OBR shouldn’t take a Bernie Madoff approach to public sector pensions

Two things struck me about the OBR report published yesterday. I shall blog about the other later…

The first was its treatment of public sector pensions. This is an area where the IEA has published a lot of work – including a paper published on the same day as the OBR report. The approach of IEA authors to calculating public sector pension liabilities is now widely accepted amongst those who do not have a vested interest in not changing current practice. The OBR should join that group of independent observers and not align itself with the special interests. Not only did the OBR use existing government figures for public sector pension liaibilities when the best estimates are about £400bn higher than the government’s estimates, it also suggested that the most appropriate estimate of the annual cost of public sector pensions going forward is what is known as the “current service cost”. It used the government figure here of about £28bn. This is incorrect for two reasons. Firstly, the government’s current service cost uses an inappropriate discount rate which leads it to be understated by about £7bn. Secondly, this figure also ignores the fact that previously granted liabilities are discounted. As each year passes they get nearer and thus the discounting effect gets less and the liabilities grow. This might add another £30bn to the annual cost.

Calculating the outstanding liability wrongly leads to an understatement in the total accrued liability equal to more than 50% of the outstanding government debt to which the government admits. If public sector pension liabilities are included in the national debt then it would rise to about 2.5 times the level the government has declared. The second omission leads to an understatement of government borrowing of about 25% of existing borrowing levels (though it is possible that there are some offsetting factors here caused by the incoherent way the public sector pension liabilities are included in official figures – as well as important under-statements of costs, there are some over-statements too).

The OBR says that it will continue to assess this, drawing on the work of GAD and the ONS. Help! Perhaps it should draw on the work of Bernie Madoff too – indeed there is a marked similiarity between these government schemes and Bernie Madoff’s fraudulent ponzi scheme.

This is not entirely the OBR’s fault. In the first report it was merely asked to discuss these issues. It has done that. But it is supposed to go further in future years in analysing these issues. The single additional sentence “we will also draw on the work of the many independent groups in coming to an independent assessment of off-balance sheet liabilities” would have been comforting. The OBR simply drawing on the work of the Government Actuary and the Office for National Statistics to calculate public sector pension liabilities is not good enough. It will not be able to provide an independent assessment of the government finances if that is all it does. There is no excuse any more. All the relevant information is in the public domain and reasonable people independent of government do not dispute it.

I do think the governmment is to be congratulated on trying to reduce the impact of (some)politicians trying to fiddle some of the national economic and financial numbers.But, as Sir Alan Budd (I understand) has very sensibly pointed out, even an ‘honest’ estimate of many of the numbers is subject to a large margin of error.So I welcome Philip’s criticism and hope it will lead to a more informed estimate concerning public sector pensions next time.Incidentally, I believe there may be room for more than one opinion on the ‘appropriate’ discount rate to use — to which the estimates are extremely sensitive.

There is room for more than one opinion, and this can certainly be discussed in documents such as the OBR publications. The implications of using other discount rates should be spelled out (eg if there is a risk premium added that would imply that it cannot be assumed that people will receive their pensions with certainty).

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