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A striking problem

Soaring public sector pension costs will eventually stretch political consensus to breaking point says Stewart Ritchie

Public sector pensions are becoming a big issue in the nation’s consciousness. This is because, apart from employee contributions, they are paid for out of taxation and have changed very little while private sector final salary provision has shrunk dramatically.

I see three distinct aspects to this – the context, numbers and politics. Starting with the context: public sector jobs are often vital to the effective running of society, which includes the private sector. Where would we be without nurses, firemen, teachers, policemen and so on? Also we cannot look at public sector pensions in isolation from other aspects of public sector employment, such as salary, perks and job security. Public sector workers typically regard a good pension and job security as compensation for lower pay and perks than many private sector workers enjoy.

The problem is that in recent years the value of the pension element of a typical public sector package has gone up, because of the recognition of increased longevity, while that of an average private sector worker has gone down because of the move from defined benefit to defined contribution. So if there was some kind of equilibrium at the beginning of this decade, it has now gone.

On the numbers, there are a couple of useful official publications. “Long term public finance report : an analysis of fiscal sustainability” was published alongside the 2008 Budget in March. Table 4.1 gives spending projections, as a percentage of Gross Domestic Product (GDP), for the next 50 years. It shows public sector pensions rising from 1.5 percent of GDP in 2007-08 to 2.0 percent of GDP in 2027-28, and falling back to 1.8 percent of GDP in 2057-58. These numbers sound relatively manageable, but remember that 2.0 percent is a one third increase over 1.5 percent. Also, if the economy slows, these percentages of GDP will almost certainly rise, because the pension outgo does not move in sympathy with the nation’s wealth creation.

The other very helpful official document is “Scrutiny Unit Briefing Note – Public Sector Pensions”, published by Parliament in May 2007. This is a mine of useful information, giving facts and figures for all the main public sector schemes, both funded and unfunded. For example, “The [pension scheme] costs do not form part of departmental budgets determined in the three-year Spending Reviews, so there is no DEL (Departmental Expenditure Limit)”. This sounds like “our pensions cost what they cost, so there is no point in worrying about it”. To be fair, it remains to be seen what effect the cost caps negotiated by Alan Johnson will have.

The same document also restates the Treasury’s position as “Following international best practice, the Government uses the same accounting standards to calculate the public sector pensions liability as private sector pension funds. However, what matters is the annual cash requirement to pay pension benefits, which remain fully affordable”. This is a very comforting statement, drafted by civil servants with a public sector pension, and signed off by government ministers with, er, a public sector pension… which brings us on to the political aspect.

I started thinking about this in terms of national politics. The twenty-something per cent of the workforce who are in the public sector would be highly motivated to vote to protect their pensions. But, I thought, there must come a tipping point where the private sector voters get so concerned about the tax implications of public sector pensions that they outweigh the public sector voters. However, it was pointed out to me that this only works if one of the political parties offers public sector pension reform as a policy. It would be a brave politician who would countenance waves of national strikes by nurses, teachers, prison offciers and so on, not to mention the grief he or she might receive from fellow MPs worried about their own pensions.

Perhaps, therefore, if there is to be a strike over public sector pensions, it will come from exactly the opposite direction. Imagine Council Tax bills rising sharply to pay for local public sector pensions. Now imagine the reaction of less well-off Council Tax payers, such as private sector pensioners. Remember the Poll Tax riots from the Thatcher years? People can get very upset when they think their local taxation is fundamentally unfair.

Perhaps the smart political policy would be to legislate for the cost of public sector pensions to be shown explicitly in the Council Tax breakdown, and let democracy take its course.

Stewart Ritchie
Director (pensions Development), at Aegon

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