The basic state pension could be taxed at source under a proposal that would fuel the pensioners’ revolt against the “granny tax” announced in last month’s Budget.
The state pension, which rises from £102.15 to £107.45 a week today, is taxable but it is currently paid without tax being deducted immediately. Under the plan, which would force many pensioners to change the way they plan their household budgets, it would be subject to the 20 per cent basic tax rate at source, reducing it to £85.96 a week for millions. Wealthier pensioners on the 40 per cent tax rate would receive £64.47 a week.
The reform is being considered by the Treasury’s tax advisers, who will report to George Osborne later this year in time for him to include any changes in next year’s Budget.
In an interview with The Independent, John Whiting, tax director of the Office of Tax Simplification (OTS), said the question of whether to bring the state pension into the pay-as-you-earn system was “the front-runner” for its inquiry into how to streamline the tax system for pensioners.
Although supporters of the idea insist pensioners would be no worse off over time, Mr Whiting admitted it would cause “cash-flow issues” for some pensioners. He said the OTS would also consider the administrative cost for the Department of Work and Pensions (DWP) of putting Britain’s 12 million pensioners on PAYE. About 5.6 million of them pay tax, while the rest have an income below the tax-free threshold –currently £10,500 for 65- to 74-year-olds and £10,660 for those 75 and over.
Surveys show that only four in 10 elderly people know the state pension is taxable and many discover it only when HM Revenue and Customs (HMRC) tries to claw back the tax they owe later. Some get into debt and are unable to pay.
Mr Whiting said: “There is poor liaison between the DWP and HMRC, so tax on your state pension has to be captured by fiddling with your tax code. One result is that a lot of pensioners [1.6 million] get drawn into self-assessment, filling in forms, mistakes are made and it is a big source of problems.
“The obvious solution is to apply PAYE to the state pension. DWP would become like another pension provider [by paying pensions net of tax]. There is potential for better explanation and better information flow, more joined-up payments and less chance of errors. Fewer pensioners would end up filling out tax returns.”
Pensioners’ groups, already seething over the Chancellor’s freeze in age-related allowances, warned that the latest proposal would be seen as a “mark two granny tax”. The National Pensioners Convention said that, rather than tax payments at source, the Government should exempt the state pension from tax altogether.