Earlier this week, the government announced a new pension reform which would involve the creation of a flat-rate state pension at around the minimum level of income deemed necessary to support a person in old age. Despite the protestations of the opposition, there is pretty much universal support for this policy amongst the political classes. Of course, this will be a pension, like all state pensions, that is not ‘funded’. That is, the current generation of taxpayers, by supporting this proposal, will be voting themselves a benefit that will be paid for by a future generation of taxpayers. This approach has been described as a ‘fiscal commons’ by Richard Wagner. Future taxes are – more or less - a free good for the current generation who are grazing that revenue source at will.
This problem was presciently noted by a former president of the US Society of Actuaries at the centenary meeting of the Institute of Actuaries in 1948. He said:
‘There was at the existing time great political pressure from governments to adopt or maintain ambitious programmes of so-called social security, with perhaps too little understanding of their ultimate effect on the economic and social structure. A sound social insurance and superannuation programme could sustain and strengthen a nation; on the other hand, a sufficiently unsound one could ultimately destroy it. Furthermore, once such a programme was put into effect it became politically impossible to discard it or to reduce the benefit scales which it was beyond the ability of the nation’s economy to support.’
In a life-cycle model of consumption, you would expect people to save during their working life to provide services and an income stream in old age. This would include provision for healthcare, pensions and long-term care. The welfare state allows us to simply impose those burdens on future generations of taxpayers. In addition, as the electorate ages, there are political pressures to expand benefits at the very time when spending pressures are most acute (hence the triple lock to increase pensions above the rate of inflation, and the ring-fencing of health spending whilst benefits to families are cut). Most estimates of the unfunded liabilities of the welfare state, when added to total explicit debt, produce numbers around 500 per cent of national income. The situation is not very different in other western countries.
In the UK, we have a mechanism that has enabled people to save for retirement rather than impose a debt on future generations of taxpayers. This is a process known as ‘contracting out’ and was introduced in 1961. Those who made their own provision paid lower taxes and did not receive part of the state pension. Contracting-out was supported by successive governments – of both colours – and was extended by ministers such as Barbara Castle who was very unfriendly towards the market economy. Indeed, this policy was sufficiently successful and mainstream for the Conservative Party to run two successive elections on the platform of radically extending the scope of private pension provision and reducing state provision (in 1997 and 2001). These proposals were certainly not why they lost those elections.
Sadly, Gordon Brown seriously undermined contracting out and the coalition is now bringing it to an end.
The proposed pension reform has some merits. It introduces some simplicity into a fiendishly complex system described in The Way Out of the Pensions Quagmire. However, it is being introduced dishonestly. The minister is arguing that it is better for women who have had caring responsibilities. This is simply not true and no private pensions’ salesman would be able to make such claims. It is being argued that it will cost no more than the current system. This is only true if you regard the national insurance reduction that people who opt out of part of the current state system and that will be abolished as ‘government spending’. It is certainly a very perverse logic that describes taxes that people do not have to pay as ‘government spending’.
But the main problem is that the reform is another step in the nationalisation of welfare. Readers of this blog will differ with regard to their policy positions on the welfare state. Some will not be in favour of government-provided welfare at all. However, as a minimum, surely those who can demonstrate that they can make their own private provision should be able to opt out of state provision and opt out of the taxes necessary to fund that state provision. This not only raises private saving, but it helps keep the government honest, by ensuring that at least some pension commitments are financed by sacrifices made today.
Instead of enrolling everybody into a new state pension scheme and raising taxation and the burdens on future generations, the government should be extending the possibilities for people to replace state provision with private provision and extending that principle to the rest of the welfare state.