Jeremy Warner: Pensions muddle just gets worse and worse

Outlook: Not content with the mess it has already made of Britain's private sector pension arrangements, the Government seems intent on doing them even more damage in its desperation for new sources of tax revenue. Just three years after introducing some much-needed simplicity into the rules governing pension contributions, ministers have gone spectacularly, and for many ruinously, into reverse with the Budget announcement that higher- rate tax relief on contributions from earnings above £150,000 is going to be removed.

For most people, this is of course something of a non-issue. The chance of earning even close to £150,000 would be a fine thing, and anyway, it always did seem unfair that those who can afford to save for a pension most were getting the biggest tax incentives to do so. For the better-off, pension contributions had become an officially sanctioned form of tax avoidance. The Government hopes eventually to save more than £3bn a year by limiting the relief in the manner proposed.

Yet in so doing, the Government is recreating a quagmire of complexity and anomalies in the pensions system, is essentially breaking its contract with the taxpayer over pension contributions, and is reinforcing the already gaping apartheid between public and private sector pensions. The new system is manifestly unfair. It would take an entire column to detail its absurdities in full, so I'll restrict myself to a few of the most glaring.

I'm not going to concern myself with what the Revenue is planning to introduce two years out. This is subject to consultation and there will in all probability have been a change in Government by then. Suffice it to say that it is mind-bogglingly complicated, presumably deliberately so, and is almost certainly the final death blow to Britain's already crippled final salary pension schemes.

Rather, I'm going to address the "interim" measures established to stop high earners taking advantage of the old reliefs by whacking their entire salaries into their pension pots before the new regime comes into place.

Any attempt to limit the higher rate of tax relief to earnings below £150,000 was plainly going to be problematic. What's to stop you simply reducing your salary to below £150,000 and getting the employer to increase his contributions to make up the difference?

To get round this and other problems with the concept, the Government proposes to restrict pension contributions that qualify for the higher-rate relief to £20,000 for top earners. This sum, by the way, seems to include both employee and employer contributions, thus closing off the potential loophole of altering the balance between employee and employer contributions.

Those who can demonstrate a history of having contributed more can continue to claim the higher-rate tax relief on such payments, at least for the next two years. Unfortunately, the qualifying history has to be one of payments made quarterly or more frequently. This would seem to disqualify the self-employed, most of whom make single, lump-sum annual payments, and City workers who would in the past occasionally have put their entire bonus into their pension pots.

OK, so this is a straight tax raid on the better-off. Who cares, unless you happen to be one of them? Yet these high-earning professionals are a disproportionately important part of the economy. For some, this may be the last straw. By making Britain less tax-competitive for higher earners, it may contribute to a potentially disastrous brain and talent drain.

The more nit-picking criticism is that it is just plain unfair. Those on less than £150,000 a year seem to be completely unaffected. If you earn more than £150,000 you can get higher rate tax relief on only £20,000 of contributions: those on £149,999 or less qualify for as much as they like. And just in case you might be tempted to take a pay cut to gain the extra reliefs, the Revenue has thought of that one, too. The cut-off point is determined according to your two-year history of earnings.

The upshot is that unless already very close to achieving the life-time limit of £1.75m in your pension pot, there is virtually no chance of you ever reaching it if you earn more than £150,000 a year. Nor would there actually be any point, as the limited tax relief you would gain on putting money into the pension would be more than offset by the higher rate of tax paid on the eventual income.

If you earn less than £150,000, on the other hand, it might still be possible. Bizarre, eh?

On-the-hoof tax raids rarely make good policy, however desperate the Treasury is for hard cash. One way or another, they nearly always end up costing more than they raise. It all amounts to another fine mess for the next Chancellor to clean up. When will governments learn to stop meddling with pensions? The A-day reforms of three years ago were a rare move in the right direction. As for virtually everything else the Government has done on pensions over the past 12 years, public policy has succeeded only in making a bad situation worse.