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In a wide ranging report on tax reform, the IFS argued there were problems with how returns generated by wealth were taxed. “Large capital gains – many of them the result of luck – have been at the core of the rise in net household wealth and the growing intergenerational divide,” it said.
The IFS added there was a “strong case” for taxing housing capital gains, and that pensions gave “overly generous” subsidies to wealthy groups who were not in danger of penury in old age.
For example, it pointed to lump sum rules, which allow people to withdraw a quarter of their pension, up to a limit of £268,275, free of income tax. “Given that there is also income tax relief on contributions, this means that a significant portion of pension wealth…is never subject to income tax. The design of this feature means that the tax break is largest for those with the most pension wealth,” it said.
Meanwhile, the think tank found workers’ income is taxed in a way that is “unnecessarily complex and opaque”, with rising effective tax rates threatening to disincentivise work.
“Many people are likely unaware, for instance, that each additional £1 paid by an employer to an employee earning £25,000 a year will ultimately be taxed at an overall rate of 40pc,” it said.
The number of earners paying the top rate of tax is expected to double this year, according to official figures. Chancellor Jeremy Hunt’s decision to lower the additional rate threshold down from £150,00 to £125,140 earlier this year will mean 862,000 earners will pay the 45p rate in this tax year, up from 433,000 in 2020/21.
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