Age: the taxing issue for politicians

There is tension between working people who pay most tax and pensioners who are large recipients of public funds

The Government clearly does not mind taking on the students, witness its efforts to get more money out of undergraduates and into universities. It has been chary about taking on pensioners, for it is trying to squeeze a bit more money into pensioners' pockets and is dragging its feet about setting a higher retirement age. And yesterday we saw the Government shy away from proposals for massive increases in council tax.

The Government clearly does not mind taking on the students, witness its efforts to get more money out of undergraduates and into universities. It has been chary about taking on pensioners, for it is trying to squeeze a bit more money into pensioners' pockets and is dragging its feet about setting a higher retirement age. And yesterday we saw the Government shy away from proposals for massive increases in council tax.

All this shows how politics has changed. The division is not so much between left and right, between rich and poor, between state provision and private provision. There are divisions between the parties to be sure but these are not huge compared with the divisions of a generation ago. The difference is a couple of percentage points of GDP going through the state or remaining in people's pockets. The new clash is between the interests of the young and the old, or to be more precise, between working people and dependants.

You can seen this in two of the political topics of this week: the CBI plan for much higher basic state pensions, but as a quid pro quo, retirement at 70; and the Government's plan to shift more of the tax burden on to an increased and rebalanced council tax.

The pension issue has been on everyone's radar for some time, though perhaps not as clearly as it should have been. Only now are people waking up to the fact that Gordon Brown's change in tax treatment of pension funds has extracted some £50bn of value over the past seven years. Had that money been retained much of the present shortfall in company pension schemes would be covered. But that still would not solve the problem, for only half the country has private pension provision and the basic state pension, linked to prices, not wages, will become increasingly inadequate. The CBI proposal attempts to square the circle. It is self-evidently in the interest of the retired to have higher pensions. It is self-evidently in the interest of companies not to have to pay much more towards them. It is in the interest of working people not to pay more tax on their earnings. So what gives? The only way through is for people to retire later.

We will have to see how that plays politically: most 65-year-olds would not relish the thought of having to flog on for another five years. The initial reaction of the Government has been to squash the idea. But it is easy to see the tension between the two interest groups: working people who pay most of the tax and pensioners who become (with health care) large recipients of public funds.

The tension between the people who pay council tax and other taxpayers is less evident but real. The great thing about council tax, as with any property tax, is that it is hard to avoid. The bad thing is that it has little relation to the ability to pay. The hardest hit in practice - because often their homes were bought long ago - are the retired.

By contrast the broad mass of revenue - income tax, national insurance contributions and most VAT - comes from the people in work. Charging people in expensive homes more and cutting charges for those in cheaper homes may, to some extent, rebalance the burden. But it will rebalance between homes in the north and the south as well as large and small. Since the highest proportion of elderly people live on the south coast of England one consequence will be to boost revenues from the elderly. I don't think this Government has quite figured out the implications of that - unless it accepts that elderly people in southern England are not going to vote for them anyway, so why bother? Let them move to cheaper homes.

We are seeing the first skirmishes of a big debate, in which the inescapable dilemma for politicians is that the votes are with the old and the money comes from the young.

The two armies, old and young, are quite evenly matched in terms of their attractiveness to politicians. Older people are not only becoming more numerous but they are also statistically more likely to vote than the young. So that gives them a natural lift. But the young are more likely to move. They can move not just between cities, typically from north to south; they can, at least within Europe, move country with great freedom. The revenues they bring enable governments to give better provision for the old.

One way of easing the burden on young taxpayers is to attract more of them. It is a tacit aim of public policy to bring more young Europeans into the UK universities for post-graduate training in the hope that some of them will stay, get jobs, and become British taxpayers. There is some evidence of success here. The danger is that the UK becomes a stepping-stone to a career in the US. More than half of the continental Europeans who do post-graduate work in the US stay on and get jobs there.

This suggests that the wise government in the future will be one that follows a twin strategy. On the one hand it must tailor taxation so that the elderly voters are encouraged to give their support. On the other hand it must bid for mobile young. But how?

Bidding for the young, particularly the skilled young, is already in place. The UK now attracts more Chinese students than the US. The world's largest financial services centre may be physically located in London but it runs to a huge extent on foreign talent. We have done well at reforming the work visa system for the highly paid on the assumption than someone coming here to do a job paying £50,000 or more is not taking the bread out of British workers' mouths. So applications at the top end of the job market are fast-tracked. The UK's ability to grab clever people may be more by accident than design but it is certainly to the credit of this Government that it understands the importance of human capital in immigration policy.

So that is being done for youth. How about the old?

For a start the wise government would look at taxes that annoy the old but do not bring in much revenue. Foremost among these is estate duty, a tiny revenue earner, the effects of which are distorted by the surge in home values. It may seem irrational that elderly people are so concerned about a tax that they themselves will not pay. But surveys suggest that this is a particular concern. Politically it is hard to abolish because it is seen as a redistributive tax but actually it is a tax on a lack of financial sophistication, for it is easy, with good advice, to avoid. In any case the actual flow of funds is so small as to be negligible in the broad span of public finance. So it does not have much redistributive effect.

Labour cannot move on that for political reasons and the Tories are not bright enough to grab the issue. Council tax, on the other hand, could become the key issue in a coming election. Not only would an increase tend on balance to hit the old in terms of cash paid over; it could also affect house prices in much the same way that the change in pension fund taxation hit the pension pots.

If money is taken out of the housing market it has to come from somewhere. That somewhere will be house prices. Just as Labour hit share prices a little before they were due to go down anyway, it may have the same impact on house prices. Politically it got away with pension taxation because no one understands pensions. But people do understand house prices.

New Labour has been good at understanding the young; but the old have the votes.