Pensioners and high earners hold their breaths for Budget D-Day

The Chancellor must plug the gaping hole in public finances but has little room for manoeuvre. While scrapping higher-rate tax relief would bring in £7bn, it would damage pensions.

Millions of British savers will be looking to the Budget next Wednesday for rescue from the meagre returns they are receiving on deposits. The Bank of England's dramatic cuts in interest rates from 5 per cent last autumn to 0.5 per cent today – aimed at preventing the recession turning into a depression – has left savers scrabbling around for paltry returns. This is a particularly acute problem for pensioners, who rely on savings to bolster what the state pays them.

"They have seen their incomes dwindle to almost nothing in just a few months. Some are dipping into their capital to keep up living standards but this can only go on so long. They need help on Wednesday," says Charlotte Black, a spokeswoman for investment management firm Brewin Dolphin.

Ms Black echoes other financial firms and opposition MPs in calling for an emergency tax break for savers. "The Chancellor was to have announced a one-year, basic-rate, tax holiday on all income derived from savings accounts and company dividend payments. The latter is important because it will encourage people to remain invested in the stock market, which will aid economic recovery."

A possible alternative option to help savers is a one-off expansion of the amount people can pay into individual savings accounts (ISAs). At present, people can put up to £3,600 into a cash ISA or £7,200 into equities or a combination of equities and cash. All money held in an ISA grows free of tax. "Because savings rates are so low, the Government isn't bringing in that much from the tax it imposes on deposits anyway, so there is room for them to, say, increase the ISA limit to £10,000 for a year, which would allow people to shelter more from tax," says John Whiting from accountancy firm PricewaterhouseCoopers.

However, those hoping depositors will be given a helping hand may be disappointed, as talk among Whitehall officials of this being a "budget for savers" has all but evaporated. "We are worried that things have gone very quiet of late and that savers – who have done the right thing and not over-borrowed – will be left to fend for themselves," says Ms Black.

High earners already know there is pain on the way. From 2011, people earning over £100,000 will have to pay a new top rate of tax of 45p in the pound. In addition, a half-pence rise in national insurance contributions is also planned. One option for the Chancellor would be to bring these tax hikes forward to 2010. A further increase to NICs can't be ruled out either. "National insurance increases are a nice one to sneak under people's radar. Everyone is affected, but no one gives it the same weight as an income tax increase," says David Kilshaw, the head of private client advisory at accountancy firm KPMG.

Capital gains tax (CGT) could also be an area from which the Government could squeeze some extra cash: "The current CGT rate of 18p is much lower than the 40p top rate of income tax. In the past, differentials between the two haven't lasted long, with the lower tax rate rising in line with the higher one," Mr Kilshaw adds.

Top earners may also suffer if the Chancellor decides to scrap higher-rate tax relief on pension contributions. At present, basic-rate tax payers get relief at 20p in the pound on pension contributions, but higher-rate tax payers enjoy 40p in pound. Scrapping higher-rate tax relief would raise around £7bn a year for the Treasury but could damage retirement savings further: "This would be a disincentive to save. What is forgotten is that pension tax relief is really just tax deferred. You may get 40 per cent relief on the way in, but in retirement these same people will have to pay income tax on their pensions," says David Cule, a principal at Punter Southall.

More generally, the temporary cut in VAT from 17.5 per cent to 15 per cent announced in the pre-Budget report is set to run until the end of the year. After that, however, VAT could be shifted to a new higher level. "This could bring in billions for the Treasury," says KPMG's Mr Whiting.

"Ultimately, the markets are looking for the Chancellor to set out how the Government will close the gaping hole in public finances. In the short term, this means room to spend more money will be very tight; in the longer term, there will be tax rises," he said.

The savers

Malcolm and Evelyn Coulson, both 61, retired, Cambridge

Savings rates are diabolical. We're not feeling the pinch as much as some friends, but we have cut back on our leisure activities. Generally, we are relying on the state pension as well as breaking into capital such as bonds and ISAs to fund current expenditure. Food and fuel costs are taking a big chunk of our weekly spend, so it would be good to see something done there, perhaps a cut in fuel duty or at least no increase. As for our savings, we are hoping that the ISA allowance will go up this year so that we can at least keep more of the paltry interest earned. It would also provide an incentive for other people to save.

The teacher

Catherine Gilchrist, 30, from Bournemouth

More money for public transport should be a priority. In the country, services are poor. I'd like something done for savers. I'm on a tracker mortgage so have benefited from low interest rates, but I have elderly relatives who have done the right thing and they are being punished.

Taxes on cigarettes and alcohol should be raised to the skies as the long-term health implications are enormous, as are the costs to the NHS.

Any talk of a freeze on public-sector pay being announced is worrying. Teachers and other public-sector workers are undervalued as it is. Why would a science graduate want to be a teacher?

The high earner

Michael Phillips, 32, director, London

I'm a busy man, so improved nursery provisions would be good. Overall, spending on schools and the health service is essential to keep up, despite the recession, as both are woefully under-resourced. The Government should also be thinking green and trying to introduce a much clearer grants system for energy-efficient home improvements. On balance, I think it's fair to up the tax rate for higher earners. But 45 per cent taxation for six-figure earners is posturing. The contribution to UK debt is a drop in the ocean.

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