New report highlights the impact of population ageing on tax revenues

David Kingman reports on the latest pieces of research from the think tank Reform, which models how population ageing will affect the government’s tax incomeTaxation HM Revenue

Economic debates over population ageing usually only look at how much it will affect government spending, especially in terms of pensions and healthcare. However, because the burden of taxation falls differently on people who belong to different age groups, ageing will also have an impact on how much money the government receives in income.

This dimension of the ageing debate has received far less attention over recent years, even though it raises lots of interesting questions. However, a new report from the think tank Reform has sought to fill in this gap by analysing what effect the ageing of Britain’s population is likely to have on government revenues, and suggesting policies which could help make the tax system fairer and more efficient at the same time as it confronts this challenge.

Key Arguments

The report, which came out on Wednesday 27 November, is called Mind the (fiscal) gap: direct taxes, public debt and population ageing. It makes a number of key observations about the impacts of ageing on the UK tax base,which are summarised below:

  • The government cannot afford for tax revenue to decrease without it causing the national debt to become even higher; this means that there is no scope for significant tax cuts, and in order for current tax revenues to be maintained, some parts of the tax system may need to be redesigned to achieve a system which is both fair and does the least damage to the rest of the economy.
  • The ageing of the population means that a higher share of taxes is being paid by members of the older generation; the share of direct taxes paid by the over-65s was 4.5% in 2010 and this is projected to rise to 6% by 2033, assuming there are no major changes in policy.
  • Current tax policy is broadly favourable towards members of the older generation. This is especially true in relation to direct taxation; for example over-65s have a higher income tax personal allowance than members of younger age groups and do not have to pay employees’ national insurance contributions. As the older generation accounts for a larger share of taxpayers, the amount of revenue which is forgone by the Treasury owing to these exemptions will also increase, placing a larger burden on taxpayers who are of working age.
  • There is a danger that over the coming years, governments will attempt to pile more of the burden of taxation onto people of working age rather than trying to adapt the tax system in a more ambitious manner to suit current demographic trends and developments in the economy (such as the increase in the number of people who continue working above state pension age). Reform cites research by the Institute for Fiscal Studies which shows how the exemption from National Insurance contributions has become more valuable over the last decade as National Insurance contribution rates have gradually been raised rather than increasing income taxes. This is one of the reasons why the gap in average tax rates between pensioners and non-pensioners has nearly doubled over the last 30 years.

Possible solutions?

Reform argues that this situation is intergenerationally unfair, and calls for the tax system to be redesigned according to a “broad base, low rate” approach, where more of the wealthy members of the older generation are brought into the tax system in order to reduce the burden on younger workers.

The report’s authors have two main recommendations for specific reforms which could help to achieve this goal. Firstly, they estimate that removing the exemption which is currently given to people above state pension age from paying National Insurance contributions could raise £735 million per year while only affecting the wealthiest 6.35% of over-65s. Secondly, they argue that the current arrangements surrounding tax relief on private pension saving are inefficient, particularly as they are very expensive while mainly benefiting the wealthier members of society. However, they argue that any such reforms to tax relief would need to be very carefully designed, as pension tax relief mainly benefits today’s workers rather than current pensioners.

Overall, Reform’s report makes an interesting contribution to the debate, and shows that as Britain deals with population ageing, the costs in terms of lost taxation need to be looked at just as closely as the difficult spending decisions that Britain will also have to face.