Is there a solution to the debt timebomb?

A great deal of IEA work corroborates studies produced by the government in suggesting that we have a huge implicit government debt. We can do the fancy maths to try to quantify this government debt ‘iceberg’ but the reality will hit home as the government tries to fund its spending over the coming generations. There will either have to be large cuts in spending or unrealistic increases in taxation or both. These have been quantified in a recent post by Ryan Bourne and brought to life in this video.

But, in practical terms, what are we to do? The essential problem is that promises have been made to the forthcoming older generation which rely on that generation not living longer and also have relied on that generation having sufficient children so that the relative number of taxpayers will not decline. People are living longer, healthcare is becoming more expensive and the fall in the birth rate after the 1950s is reducing the relative size of the tax base.

It is not feasible to inflate away these liabilities to future generations. Most of them are either defined in real terms (or with higher levels of indexation such as pensions) or they involve the delivery of a package of real goods and services (healthcare). Simply not paying them is not easy either. Today’s older people have been brought up in a system that has not expected to build up capital funds for old age. However, what we can do is adopt ‘do-no-harm’ policies, ensure that the problem does not recur, shave back the liabilities and ensure that labour markets function better.

Do-no-harm policies would include not raising state pensions by the higher of wages, prices and 2.5 per cent and examining welfare benefits paid to the elderly with the same rigour that benefits being paid to the younger generation are being examined. The new higher flat-rate pension should also not be implemented. Furthermore, it is quite extraordinary given the fiscal situation that successive governments eroded and now have abolished the system whereby individuals could ‘contract-out’ of part of the state pension system and make their own private provision. At the very least, this system should be revived on a sustainable basis. This has the advantage that, when the government makes pension promises, it actually has to refund social insurance taxes to those who contract out at the time the promises are made. Those funds are then invested in order to provide a secure basis for future pensions.

Secondly, younger people should make the transition to fully-funded pensions and have at least some funded healthcare. Healthcare is, like pensions, a cost that is mainly incurred towards the end of life. It is possible to mix insurance and saving in order to meet these costs without throwing a potentially unsustainable burden on future taxpayers. In addition, some charging could be adopted for healthcare.

Thirdly, we should look at how we can shave pension and healthcare promises. The most obvious way pension costs can be shaved is by raising the state pension age much more rapidly. It could, for example, be moved to 68 within ten years and then be linked to life expectation. With regard to healthcare, the government could use the tax system to encourage older people to take out private insurance as happened before 1997.

Finally, there is the labour market. Supply-side policies could raise productivity, increase the tax base and reduce the relative burden of future spending commitments. This should include attempts to raise participation in the labour force at older ages. Despite rising life-expectancy, the UK’s employment rate for 55-59 year old men has fallen from over 90 per cent in 1968 to 80 per cent in 2008 (though it has now turned a corner). Raising the state pension age is likely to raise labour market participation but the evidence also suggests that employment protection legislation and age discrimination laws can act to encourage early retirement. Exemptions from employment protection legislation for those close to state pension age may be beneficial.

Academic and Research Director, IEA

Philip Booth is Senior Academic Fellow at the Institute of Economic Affairs. He is also Director of the Vinson Centre and Professor of Economics at the University of Buckingham and Professor of Finance, Public Policy and Ethics at St. Mary’s University, Twickenham. He also holds the position of (interim) Director of Catholic Mission at St. Mary’s having previously been Director of Research and Public Engagement and Dean of the Faculty of Education, Humanities and Social Sciences. From 2002-2016, Philip was Academic and Research Director (previously, Editorial and Programme Director) at the IEA. From 2002-2015 he was Professor of Insurance and Risk Management at Cass Business School. He is a Senior Research Fellow in the Centre for Federal Studies at the University of Kent and Adjunct Professor in the School of Law, University of Notre Dame, Australia. Previously, Philip Booth worked for the Bank of England as an adviser on financial stability issues and he was also Associate Dean of Cass Business School and held various other academic positions at City University. He has written widely, including a number of books, on investment, finance, social insurance and pensions as well as on the relationship between Catholic social teaching and economics. He is Deputy Editor of Economic Affairs. Philip is a Fellow of the Royal Statistical Society, a Fellow of the Institute of Actuaries and an honorary member of the Society of Actuaries of Poland. He has previously worked in the investment department of Axa Equity and Law and was been involved in a number of projects to help develop actuarial professions and actuarial, finance and investment professional teaching programmes in Central and Eastern Europe. Philip has a BA in Economics from the University of Durham and a PhD from City University.