Labour needs to make a bold statement on the state retirement pension

By Peter Barnard

Pensions have been in the news for a good few years now, usually beginning with the statement (or something like it) : “My goodness! Look at all these pensioners …. what are we going to do?”

Well, the first thing we should not do is panic. Although the number of pensioners is set to rise from 12 million this year to 16.2 million in 2041 (shock! horror!), the proportion of people of working age declines from 62.0 per cent to 60.9 per cent: a marginal decline.

Pensioners are ‘economic dependents,’ in the dry and dismal language of economists. There is, however, a second class of ‘economic dependents’: the young (classed as those aged 0 – 16 at present) and when looking at the total economic dependency ratio, it increases from 614 per 1,000 people of working age in 2009 to 642 per 1,000 people of working age in 2041, an increase of 4.6 per cent. (Source : Government Actuary’s Department)

This is not cataclysmic. In 1973, following the raise in school-leaving age to 16, there were close on 15 million children aged 16 or less and 9.3 million people of pension age, out of a total population of 56 million, so that the total economic dependency ratio in 1973 was 764 per 1,000 people of working age – mainly due to the high birth rate in the late 1950s and early 1960s.

Back then, I do not recall anyone saying, “My goodness! Look at all these children …. what are we going to do?” In fact, the working age ratio of the total population dropped to 56.7 per cent in 1973, and this is a lot lower than the Government Actuary predicts for the rest of this century. (Source : Annual Abstract of Statistics, 1983)

So what is Labour’s bold statement that is required? It is this : over the next fifteen years, we will increase the total amount paid out in basic state pension to 10 per cent of GDP and this will be paid out of ring-fenced taxation. From 2024 onwards, the total amount paid out in basic state pension will stay at 10 per cent of GDP.

This will have the effect of more than doubling the basic state pension as it stands. In 2006/07, the National Insurance Fund paid out £55 billion in state retirement pensions : just 4.2 per cent of GDP.

Can it work?
Of course it can : all it needs is political will and political courage. Labour, on occasion, hasn’t been short of these attributes in the past and it’s time to re-discover these attributes.

The current system in the United Kingdom relies on two sources of retirement income: state-provided and private-provided. However, we are seeing the rapid demise of ‘final salary’ based pensions, due to a number of factors: people are living longer, the indexation of final salary based schemes and poor equities performance since 1996.

What will happen under this ‘bold statement’ is that salary deductions (and matching employer contributions), or a part thereof, currently made in favour of private sector schemes will be made to the state-guaranteed ’10 per cent of GDP’ rule.

I anticipate howls of objections, “What about Gordon Brown’s tax-grab on dividends paid into pension funds?” Well, Stephen Yeo of pensions consultants Watson Wyatt went on record in 2007 that GB’s “tax grab” is ‘not even in the first three reasons for the current pensions situation.’

The macro economics stuff:
From 1948 to 2008, GDP increased from close on £300 billion to more than £1,330 billion (in constant £2005) : 2.5 per cent per annum. It increased by 95 per cent between 1948 and 1978, and by 94 per cent between 1978 and 2008. If we assume a similar growth between 2009 and 2041, GDP will double from £1,400 billion to £2,800 billion (these numbers are rounded a little, but the rounding does not detract from the principle) and the amount paid out in state pensions would double – in real terms – from £140 billion to £280 billion.

In this period (2009 – 2041), the number of pensioners increases from 12 million to 16.2 million (+ 35 per cent), so that the state retirement pension increases in real terms, at around half of the increase in GDP.

The simplicity of this ‘bold statement’ is that it tells everyone what they can expect from the state, in retirement, in general terms – a steadily growing income, based on our aggregate (‘gross national’) income.

The effect on the ‘final salary’ pension:
The ‘final salary’ scheme is insecure and unsustainable – in both private and public sectors. Private sector employers are recoiling as they see what they are obliged to pay out in occupational pensions and it is unreasonable that public sector employees – especially those at the top level – should expect final-salary based pensions.

Having said which, there is nothing to prevent employees, with or without the assistance of their employer, making their own savings but the final pay-out will be subject to investment performance – and without the currently-enjoyed tax relief enhancement.