Tug of war

Apr 6th 2006
From The Economist print edition

Despite his peace overtures to Tony Blair, Gordon Brown hasn't let go yet

NOT for nothing are pensions often called the third rail of politics: touch them at your peril. In America, George Bush lost authority last year as his proposed reforms to Social Security went nowhere. Now, in Britain, a plan to rebuild a crumbling pension system has been causing trouble at the very top of government.

Pensions have become the latest high-voltage dispute in the long-running struggle between Tony Blair and Gordon Brown. The prime minister and the chancellor of the exchequer have been feuding over a reform plan laid out in November by the Pensions Commission, a government-appointed body.

Chaired by Lord Turner, a former director-general of the Confederation of British Industry, the commission had already established in 2004 that the existing pension system would be unable to deal with an ageing population. Britain has historically relied upon a partnership between employers and the state. Voluntary occupational and personal pension plans buttress meagre state pensions, which are topped up for more and more pensioners with means-tested benefits.

That partnership has been crumbling, however, as companies cut back their pension plans. New figures presented by Lord Turner on April 4th show that corporate retrenchment continues apace (see chart above), while public-sector workers inhabit an increasingly privileged pension world. Yet the need for adequate pensions for employees, wherever they work, has never been greater as the post-war generation of baby-boomers heads for retirement.

In November 2005 the commission moved from diagnosis to remedies. It made four main recommendations. First, the state-pension age—already due to rise for women from 60 to 65, the present age for men, between 2010 and 2020—should increase to 68 by 2050 in line with increasing longevity. Second, there should be a new low-cost national savings scheme, in which workers would be automatically enrolled, but with a right to opt out. Third, employers would be obliged to contribute to this scheme if workers decided to stay in it. And fourth, taxpayers' money would have to buttress the basic state pension (BSP), the main—and not means-tested—benefit for pensioners.

The commission's proposals won a warm welcome in most quarters, including 10 Downing Street. Crucially, however, that consensus did not include the Treasury. Mr Brown made clear that he disagreed with the fourth proposal. Since 1980, the BSP has generally been uprated each year with prices rather than earnings. Lord Turner called for the earnings link to be restored from 2010. Since earnings rise faster than prices, this will gradually raise public spending on pensions compared with current policy.

On April 4th Mr Brown appeared to soften his opposition to Lord Turner's plans, saying that he and Mr Blair were “90-95% of the way there with Turner”. That was interpreted by some as a cave-in by the chancellor. Yet Mr Brown insisted again that the cost to the exchequer remained a stumbling-block, saying that he wanted “to avoid a tax consequence” from Lord Turner's recommendations. If that remains the case, the commission's proposals will not be fully implemented. Under current government policy, state spending on pensioners will fall from 6.2% of GDP in 2010 to 5.9% by 2020 (see second chart), as women's pensionable age rises to that of men. Under Lord Turner's proposal, however, spending rises from 6.2% of GDP to 6.3% over the same period.

The cost of the commission's plan can thus be represented as large or small. Compared with existing policy—the perspective adopted by Mr Brown—the proposal would cost an extra 0.4% of GDP in 2020. That's equivalent to £5 billion ($8.7 billion) in today's money, or nearly 2p on the basic rate of income tax. Compared with projected spending on pensioners in 2010, on the other hand, the additional cost would be just 0.1% of GDP: £1.5 billion in today's money or 0.5p on the basic rate of income tax.

Lord Turner insists that restoring the earnings link, despite its cost, is vital in order to arrest the spread of means-testing which discourages saving. Already, 40% of pensioners are eligible for the means-tested pension credit that Mr Brown introduced in 2003. Without a change in policy, the commission expects this to increase to around 75% of pensioners by 2050.

The central message from the commission this week was that its prescriptions ought to be treated as "an integrated package". Presenting a final follow-up report, Lord Turner spelled out why the earnings link should be restored: "If the state pension system is not reformed in a way which limits the spread of means testing, the success of the proposed new system of private pension saving will be undermined." In particular, it would no longer be clear to middling earners that they would be better off staying in the new savings scheme. This would add to costs by making financial advice necessary.

The government is due to make its formal response to the commission's proposals in two months. Mr Blair and the chancellor may have agreed a truce, but it is premature to conclude that Mr Brown has really come into line. The chancellor knows that money will be extraordinarily tight around 2010. The Turner reforms are not in the bag yet.