed to abolishing the two-child limit at all.

The anomaly would also have been absurd as a matter of policy. First, it clearly contradicts the triple lock – whatever you think of it – because any uprating event could be undermined by an increase in the amount clawed back via tax. Second, the new ‘single tier’ state pension is supposed to operate as a reliable savings platform; this is jeopardised if the actual value of the platform is subject to annual tax changes. 

*Correction

Before we go any further, it is necessary to correct myself (and indeed Sunak).

First, the state pension is already taxed: some people in retirement with pre-single tier entitlements will be receiving State Earnings-Related Pension Scheme (SERPS) or State Second Pension (S2P) benefits, alongside the old ‘basic’ state pension. This could mean their state pension income is above the current level of the personal allowance.

I think this is regrettable, but understandable: SERPS and S2P were not necessarily intended to operate as conventional social security benefits, rather substitutes for private provision for those with less access to the private pensions system. There is, in contrast, no justification for taxing the single-tier state pension.

Second, although personal allowance rates should ensure that the state pension is not taxed in practice, it is of course correct that it is taxable in principle.

The state pension should form part of a retiree’s taxable income, so that private pension income above the value of the state pension is taxed in full. The UK spends around £50 billion a year on pensions tax relief to help people accumulate a private pension. In return, the income this helps to generate for individuals must be subject to income tax.

A good age

A little bit of history might help here. The triple lock plus will ostensibly reintroduce what we used to call ‘age-related personal allowances’, which meant that pensioners had a higher tax-free allowance than working-age people. Introduced in the 1970s, these allowances were set at much higher level than the value of the basic state pension, and were therefore designed to partially protect people with private pension income (or SERPS and S2P, to some extent) from income tax.

In the context of the state pension being set a such a low level – remember that New Labour did not reverse the Thatcher government’s abolition of state pension earnings uprating, let alone introduce a triple lock, until the very end of its time in office – it made sense that pensioners with private income were allowed to keep a little more of it. Of course, this also disproportionately benefited more affluent pensioners, who were more likely to have private pensions income in the first place (although the allowances were gradually withdrawn for pensioners on higher incomes).

The 2010-2015 coalition government effectively abolished these allowances, but only by allowing the working-age personal allowance to catch up with them – another accidental pensions tax policy. But in the context of the state pension rising in value, and almost everybody having some private pension income as a result of automatic enrolment, it was a happy accident.

It clearly becomes necessary to revisit this outcome when the state pension, as well as private pensions, become subject to income tax for almost everyone.

Starmer image: Rwendland (CC BY-SA 4.0). Sunak image: Number 10 (CC BY 2.0)

Tax turmoil

There are aspects of the existing system of pension tax that are much more deserving of criticism than the prospective triple lock plus. Pensions tax relief is quite obviously broken: in my book Pensions Imperilled, I refer to it as ‘an exorbitant irrelevance’.

The value of relief is vastly higher than the amount the Exchequer gets back on pensions in payment, mainly because higher-rate taxpayers receive tax relief at their marginal rate during their working life, but often only pay income tax at the basic rate in retirement. Pensions tax relief has no meaningful impact on savings incentives.

Labour had planned to make pensions tax relief slightly more progressive by reintroducing the lifetime allowance (LTA), which restricts the amount an individual is able to save in a pension before losing access to pensions tax relief.

The Conservative government had abolished this restriction; Labour wanted to reverse this decision, but now appears to have changed its mind. Reintroducing the LTA would have been very complicated, and could have ended up penalising very high-earning public servants such as surgeons. But it would be disappointing – and a missed opportunity – if a Labour government decided not to touch pensions tax at all.

Pensioners also continue to benefit from tax-free lump sums, and an exemption from National Insurance. And wealthier cohorts in later life have benefited from the UK’s property and wealth taxes, which range from non-existent or antiquated to dysfunctional or deeply regressive.

No-brainer

These are the areas that should be considered if the next government really needs to find a couple of billion in revenue from pensioners. It is neither desirable nor necessary to allow another bad policy to be introduced by default, in order to compensate for our failure to tackle a long list of other bad policies.

The Conservative government will have known about the collision of the triple lock and frozen personal allowances for years. It could have been fixed at any recent fiscal event, but they were obviously saving the announcement for the election campaign.

Labour should have pre-empted this when defensively committing to retain the triple lock. Should’ve, but couldn’t have… because the Conservatives smartly ensured this would be a new spending commitment, outside the pre-election fiscal baseline, knowing that Labour would not want to make any new commitments during the election campaign.

The government explained that the cost of the triple lock plus would be met through tackling the tax avoidance it had neglected to tackle in the last fourteen years, but Labour had already picked this magic money tree’s fiscal fruit to increase spending on public services.

And that’s exactly why Sunak highlighted the policy during the first debate. He didn’t exactly land it, but the possibility that he might have done was not a risk Labour needed to take.

Is Labour actually eyeing up the £2.4 billion, despite knowing it would be hugely unpopular when pensioners started to notice paying income tax on their state pension in 2027? No.

(Note also that, because the state pension is not part of the PAYE system, in many cases pensioners will be axed to pay this tax as an annual lump sum.)

Did Labour want to provide the Conservatives the ammunition to claim Labour was making an unfunded spending commitment? Also no.

So as a result of its ultra-cautious approach to fiscal policy, Labour has to claim to be in favour of an accidental tax that it has no intention of introducing when it actually gets into government. It has to pretend that it will swallow this anomaly – undermining its own commitment to the triple lock – because the other side of this make-believe line leads to fiscal calamity and electoral oblivion.

Labour will, of course, get away with this fudge, and win the election anyway.

The problem is whether this reluctance to have difficult conversations about tax – even around no-brainer policies like the triple lock plus – places limits on the party’s room for manoeuvre once in government. Labour is at risk of winning a landslide without the mandate it needs to do the many things it will need to do in government that involve higher public spending.