Commentary: Pensions and Pensions Policy
Broadbent, Simon, van de Ven, Justin, Weale, Martin, National Institute Economic Review
The Pensions Commission is to make its recommendations on pension policy reform later this year, in the light of comments on the challenges identified in its first Report. Widespread agreement on the need for such reform is partly a consequence of problems which have already surfaced, such as the insolvency of some pension schemes, moves to curtail benefits and mis-selling scandals. However the main impetus comes from the fact, clearly demonstrated by the Pensions Commission (2004), that for pensioners to enjoy the current relative standard of living in fifty years time will require people either to (i) retire later (ii) save more; or (iii) pay higher taxes. In the Commission's view the key issues are to find a consensus on the appropriate combination of these three, or of the alternative of lower pensioner incomes, and to find ways of bringing about such an outcome. We focus on aspects of such a reform and suggest one measure which could be implemented without further ado.
For many years the British system of a relatively frugal contributory state pension combined with funded occupational and personal pensions appeared relatively successful. Pensioners' incomes grew faster than average earnings, although some people did better than others--anyone relying upon the Basic State Pension (BSP) saw a steady erosion of their position. People who had changed jobs a lot, and many women, also did poorly. In retrospect this 'golden age' seems to have been something of a fool's paradise. Unusually and unsustainably high investment returns (and hence annuity rates) allowed pension schemes to meet their obligations while running up surpluses and even taking contribution holidays. Looking ahead, it must be assumed that real investment returns will be closer to the long-term rate of growth of the economy and that life expectancy will rise and with it the number of pensioners. Any new arrangements will have to embody some combination of the three changes mentioned above.
Pensions and the Government
It may seem self-evident why the Government should prescribe the structure of the pension system in great detail. Pensions are, after all, the largest single item of public expenditure, even before tax incentives to encourage private provision are taken into account. At the very least these resources need to be efficiently deployed. But this requires a clear view of the most basic question: why have a pension system at all? In today's society, people can expect to spend a lengthy period of their lives in retirement. The fact that this is expected, however, means that individuals can presumably plan for it. One may take the view that the issue of when during their lives an individual chooses to spend their income is not very different from the issue of what they choose to spend their money on at any one time. The state does not interfere to any great extent in the latter decision so why should it need a policy over the former?
There are three obvious answers to this question. First, it is not politically feasible for the state to wash its hands of people who reach retirement with inadequate savings or pensions, however clearly they have been urged to save for themselves. The conclusions of the Commission's first report demonstrate the failure of policy that leaves people to make their own arrangements. For more than twenty years, people have known that the Basic State Pension (BSP) was linked to prices rather than wages. The very elderly have seen their pensions fall relative to wages as a result, but have not been in a position to do much about it. People who are now reaching retirement age, however, have had plenty of time to adjust their savings in light of price indexation, and in many cases have not done so. It is possible that they believed (correctly) that the pension regime would become more generous by the time that they reached retirement, as it has done with the introduction of the Pension Credit (PC). …