Why the UK pensions triple-lock is a costly economic – and political – mistake
20 October 2015
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19 October 2015
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Politicians spend much of their time worrying about repeating the political mistakes of their predecessors. In recent weeks, Conservative MPs have mused over whether changes to tax credits could have the same impact on support for the government as Gordon Brown’s abolition of the 10p tax rate, or could even be their “poll tax”.
Yet with huge headwinds facing the public finances in the form of an ageing population, the public would benefit from governments taking forward-looking economic decisions, rather than backward-looking political ones.
Nowhere is this more obvious than on the state pension. The coalition government’s decision to introduce the so-called triple-lock in 2010, so that the state pension rises every year by the higher of the rate of inflation, wage growth or 2.5 per cent, is already proving extremely costly indeed.
A report published then hastily deleted by the Government Actuary’s Department last week estimated the annual cost of the policy change at £6bn already. This is fully half the amount the government is looking to save annually from its controversial cuts to the working age welfare bill.
But this policy was in part implemented to avoid Gordon Brown’s supposed political mistake of 1999, when many lamented his 75p nominal increase to the state pension as “derisory”. The criticism of Brown was always unfair, of course.
The pension at the time was linked to changes in inflation in order to preserve pensioners’ real purchasing power. Inflation that year had been low. So in order for pensioners to be able to buy the same amount of stuff, the necessary rise in the state pension was itself low. Brown had economic logic on his side, if not a good headline.
One could argue, of course, that the pension should have been linked to wage growth rather than prices. The argument for this would be that pensioners should see their relative earnings compared with workers protected. But to avoid upsetting pensioners, policy has now swung too far the other way. To link the state pension to either of these, or 2.5 per cent, whichever is highest, has no economic justification whatsoever – unless your objective is to bake in ever higher pension spending. And it’s particularly costly in periods like we’ve just been through, when inflation and earnings growth are low.
The longer-term consequences of the triple-lock as the population ages are more dramatic still. Compared with an earnings uprating, it’s estimated to add 9 per cent to benefit expenditure by 2040 and 23 per cent by 2070. In a situation of low inflation and earnings growth, this could rise to 41 per cent by 2070. Were the UK to endure a period of entrenched deflation like Japan, it could cost 238 per cent more than the earnings link would have done by the same date.
For a government rhetorically committed to getting debts under control to prevent future generations picking up the tab, maintaining such a policy is unjust on an intergenerational basis.
As the Conservative MP Liam Fox made clear in an IEA speech yesterday, the impact of an ageing population is something the government has so far largely ignored. The triple-lock in particular creates significant long-term liabilities due to its interaction with demographics, promising benefits to future pensioners which will inevitably have to be reneged upon at some point. With tight public finances, it’s also generationally unjust – with the policy having redistributed significant resources in recent years from working age people, who have seen low earnings growth and cuts to welfare.
Of course, pensioners are a significant voting group and politicians are in the market for votes. Most of today’s MPs will be long gone by the time their decisions need to be cleaned up. But for the public’s sake, it would be nice to hear a few more voices articulating that we should avoid allowing the so-called political mistakes of the past to become economic gambles with our future.
Ryan Bourne is the IEA’s Head of Public Policy. This article first appeared in City AM.
Yet with huge headwinds facing the public finances in the form of an ageing population, the public would benefit from governments taking forward-looking economic decisions, rather than backward-looking political ones.
Nowhere is this more obvious than on the state pension. The coalition government’s decision to introduce the so-called triple-lock in 2010, so that the state pension rises every year by the higher of the rate of inflation, wage growth or 2.5 per cent, is already proving extremely costly indeed.
A report published then hastily deleted by the Government Actuary’s Department last week estimated the annual cost of the policy change at £6bn already. This is fully half the amount the government is looking to save annually from its controversial cuts to the working age welfare bill.
But this policy was in part implemented to avoid Gordon Brown’s supposed political mistake of 1999, when many lamented his 75p nominal increase to the state pension as “derisory”. The criticism of Brown was always unfair, of course.
The pension at the time was linked to changes in inflation in order to preserve pensioners’ real purchasing power. Inflation that year had been low. So in order for pensioners to be able to buy the same amount of stuff, the necessary rise in the state pension was itself low. Brown had economic logic on his side, if not a good headline.
One could argue, of course, that the pension should have been linked to wage growth rather than prices. The argument for this would be that pensioners should see their relative earnings compared with workers protected. But to avoid upsetting pensioners, policy has now swung too far the other way. To link the state pension to either of these, or 2.5 per cent, whichever is highest, has no economic justification whatsoever – unless your objective is to bake in ever higher pension spending. And it’s particularly costly in periods like we’ve just been through, when inflation and earnings growth are low.
The longer-term consequences of the triple-lock as the population ages are more dramatic still. Compared with an earnings uprating, it’s estimated to add 9 per cent to benefit expenditure by 2040 and 23 per cent by 2070. In a situation of low inflation and earnings growth, this could rise to 41 per cent by 2070. Were the UK to endure a period of entrenched deflation like Japan, it could cost 238 per cent more than the earnings link would have done by the same date.
For a government rhetorically committed to getting debts under control to prevent future generations picking up the tab, maintaining such a policy is unjust on an intergenerational basis.
As the Conservative MP Liam Fox made clear in an IEA speech yesterday, the impact of an ageing population is something the government has so far largely ignored. The triple-lock in particular creates significant long-term liabilities due to its interaction with demographics, promising benefits to future pensioners which will inevitably have to be reneged upon at some point. With tight public finances, it’s also generationally unjust – with the policy having redistributed significant resources in recent years from working age people, who have seen low earnings growth and cuts to welfare.
Of course, pensioners are a significant voting group and politicians are in the market for votes. Most of today’s MPs will be long gone by the time their decisions need to be cleaned up. But for the public’s sake, it would be nice to hear a few more voices articulating that we should avoid allowing the so-called political mistakes of the past to become economic gambles with our future.
Ryan Bourne is the IEA’s Head of Public Policy. This article first appeared in City AM.
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“Compared with an earnings uprating, it’s estimated to add 9 per cent to benefit expenditure by 2040 and 23 per cent by 2070.”
This may be true, but it is the overall cost which is important, not the cost compared to what it would have been. What is happening to the overall cost? People are also living longer which implies higher cost but the pension age is going up (and people will contribute for longer as a result) which will reduce cost. Higher state pensions will also lessen the need for means-tested pensioner benefits, this partly cancelling out the extra cost of the triple lock. We need to know the overall picture, not just the effect of the triple lock compared to not having the triple lock.