By agreeing to exclude those within 10 years of retirement from any deal, as well as increasing the pension accrual rate, the coalition has wiped out, for the next 10 years, any scope for meaningful cost savings. The only remaining benefit, within that timeframe, will be additional employee contributions, a mere trickle when compared to the burgeoning cost of meeting pensions in payment.
Four years ago the public sector pensions’ cashflow gap (between contributions and pensions in payment) was an insignificant £200m. In 2010-11 it was £4.3bn, and in this year’s March Budget the gap was forecast to be £7.2bn in 2014-15. Last week’s OBR report, accompanying the Autumn Statement, increased the 2014-15 forecast to £10bn (and rising thereafter). With three-year forecasting volatility such as this, the unions’ claim of on-going affordability, based upon a 50-year cost projection, is totally lacking in credibility.
In the meantime, the gap has to be plugged by the Treasury; this, together with employer contributions, leaves taxpayers meeting at least 80 per cent of the cost of public sector pensions. So increases in employee contributions that are small relative to the total cost of pensions will be of limited benefit to the Treasury. The real economic benefits only arise well beyond 10 years hence, principally powered by Lord Hutton’s proposal to link the retirement age to the retreating State Pension Age. Helpful in the future, but of no political value today.
Furthermore, as part of the recent concessions, the acceptable range for the cost of public sector pensions will be increased, from 17 per cent to 21 per cent up to 20 per cent to 22 per cent of the annual wage bill. The latter is approximately £182bn; the 3 per cent increase in the lower end of the range is £5.4bn per year. Consider an alternative use for this state spending; it is equivalent to cutting the rate of corporation tax by 4p. Imagine the potential for economic growth were such an initiative to be implemented today.
There was an alternative: there are a few cashflow quick wins which the Treasury could have used as far more effective bargaining counters. The most productive would be to put an end to contracting out of the State Second Pension (S2P), saving some £3.9bn annually on allied national insurance contributions rebates. Indeed, the coalition should have started the process of public sector pensions reform by raising the state pension to at least £140 a week. By putting in place a bedrock of retirement income above the means-testing threshold, the coalition could claim to have addressed the unions’ legitimate concerns over pensioner poverty. It could be (more than) financed by reinvesting the ensuing reduction in means-tested benefits (saving up to £8.6bn annually) and ending higher rate tax relief (£7bn annual saving). The coalition would then be in a stronger position to negotiate a route map to a wholly defined contribution based framework for public sector pensions.
To date, the unions have comprehensively outwitted the coalition in the media war, harnessing to full effect the opportunities for obfuscation and bamboozlement offered by the pensions theme. But, paradoxically, could the unions’ success, to date, ultimately be their undoing? Such is the opacity of pensions that few within the public sector appreciate just how good the current offer is. By striking, public sector workers could have made a tactical error of Scargillian proportions, a major step towards snatching defeat from the jaws of victory. The coalition could still just pull the current deal off the table, and walk away. To be clear, what is on offer is a pension that is roughly three times bigger than that which is typically available to a private sector worker on the same salary.
In the interim, the unions may accept the deal, but this could ultimately prove to be a Pyrrhic victory, the price being even greater subsequent job losses to exert some control over the cost of future pensions. Meanwhile, the chief secretary to the Treasury should reconsider his ludicrous comment that the proposals would “endure for at least 25 years.” Over that timeframe, no one knows how our economy will perform, or what the additional costs may be from increasing life expectancy. This leaves one final question, to the Prime Minister. He has made it clear that the pensions offered to the public sector are “far, far better than pensions in the private sector.” Why should they be?
Michael Johnson is a research fellow at the Centre for Policy Studies.