Recent government commitments to continue to increase state pension expenditure in real terms are both unaffordable and irresponsible. Instead, the government must accelerate the introduction of a later retirement age and urgently reform labour market regulations to enable people to work longer. New research from the Institute of Economic Affairs outlines ten policies which could alleviate the fiscal problems caused by an ageing population.
Employment rates amongst older-middle-aged people have fallen significantly. Between 1968 and the end of the 1990s, employment rates for men aged 60-64 slumped from around 80% to 50%. Despite a recent recovery in employment rates to 60% for males aged 60-64, in the last generation, there has been a marked decline in employment of older-middle-aged people.
The result is that, under current policies, state pension provision and other benefits paid to those who retire before state pension age represent a ticking time bomb for the public purse. State pension expenditure is expected to rise by 2.4 percentage points of GDP between 2012 and 2062 – an increase of 42% as a proportion of national income.
In Income from Work – The Fourth Pillar of Income Provision in Old Age, Gabriel Sahlgren conclusively finds that the current state pension system is incentivising early retirement. He also finds that employment protection legislation raises unemployment at older ages - including before state pension age. Later retirement benefits the individual through improved health* and higher incomes and it also benefits taxpayers by reducing the costs of ageing populations.
Ten policy recommendations to ease the state pension time bomb:
- Accelerate the rise in retirement age. From November 2018, the state pension age for men and women should increase by two months every quarter. This would see the age increase to 68 by January 2023.
- Link retirement with life expectancy. From January 2023, the state pension age should be tied to life expectancy.
- Exempt older workers from employment protection legislation. Employment regulation hurts the elderly overall, especially those currently unemployed. Removing regulations would incentivise employers to take on older workers and also enable greater labour mobility and flexible working patterns.
- Introduce a pilot scheme to exempt older workers from age discrimination laws. If rigorously enforced, there is some evidence to show age discrimination laws make companies more reluctant to hire older workers. A large-scale pilot exempting some firms should be trialed.
- Encourage individuals to save for their own retirement. With greater private pension provision, older workers would have to bear the costs of early retirement themselves.
- Consider the introduction of compulsory private pension provision to replace the state pension. In Australia, pressure on the public finances has been successfully alleviated through a system of compulsory private pension provision. These reforms saw employers putting aside at least 9% of employees’ pre-tax earnings into a personal fund. Under such arrangements, individuals who choose to retire later benefit financially.
- Reform disability insurance schemes. Often used as de-facto early retirement schemes, the government should tighten eligibility requirements. The overall incentive framework must be reformed to encourage labour force participation where possible.
- Reform unemployment benefit schemes. These can also be used as an early exit route from the labour market. Evidence shows that countries with more generous unemployment insurance have an increased likelihood of the unemployed entering retirement.
- Cut labour taxes. The government should extend National Insurance exemptions, reducing contributions as soon as a full state pension has been accrued.
- Government should refuse to grant stronger union prerogatives over wage bargaining. Evidence suggests that higher levels of union involvement in wage setting put older workers at a disadvantage compared to prime-aged workers.
Commenting on the research, Professor Philip Booth, Editorial and Programme Director at the Institute of Economic Affairs, said:
“The government needs to wake up to the reality of the long-term state of the public finances. People retire earlier on average today than they did in the 1960s despite huge improvements in life expectancy. People should have both the opportunity and incentive to continue some form of paid work into older age. Policymakers must urgently implement a coherent package of reforms, including a more rapid increase in the retirement age and a substantial reduction in employment protection legislation which is especially damaging to older people.”
Notes to editors:
To arrange an interview with an IEA spokesperson, please contact Stephanie Lis, Head of Communications: email@example.com  or 07766 221 268.
The full report Income from Work – The Fourth Pillar of Income Provision in Old Age, by Gabriel Sahlgren, can be downloaded here.
*In May 2013 the IEA published Work Longer, Live Healthier: The relationship between economic activity, health and government policy . The report found that retirement has a detrimental impact on both mental and physical health over time.
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