View from City Road: Nail-biting time for the pension funds

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The City is rightly worried that the Chancellor may be on the prowl for more pension fund cash. The cut in the tax rebate paid to pension funds was one of the least politically painful measures introduced by Norman Lamont. By comparison with VAT on fuel and power, it was the secret tax increase. Yet the changes to dividend taxation will raise some pounds 900m in 1995/6, nearly half the amount raised by the VAT rises.

Until BZW's warning letter to finance directors, the cognoscenti had assumed that Kenneth Clarke would not go any further. After all, Mr Lamont cut the rate of advance corporation tax to 20 per cent (combined with the cut in tax rebate to pension funds, which is where the revenue raising comes in) on the grounds that the income tax rate would eventually catch up when the Government achieved its 20 per cent ambition. A cut beyond 20 per cent would signal that the Chancellor had spotted the industry as a pliant milk cow.

However, Mr Clarke could still argue that pension funds enjoy particular tax benefits that he could be legitimately offset in the interests of a level playing field between different types of saving. True, pension funds do not look as privileged now that personal equity plans and Tessas allow savers to withdraw their returns tax-free, but there is still the anomaly of the tax-free lump sum: uniquely, pension funds can attract money from gross income, and then pay at least some of it out tax-free.

Dealing with the lump sum itself would raise all sorts of unpleasant political problems: outright abolition would enrage those near to retirement. But a more gentle change to pension fund tax rebates could still be dressed up as an intellectually respectable tax increase. The great advantage is that the voter would notice only when companies asked for a larger pension contribution if final salary schemes were to be preserved. Given the recent worse-than-expected figures for public sector borrowing, it is nail-biting time among the pension funds.