While the current method of uprating the state pension is imperfect, Theresa May’s proposal to abolish it is based on a flawed view of intergenerational fairness
It is now almost certain that the state pension ‘triple lock’ will be abolished once Theresa May retains her premiership at the 2017 general election. The triple lock dictates that the state pension (both the basic state pension and its successor for new pensioners, the single-tier state pension), must be uprated annually by the higher of average earnings growth, inflation or 2.5 per cent.
The Conservative manifesto promises to end the policy after 2020 and replace it with a ‘double lock’ to uprate pensions annually by the higher of earnings or inflations. The 2.5 per cent lock has in recent years been called upon more often than envisaged, due to sluggish earnings growth and low inflation (measured in terms of the consumer price index (CPI)). The change is apparently being made in service of ‘intergenerational fairness’, because pensioner expenditure has as a result been rising much faster than working-age benefits.
My recent SPERI Brief The Long-Term Impact of the State Pension ‘Triple Lock’ demonstrates the duplicity of such arguments. The UK electorate is increasingly weighted towards older people – which helps to partly explain the neglect of young people’s interests in policy areas such as housing – but the UK today is far from a ‘pensioners’ paradise’ as a result. Pensioners and, especially, near-pensioners (who are actually the real power-brokers within the UK electorate) have suffered very considerable cuts in public spending since 2010, including cuts to state pension entitlements.
Overall, the UK has one of the least generous state pension systems in the developed world. Compared to an OECD average of 63 per cent, the UK’s state pension ‘net replacement rate’ (the proportion of average earnings which different forms of pensions provision and pension-related benefits [minus taxes] are equivalent to) is only 29 per cent. The most important purpose of the triple lock is to rectify this over the very long term.
Even then, however, its impact is rather modest. Today, the full state pension rate represents only 31.4 per cent of average earnings. If the triple lock were to remain in place, it will take eleven years until the state pension level surpasses 32 per cent of average earnings, and twenty years before it surpasses 33 per cent. An individual aged 18 today, retiring in 50 years at the age of 68, can expect to receive a state pension worth only 36.4 per cent of average earnings.
The argument (made explicitly or implicitly by bodies such as the Institute for Fiscal Studies (IFS), Institute for Economic Affairs, Government Actuary’s Department, Office for Budget Responsibility and Work and Pensions Select Committee), that the triple lock is simply too expensive has been hugely exaggerated. If the state pension had been uprated by only a ‘double lock’ of earnings growth or CPI, it would have cost around only £1 billion less per year. This is not a particularly significant uplift; in 2015/16, for example, the triple-locked state pension cost £68 billion, while a double-locked state pension would have cost £67.1 billion.
It is also worth noting that, despite the triple lock, state pension expenditure has somewhat remarkably risen by less than it would have had indexation by the retail price index (RPI; an alternative measure of price inflation) continued to operate – as it had done before 2010. The cost of the state pension is of course set to rise significantly, but this is story about higher caseload far more so than an over-generous uprating framework.
The intergenerational fairness rationale for triple lock abolition is therefore, at best, faulty and, at worst, duplicitous. The wrongness of recent coalition and Conservative government policy on working-age benefits should have no bearing on the validity of policies related to pensioner benefits. Too many commentators have been too quick to accept the nonsensical notion – which is deeply embedded in austerity politics – that any savings made in one area of public spending can alleviate the need for cuts in other areas. This perspective was evident in a recent Financial Times leader, which argued:
“The consequences of this pledge… have been perverse. Pensioners may have done well under the triple lock, but the resulting cuts to benefits elsewhere have caused much pain… Ringfencing the state pension from spending cuts has also fostered generational jealousy between those who are working and those who are not [emphasis added].”
A more sober analysis would suggest that that the main beneficiaries of the triple lock are the still-young, not the already-old, given that its impact on state pension values compounds over the long term.
Moreover, the policy is not fostering ‘generational jealousy’: it is popular among all age groups. Indeed, the triple lock is perhaps the one ray of light within a very gloomy pensions picture for today’s young people, as they look ahead to a retirement relying on individualised and inefficient ‘defined contribution’ pensions (further problematised by the wilful destruction of the annuities market by former Chancellor, George Osborne) and, it appears, the burden of self-funding their care needs in later life.
In fact, even within the state pension system, the triple lock is inadequate compensation for the abolition of the second state pension and the accelerating pace of state pension age increases – both of which serve to make state pensions significantly more regressive.
The triple lock has to be seen as a pensions policy, not a pensioner policy – focused on the long-term features of the pensions system, not simply the welfare of existing pensioners. It is disappointing therefore that even the Labour opposition’s defence of the triple lock forms the central element of its ‘pensioner offer’. This failure to articulate the clear – albeit limited – value of the policy to future pensioners indicates how clumsy our understanding of intergenerational bargains around social security and public services has become.
Of course, even with more sophisticated intergenerational lens, we should not assume that the triple lock is a satisfactory policy. It should, above all, become more ambitious, based on the recognition that a higher value state pension incentivises private saving by enabling individuals to take greater investment risks.
An alternative to the triple lock – and a way of further focusing its benefits on young people – would be to increase directly the state pension accrual rate, that is, the level of state pension entitlement being accrued for each year of National Insurance contributions.
At the moment, indexation arrangements for state pensions in payment act as a de facto accrual mechanism in a nominal ‘pay-as-you-go’ system (meaning that the government of the day determines retrospectively the value of entitlements when deciding how to uprate the state pension). Crucially, accrual rates could be more generous for younger people, meaning that the value of the state pension would effectively rise significantly over time, but current expenditure would ostensibly be unaffected by current economic circumstances.
Of course, both operationalising and communicating this system would be a highly complex task.
A simpler and perhaps even more sustainable approach to the problem the triple lock is trying to solve would be to ‘over-index’ the state pension during periods of stable growth, but revert to a double lock during more difficult periods.
One of the key threats to the legitimacy of the triple lock is that it only really bites when earnings growth is sluggish, that is, when the economy is likely to be experiencing a downturn. If the uprating framework for the state pension is to be focused predominantly on the long-term implications for state pension value, then its reliance on economic downturns to achieve its core goals is rather problematic.
Understanding the triple lock as a pensions policy and not a pensioner policy would shift the debate about our pensions system towards how it can better benefit people in the UK – of all ages. This is the debate we ought to be having both now and after the election on June 8th.