Public sector workers will be waiting nervously for John Hutton’s pension review, due out tomorrow. It is likely to mandate extra pension contributions of around 2.5-3.5 percent of pay and new ways to make entitlements grow more slowly. Policy Exchange advocated a similar solution in a report published last year.
Predictably, the TUC is up in arms. It says that public sector pay is not significantly out of line with the private sector – despite all the evidence that it is. The main reason why those in the public sector get a better deal is their pensions.
These add up to the equivalent of 44 per cent of public employees’ wages and 71 per cent for uniformed services – but are just 9.3 percent for (less secure) private sector schemes. Despite much longer retirements (around 25 years on recent estimates compared to 15 years ago in 1990), public workers have not been asked to pay more. Teachers, for example, contribute little more than they did in the 1920s as a percentage of their salary. Instead, the burden has been borne entirely by the taxpayer.
The liabilities for this second national debt add up to around £1.2 trillion – around £47,000 per household. Let me repeat that figure: £1.2 trillion – or over a million million. This is leading to the manifestly unjust situation where private sector workers will be paying more towards public pensions than they save for themselves – around £15,000 each. Such largesse towards the public sector is perhaps part of the reason why over half of those working for the private sector have no pension arrangements at all.
But there is another aspect to over-generous pensions. They are trapping public workers, giving them an incentive to stay on and become underperforming time-servers. To combat this, Hutton will switch accruals from final salaries to career averages – helping lower-ranking workers at the expense of high flyers benefiting disproportionately from late-career rises. He is also likely to recommend increasing the pension age to 65 – somewhat compensating for the extra 9.2 years of a public employee’s working life that are worked in the private sector.
Hutton’s reforms are a step in the right direction – but will likely turn out to be insufficient. We should expand the ‘cap and share’ system outlined in the 2009 Pre-Budget Report to limit the accrual of additional liabilities. In the longer term we need public pensions to be, in Alistair Darling’s words, ‘to be broadly in line with those offered in the private sector’. This might mean creating fully funded money purchase schemes, which some organisations such as Ofcom have already done. We also need much greater clarity about the scale of the problem: the OBR continues to accept government discount rates, which have been widely discredited, leading it to underestimate the real liabilities by half.
The coalition has been brave thus far. Of necessity, it has already taken a great deal of flak for its measures to deal with the national debt. But unless urgent action is taken, this second national debt will continue to haunt us.
Ed Holmes is a research fellow in the Economics Unit at Policy Exchange
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