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Budget 2014 Analysis
Osborne's pension reforms will stick in the memory
Analysis by The Sunday Times' Economics Editor David Smith
Budgets are easily forgettable but George Osborne's fifth effort is likely to remain in the memory for its five-minute flourish at the end, which signalled the biggest shake-up in pensions for decades. That and some meaningful reforms to encourage savings ensured both that the grey – and greying – vote will sit up and take note, that the pensions industry has work to do and that the chancellor has provided himself with a legacy.
More on that in a moment. Could Osborne have announced his pension shake-up earlier, easing the worries of people retiring and being trapped in low annuities? He could, but the priority for the past three years has been ensuring that growth got going and that the budget deficit continued to fall. At times it has been touch and go. A big reform, even a welcome reform like this, might have been seen as a distraction in 2011, 2012 and 2013.
Backdrop to the budget
The backdrop to this budget was, of course, much better than that which has accompanied almost any of the chancellor's earlier efforts. This time last year the economy appeared to be on the verge of a triple-dip, the International Monetary Fund's chief economist was warning him that he was playing with fire with his policies and he was under growing political pressure.
But the triple-dip never happened, the earlier double-dip was revised away, and the IMF's chief economist has gone quiet. Instead of flat-lining, the economy has gained strength. The official forecast, from the Office for Budget Responsibility (OBR), is for 2.7% growth this year, 2.3% for 2015, before settling down to a shade over 2.5% in the medium-term. Not many years ago, such a prospect would have been regarded as unremarkable. After the experience of recent years it verges on the miraculous.
Similarly, a budget deficit or £108 billion – the prediction for 2013-14 from the OBR – would have rightly alarmed anybody six or seven years. But that deficit is lower than it was, and should drop to £95 billion in the coming year, 2014-15, and further thereafter. This was not, however, a budget with a big macro-economic impact. The "giveaways" for the next two years averaged just over £0.5 billion, to be clawed back later. It was, however, a budget with other important measures.
Raising the personal tax allowance
As always, the process leading up to the budget these days is something of a slow striptease. Perhaps because we have a coalition government or maybe because authorised leaks are the modern way politicians communicate their policies, we knew some of the budget in advance.
So the policy of raising the personal tax allowance continues, as everybody expected it would. That allowance will be £10,500 from April next year, up from just £6,475 in 2010-11, and £10,000 next month. This is a big and welcome change, even if it has resulted in an unseemly struggle between the Liberal Democrats and the Conservatives over who should get credit for it.
Indeed, so successful has it been as a policy that it has probably gone as far as it should. That is not the view of the Liberal Democrats, who have set a target of £12,500 for the personal allowance for the next parliament. But the Conservatives are under pressure to promise more on the basic rate limit – the higher rate threshold at which people start paying the 40% tax rate.
Osborne's private suggestion that people feel proud to be paying tax at 40% did not go down too well with Tory MPs or the 4.4m paying it this year, up from 1.6m two decades ago. But he did not feel obliged to do much for people in this group, raising the point at which the 40% rate kicks in by a mere 1%. Meanwhile, bodies such as the Institute for Fiscal Studies point out that a better way of helping the lower-paid is raising the point at which people start to pay National Insurance, £148 a week or £7,696 s year in 2013-14, rather than pushing on with lifting the personal allowance.
The need for more house-building
The other thing we learned, even before the budget, was that the Treasury has taken the message about the need for more house-building on board. So the Help to Buy scheme providing government equity loans for buyers of new homes (up to £600,000 in value) will be extended to 2020, following warnings from builders that the initial cut-off date of 2016 would prevent a sustained building recovery. Ebbsfleet may finally be developed, this time as a new garden city. The other big pre-budget announcement was more generous childcare, up to £2,000 of support for each child.
That left plenty on the day for other announcements. One was not unexpected: extending and raising the annual investment allowance for firms to £500,000. The chancellor wants to encourage more investment and this should do it.
Meaningful help for savers
The two other big changes were, however, unexpected. Before the budget the savings industry had pressed for changes to permit the existing ISA allowance, £11,520, to be available entirely for cash ISAs, scrapping the requirement that no more than half could be put into cash. Osborne went further, to reward savers suffering from more than five years of ultra-low interest rates. The annual ISA limit will rise to £15,000 and savers will, if they wish, be able to put the whole lot into a cash ISA. At a stroke, or at least from July 1, the annual limit on tax free deposits has almost been trebled.
An even bigger change was with pensions. In five minutes at the end of his speech Osborne announced a reform to pensions that will have implications for decades, including for people who have not yet given a thought to retirement. Allowing people more freedom to choose what to do with their pension pots – either drawing it down at their marginal rate (rather than facing a prohibitive 55% rate as now) or in other vehicles – will shake up an industry that has grown complacent on annuities. It is hard to quarrel with this reform, which is intended to take effect in April next year. Osborne may never again do anything so memorable or far-reaching.
Budget Breakfast Briefing
Part 1 of the video from the 6th annual Budget Breakfast can be viewed below: