News analysis: The Osborne Budget effect

Pay, pensions and tax were among the topics of concern to employers and employees in the Chancellor’s emergency Budget. Nicola Sullivan reports

Chancellor George Osborne’s emergency Budget took a tough stance on public sector pay and pensions, but offered some reprieve on the former Labour government’s plans to cut pensions tax relief for high earners. The Chancellor said he would work with the pensions industry to consider alternatives, such as cutting the annual allowance limit. Provisional analysis suggested an annual allowance, currently set at £255,000, would have to be cut to between £30,000 and £45,000 to achieve the £3.5bn revenue that would be produced by reducing high earners’ pensions tax relief.

Lesley Fidler, a tax director at Baker Tilly, said: “I am delighted the government has reservations about the approach adopted in the Finance Act 2010 because it could bring significant complexity to the tax system. The whole gist of the Act was to remove higher-rate tax relief from at least part of an individual’s pension savings. The trouble was, the way it set about this was unbelievably complex.”

The Budget also confirmed that employer-financed retirement benefits schemes fall under anti-forestalling legislation. Labour had announced action against arrangements that use trust and other vehicles to avoid, defer or reduce liabilities of staff and directors to income tax and national insurance (NI) or to avoid restrictions on tax relief.

Public sector pay and pensions also came under the Budget spotlight. A two-year pay freeze will be imposed on public sector workers earning more than £21,000. Lower-paid workers will receive a £250 pay rise in each of these years. Steve Beet, public sector partner at PricewaterhouseCoopers, said the Chancellor’s plans for the public sector signalled a “worrying time” for employees.

Pension inflation adjustments lowered

Inflation adjustments for public sector pensions will also be lowered. “A switch from the retail price index to the consumer price index as the basis for public sector pensions inflation will have a very real impact,” said Beet. “Had this policy been applied in the year to May 2010, the shift would have resulted in a 1.7% decrease in the adjustment.”

Dean Shoesmith, president of the Public Sector People Managers Association and head of HR for the London boroughs of Sutton and Merton, said Osborne had focused too much on making cuts, and not enough on encouraging growth.

An independent review, chaired by former Labour pensions minister John Hutton, will look into public sector pensions. Osborne referred to figures from the Office for Budget Responsibility which showed that by 2015-16, £10bn a year would be spent to meet the gap between pension contributions and payments to the unfunded pensions they support.

Economist Will Hutton has been commissioned to review public sector pay.

Other Budget measures affecting benefits include the rise in VAT from 17.5% to 20% from 4 January 2011. This could prompt employers either to lease cars or pull forward orders for new cars to 2010 to avoid the higher VAT. Mark Sinclair, director of Alphabet, said: “This will make leasing fleet vehicles even more attractive compared with purchase, because leasing companies can recover the VAT on the purchase price and pass on the benefit through reduced rentals.”

Other measures in the Budget include:

  • Compulsory annuitisation will be scrapped.
  • There will be an accelerated increase in the state pension age to 66 years and the government will consult on phasing out the default retirement age.
  • Capital gains tax has increased to 28% for higher-rate taxpayers.
  • Insurance premium tax (IPT) will increase from 5% to 6% from 4 January 2011.
  • Personal allowances will rise by £1,000 to £7,475 in the 2011-12 tax year.
  • The NI upper earnings limit will be cut to keep it aligned with the income tax higher-rate threshold.

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