Hidden in last Wednesday’s Budget speech were three short sentences on public sector pensions which will have meant little to most listeners.  …“Today we publish the result of our consultation on the discount rate, which shows that a more appropriate rate would be inflation plus GDP growth”…  Since most of the electorate do not know what the discount rate as it applies to public sector pensions is, and also have no idea how pensions are affected by discount rates, the statement did not set off alarm bells.  But the Chancellor has in my opinion made a serious error in this decision.  And this is an error in principle, not just in practice.

The public sector pension discount rate is the interest rate which the Government uses to calculate how much employees and employers together need to pay for their pensions.  For at least the last ten years, it has been 3.5% p.a. over inflation (in practice, RPI).  Now it is to be 3% p.a. over CPI (the Government’s preferred measure of inflation), even though average real GDP growth in the UK over the past twenty and forty years has been about 2% p.a..  This full percentage point over historic growth is sleight of hand, but not my main complaint.

My complaint is this.  Public sector workers are now almost the only section of the workforce who get, and will continue to get, defined benefit pensions.  They are by far the best type of pension, and the defined contribution alternative, will, in my opinion, bring huge disappointment, anger, poverty and taxpayer-burden in the coming decades.  But public sector workers do not just get something which private sector workers cannot, they also get an enormous and hidden subsidy – and this comes from the discount rate being artificially higher than that available to us – the general public.  Although we cannot directly buy CPI-linked Government bonds, if we could they would yield about 1.5% p.a.  Although the difference between 1.5% p.a. and 3% p.a. (the newly announced rate) may not seem much, it translates to paying about 40% of salary every year for a good defined pension scheme for the private sector investing at 1.5%p.a., compared to about 25% p.a. for the public sector, using the artificial 3% p.a.  This c. £15bn p.a. hidden subsidy to public sector workers is paid for by all taxpayers both now and in the future.  The Chancellor, who understands the arguments and the maths very well indeed, has thrown away a golden opportunity to demonstrate that he can see-off entrenched interests by applying sound principles of transparency and fairness.  Instead he has opted for political expediency.

Neil Record is a Commissioner of the Public Sector Pensions Commission (read its report here) and author of several publications on pensions, including Sir Humphrey’s Legacy: facing up to the cost of public sector pensions

Neil Record 154x154

Chairman of IEA Board

Neil Record was elected as Chairman of the IEA Board in March 2015. Neil is also Chairman of Record plc, a listed specialist currency asset manager. He was educated at Balliol College, Oxford, and University College London, from where he holds an MSc in Economics (with distinction). His first job was as an economist at the Bank of England; this was followed by a stint in industry. In 1983, he founded Record, the firm he still chairs.  He has lectured on Investment Management at Cambridge University, and is author of the first book on specialist currency management within an investment context: Currency Overlay (John Wiley & Sons, 2003).  Neil has been a prime mover in attempting to improve transparency in public sector pensions in the UK, and is author or co-author of four papers on this topic, including Sir Humphrey’s Legacy (2006) published by the IEA.  He is a member of the Investment Committee and Visiting Fellow of Nuffield College, Oxford.

1 thought on “The sleight-of-hand on public sector pensions”

  1. Posted 28/03/2011 at 16:18 | Permalink

    I wonder if the Chancellor of the Exchequer ‘consulted’ the Office of Budget Responsibility about the discount rate to use? I am already suffering from another trick concerning discount rates, as my own pension is from now on being index-linked to the Consumer Prices Index rather than the Retail Prices Index. Experts reckon this apparently merely ‘technical’ change will cost someone retiring this year about 15 per cent of their pension. It only shows how right the Book of Common Prayer was to say: Put not your trust in princes.’

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