Pensions #2 – Triple Jeopardy

There’s one area of public policy on which the major parties used to agree, but lately their commitment to it has become more ambiguous.  Just as well, because it’s completely ridiculous, being based on economic illiteracy at best and shameful deception at worst.

Once, Twice … Three Times A Liability

This policy is known as the “Triple Lock”, promising that the UK State Pension will be increased, year on year, by the greatest of three factors:

  • 2.5%
  • growth in wages (average earnings)
  • growth in prices (i.e. what we mean usually by “inflation”).[1]

What that means is that each year the increase to the State Pension will never be lower than the rise in prices AND will never be lower than the rise in wages AND will never be lower than 2.5%.

In terms of a rationale for this multiple-part guarantee:

  1. You can make a decent case that a state-funded pension should be linked to increases in prices in order to preserve its purchasing power.
  2. If earnings rise at a rate greater than prices, then linking to inflation alone would reduce pensioner incomes compared to those of the working population.  You can argue also therefore that the value of the pension should be linked to earnings to preserve relative living standards during retirement.
  3. It’s more difficult to justify increasing the pension by the higher of the two (in effect switching the link from year to year).  If earnings growth is low relative to inflation then the increases to pensions will be greater than the corresponding incremental tax revenue.  In effect, the interests of pensioners will have been put ahead of the current workforce, which does not have this kind of inflation protection.
  4. What certainly makes no sense at all is the idea that there should be a guarantee of a 2.5% uplift irrespective of what has happened with earnings and prices.  By definition, the resulting increase in pensions will never be lower than earnings growth, under all scenarios.  Given that both inflation and earnings have been at low levels over recent years, this policy has proved to be particularly burdensome.

Let’s Not Do A Broony

Ironically, the policy was introduced by the Coalition Government of 2010 in an attempt to learn from the political mistakes of the past.  In 1999 the then Chancellor Gordon Brown attracted widespread flak when he announced an uplift to the state pension of only 75p.

Inflation was low in 1999.  As the pension was inflation-protected, the rise for the year was corresponding low.  This was simply the application of a linking that had not previously been questioned, rather than a conscious change of policy by Brown; but, no-one was sympathetic to that as an excuse.

Triple Jeopardy

In opting for the Triple Lock (TL), the new Government was clearly counting on earnings growing substantially over the medium term, in tandem with the associated tax take.  The risk it ran was that, if the actual experience were to be different, the TL would turn out to have been a major error, with pensions outstripping the revenue available to pay for them.

Likewise, the policy objective was for interest rates (and inflation) to remain low in order to prevent the cost of debt servicing getting out of control.  The problem with this is that, if it were achieved, it would mean a significant gap existed between the inflation rate and the 2.5% minimum.  The sting in the tail would then be that the TL would have become a major burden to sustain in real terms.

The chickens here have indeed come home to roost.  Since the introduction of the TL in 2011, the State Pension has risen faster than inflation and significantly more than earnings.  The Office for Budget Responsibility forecasts that, of the likely increase in spending over the next 50 years, some two-thirds will accounted for by the TL, rather than the ageing population or any other factor.

No Cuts, Please – We’re Pensioners

As covered in the first in this series of articles, the current UK State Pension is unaffordable given the demographic landscape.  The TL simply exacerbates the issue.  A report by the Government Actuary’s Department estimated the annual cost of the TL to be £6 billion so far.[2]  In terms of scale, this is half of the amount hoped to be saved by the current cuts to the benefits paid to those in work.  Even at the minimum growth rate of 2.5%, there would be a doubling of the level of the State Pension in under 30 years.

In pursuit of deficit reduction, the Coalition cut spending in many areas and since election in 2015 the all-Tory Government has pursued more of the same.  Even for benefits protected from these explicit reductions, a 1% limit on increments was imposed from 2014 and then a complete freeze from 2016, which remains till 2019; there is therefore a cutting going on in real terms.[3]

Scottish Conservative Party Poster 2010
Scottish Conservative Party Poster 2010

What has been body-swerved is any impact on the benefits received by the elderly: pensions, subsidised travel and winter fuel allowances.[4]  Yet, these amount to more than half of the UK’s welfare budget (and possibly much more, depending on what you include in this category).  If less than 50% of spending is to be touchable, the axe must indeed cut deep when it comes down.  The full impact of that is now emerging in the new fiscal year.

In the Tory manifesto for 2015, the pledge was made not to increase VAT or National Insurance Contributions for the lifetime of the current Parliament, thereby limiting the options available for raising additional revenue. As regards Income Tax, the thresholds have been raised for the new tax year, which reduces the amount paid by higher earners.[5]

The political agenda is clear.  The rhetoric about getting debt under control is only part of the story.  Where the expenditure is on the working age poor, it must be cut.  Benefits enjoyed by the elderly are not to be touched, however.  Which of these groups, I wonder, is more likely to vote Conservative?

Let Them Eat Ostrich

The position is not sustainable, as has long been recognised.  The solution of choice appears to be a progressive raising of the State Pension Age (SPA).  That’s a programme that’s well underway.

The UK Parliament’s Work and Pensions Committee (WPC) recently commissioned research from the Institute for Fiscal Studies (IFS).  Frank Field, the WPC’s chair, observed that: “With the Triple Lock in place the only way State Pension expenditure can be made sustainable is to keep raising the State Pension Age. This has the effect of excluding ever more people from the State Pension altogether.”.

The point here is that those in disadvantaged areas have lower life expectancy.  If keeping the TL means increases to SPA, then that price is borne primarily by the poorer sections of the population.

The IFS found that, if the TL were retained but at the same time pension costs were to be capped at the current level of under 6% of GDP, the SPA would have to rise to 70.5 by 2060.

On the other hand, if the 2.5% guarantee were to be discarded, leaving in place the link to inflation and earnings, spending on pensions might be kept within a range of 6 to 6.25% of GDP and increases to SPA could then continue to follow the existing timetable for these.  (Note, though, that earnings growth running below inflation could still present a revenue issue, for the reason covered above.)

ostrich head in sand

Chancellor Philip Hammond has indicated that, although the Government undertakes to review the future of the TL mechanism, nothing will happen until the next Parliament, i.e. not before 2020.

In other words, not till after the next General Election is safely in the bag will it be okay to take this subject seriously.  The ostrich continues to kick the can down the road.

 

P.S.

As I was going to press with this article, we had the surprise announcement of a General Election in June 2017.  Too early to say what that might mean for the idea of reviewing the policy in the “next Parliament”.  Wouldn’t put it past the Tories to delay it still further.

Meanwhile, Jeremy Corbyn’s Labour Party has promised that there will be no change to Triple Lock before 2025.

Labour's Pensioners' Pledge Card 2017
Labour’s Pensioners’ Pledge Card 2017

 

 

 

Footnotes

1. Except if you reside in a country other than the UK, the EEA or one of fourteen other, selected countries, in which case you will get no increase at all.  Affected locations include the USA, Macedonia (FYROM) and Philippines.  Who knows what will be the impact once the UK leaves the EEA …

2.  This report was withdrawn shortly after publication in October 2016.  The inference has to be that it was judged to have said the wrong thing.

In March 2017, the Government Actuary’s Department published its “Periodic review of rules about State Pension age”.  In summary, this concluded that, if it increases over the long-term compared to the average level of earnings, the State Pension will become increasingly more expensive to provide, even under the optimistic scenario of a stabilisation of the dependency ratio.

3.  There is also a Benefit Cap, which restricts the total amount of benefit claimed.  The effect of this is difficult to present in simplified, summary terms.

4.  The benefits provided include free TV licences for those aged 75 and over.  Previously, the BBC was refunded the cost of these.  The wizard wheeze is that the BBC will start to pick up the tab, progressively from 2018 until it bears the full impact by 2020.

5.  In March 2017, Chancellor Philip Hammond tried to depart from the freeze on NI, to the limited extent of the contributions paid by the self-employed.  He was forced to climb down.

As an aside, note that the increase in the tax threshold for the Higher Rate band of Income Tax does not apply to Scotland, as decided by the devolved Scottish Government.

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