While reform of state pensions has been kicked in to the long grass, private schemes are being squeezed ever-harder, writes Philip Booth in House Magazine

During the 1990s, the commentariat were calling for a consensus on pensions policy. That was the only way, it was argued, that we would ensure a long-term solution to pensions problems. We now have that consensus. And it is a consensus based around burying heads in the sand and ignoring the long term. Over the last 13 years, state income transfers to the elderly have been increased significantly; more pensioners than ever now receive means-tested benefits; and increases in state pension age are lagging well behind increases in longevity.

At the same time, there has been a relentless attack on private pensions. Company final salary schemes are regulated as never before – so there are now few schemes left to regulate. Gordon Brown’s tax changes led to the cost of funding a given pension increasing by about 10 per cent. In addition, the terms on which the government allows people to contract out of the second state pension, if they make their own private provision, have been steadily eroded and now bear no resemblance to a ‘fair price’. As savings rates have tumbled, the government has looked on with apparent surprise.

So what does the future hold? The Conservatives once had radical plans to allow people to opt out of the whole of the state pension system. Sadly, they seem wedded to the status quo. With the Liberal Democrats having taken a similar position before the election, it is not surprising that the coalition has simply reaffirmed what is, in effect, the policy of the last Labour government.

Pensions will increase by wage inflation, price inflation or 2.5 per cent – whichever is the highest. It will probably not happen in the next two years, but if the country were caught in a period of severe deflation, this approach – if spread widely across the welfare system – would make public spending very difficult to control in real terms.

Given that we are not going to see radical change, it would be nice to get change by stealth. But, if we do, it will probably be in the wrong direction. The principle of contracting out of state pensions could be extended, and rebates returned to proper levels. The regulation of defined-benefit schemes could be liberalised and, in addition, tax credits for dividends could be at least partially restored.

None of these things look likely and, indeed, the scene looks ominous. Many of those who save outside pension schemes – or use rents from a second home to provide them with an income in old age – are likely to be presented with a massively increased capital gains tax bill. It is to be hoped that the Liberal Democrats’ plans to withdraw higher-rate tax relief on pensions will be dropped, as this would make the pension tax system completely incoherent and probably kill off remaining private sector defined-benefit schemes. As yet we have no word on this: if the chancellor goes after anything, it should be the tax-free lump sum.

The one bit of good news is in the field of public sector pensions. This relates to a debate that the Institute of Economic Affairs set off in 2005: pension costs are high and growing, but are kept off the government balance sheet – hidden from the electorate. A commission is to be set up to investigate this. There has been plenty of research; no commission is necessary. But at least the issue is on the government’s radar screen.

We may get public sector pension reform but, with regard to the rest of the scene, we have a grim consensus: expand state provision, make life more difficult for private savers, cross our fingers, and hope for the best.

For more commentary on the pension funding problem, see Sir Humphrey’s Legacy and Pension Provision: Government Failures Around the World.