Chris Nicholson: Here's how we can lift one million people out of income tax next April

Chris Nicholson is the Director and Chief Executive of CentreForum.

Opinion polling consistently shows that the Conservatives are still seen as the party of the rich and wealthy and not as the party that represents the ordinary working person. This has led some Tories such as Tim Montgomerie to advocate that the Government adopts Liberal Democrat ideas such as the mansion tax or other property taxes. In this way, the Conservatives can revive its appeal to today’s equivalent of Thatcher’s Essex Man or the Reagan Democrats.

The Coalition Agreement aims to raise the personal tax allowance to £10,000 by 2015. But why wait that long? There is an easy way to do this in the next Budget in April. Let me explain how.

An area where the rich benefit from huge tax relief is in the tax treatment of pension contributions. Recent CentreForum reports, 'Tax and the coalition' (pdf) and 'A relief for some' (pdf), proposed limiting tax relief on contributions to pensions to the standard 20p rate and restricting the lump sum which can be taken tax-free on retirement to £42,475 (the rate at which higher rate tax starts) rather than the current £450,000. In both cases only the wealthiest would lose out.

In 2008-09 individuals with income over £150,000 represented fewer than one in fifty of pension savers, yet received a quarter of all tax relief on contributions. This amounted to an average of £27,000 per person for higher earners, more than most people earn, and compares with an average of £1,000 for people who pay income tax at the basic rate. That can't be fair.

The justification usually given for tax relief on pension contributions has been that it avoids double taxation of both pension contributions and the subsequent income. But increasing life expectancy resulting in a decline in annuity rates means this is no longer the case. Nobody retiring at 65 with an RPI linked pension, who gets tax relief on their pension contributions at 40 or 50 per cent, will end up paying tax at that rate on their pension. You would now need a sum in excess of the new £1.5million limit on pension pots to have an annuity income taxed higher than the basic rate. There is no economic justification for this subsidy for the well off. Tax relief on pension contributions should be limited to the basic rate.

The additional tax revenue could be put to good use. The Treasury estimates that limiting tax relief on pension contributions to the standard rate would generate £7billion for the Exchequer. CentreForum estimates that putting a lower cap on pension lump sums could, over time, save £500million per annum. These measures alone would enable the government to raise the personal tax allowance to £10,000 per annum from next April. That would take over a million people out of tax altogether and increase the incentive for people to work rather than being on benefit. It would also boost demand in the economy, putting money back in the hands of those who are more likely to spend it.

It might be a liberal idea – but like the mansion tax, it is an idea that Conservatives should take seriously.