Pension Policy: New Evidence on Key Issues

25/11/2009

Pension Policy: New Evidence on Key Issues

By Tim Callan, Claire Keane and John R. Walsh (ESRI)   Changes to tax relief on pensions would save public money and be fairer, according to new research from the ESRI. Tim Callan, Claire Keane and John Walsh find that tax relief at a standardised rate could help to achieve the overall objectives of public pension policy in a more efficient and equitable way. Currently, over €8 out of every €10 of tax relief goes to taxpayers in the top one-fifth of the income distribution. This is because high income earners are more likely to participate in pension schemes, more likely to make higher contributions, and the value of tax relief at the top rate of income tax is about double that for the standard rate taxpayer. There is a strong incentive for high earners to contribute to pension schemes, but a weaker incentive for those with low and middle incomes. Evidence from the UK and the US suggests that much of the saving by high income households would take place even without the incentive (what economists call “deadweight loss”). There is also growing evidence that decisions on pensions can be strongly influenced by non-economic factors, at lower cash cost to the Exchequer. For example, pension schemes in which the default option is to enrol in the scheme, but with an option for individuals to withdraw (sometimes called “soft mandatory”), and a system of partial matching of contributions at a single rate, rather than tax relief, have been found to be effective in other countries. Should the single rate of tax relief be the standard rate or some hybrid rate between the standard and top rates of tax? Both options were examined in the ESRI report, which found:

• Standardisation of relief on all pension contributions (employee, employer and implicit government contributions) could raise revenue of over €1,000m per annum. This would imply a reduction in income tax relief for top rate taxpayers, but no change for those paying the standard rate. Revenue raised could be applied to sustaining State pension levels as demographic pressures on the financing of public pensions intensify
• An increase in the relief from the standardised level to allow relief at a hybrid, 30 per cent rate – an option similar to that recommended by the Commission on Taxation and included in the Programme for Government - would involve gains for standard rate taxpayers and losses for top rate taxpayers, and a gain to the Exchequer in the region of €500m per year.

Notes for Editors: 1. Pension Policy: New Evidence on Key Issues, by Tim Callan, Claire Keane and John R. Walsh (ESRI) will be launched by Mary Hanafin T.D., Minister for Social and Family Affairs, at 9.30 am on Wednesday 25th November. It will be published on the ESRI website at 9.30 am on Wednesday 25th November. Please note the embargo is until 9.30 a.m. Wednesday 25th November.

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