In his recent Centre for Policy Studies report, leading pensions expert Michael Johnson gets a grip on the problem. And, to continue a favourite Coffee House theme, how is it best measured? Many have argued that we should look at the unfunded liabilities; that is the present value of how much taxpayers owe to public sector workers in the form of future pensions. These estimates range from the vast (£770 billion according to the Government Actuary) to the colossal (£993 billion according to pension actuaries Towers Watson). But these estimates all revolve around arcane accounting techniques, involving the discounting of future cashflows.
There is a much simpler and more revealing calculation: how much will the taxpayer have to pay every year to make up the shortfall between pensions commitments and contributions? And here the numbers become tangible. For, in five years time, the Treasury estimates that the taxpayer will be stumping up over £10 billion a year to cover the gap between what it receives in contributions and what it pays out as public sector pensions. That is the equivalent to nearly £400 per household. A year. Every year. But it gets worse. Over 75 percent of these contributions are paid not by the employees but by public sector employers – in other words, the taxpayer. Add those contributions and the taxpayer will be paying out around £25 billion (the figures are not precise). And that will, from 2015-16, be just short of £1,000 a household. A year. Every year.
But it gets even worse. Public sector workers have no exposure to either investment risk or longevity risk: the fact that we are all likely to live longer means that private sector pensions will have to fall so that they can cover the longer retirement period. And, on top of that, you must remember that, according to the ONS, the average (mean) gross pay in the public sector is now higher than in the private sector. So the wealth-producing part of the economy is subsidising the better-off public sector workers.
So what should be done? Michael Johnson argues that Hutton faces two broad choices: to play it safe and go for cautious reform involving a watered down version of final salary schemes; or to timetable the closure of all final salary schemes and move to a defined contribution-based system. And one brilliant proposal hidden inside Johnson’s detailed proposals is to link public sector employee pensions with index-linked gilts. This will help to allay some of the union fears over their members’ pension rights.
Hutton is due to report in a few weeks time. He has already acknowledged in his interim report that the status quo is simply unsustainable. And if there is one over-arching ambition which he must embrace it is that of self-sufficiency. Anything less, and we will be having another public sector pensions review in a few years time, already being well down the path to catastrophe.
Tim Knox is Acting Director of the Centre for Policy Studies. Self-sufficiency is the key: addressing the public sector pensions challenge by Michael Johnson is published by the Centre for Policy Studies.