The Government needs to rev-erse its strategy on pensions by significantly raising the basic state pension and restoring the earnings link.
Old left rhetoric? Simplistic? Unworkable? Unaffordable? No, this is the conclusion of a major research project carried out over the last 18 months by the Institute for Public Policy Research in partnership with universities, pension providers and PricewaterhouseCoopers.
Since the 1997 election, Labour has devoted much time and effort to pensions and long-term care reform and the Government has characterised its reforms as a new contract for retirement – a settlement for the long term.
Yet retirement policy has not proved to be a source of political capital for Labour and has generated much industry criticism.
We have investigated whe-ther the Government's current settlement should continue to be pursued or whether a change of direction is necessary. We have firmly concluded the latter.
The pension environment has become more complicated since 1997. This complexity makes planning for retirement very difficult for individuals. It is also makes it more difficult for advisers and companies to give their customers the advice they need.
Means-tested retirement benefits cause other problems. First, many people miss out and live in poverty as a result. In addition, they cause severe incentive problems as private income causes loss of entitlement to benefits.
The new pension credit does not resolve these incentive problems. Instead, it spreads them out over a much bigger group of people.
According to Government statistics, in 2003, around half of all pensioners are expected to be eligible for means-tested support. By 2050, up to 70 per cent of pensioners will be means-tested. The pension credit will also bring additional complexity to the pension environment.
The state second pension will replace Serps and will give extra help to those on the lowest incomes. However, its long-term purpose is unclear. By 2050, anyone with income only from the basic state pension and the state second pension will retire at the age of 65 with an income which is already below the income support level.
Someone who works all their life and makes contributions to the state second pension will not have a nonmeans-tested income in retirement that will lift them above the poverty line.
We have examined a number of options and assessed which meet the objectives best. Our key objectives were to ensure that all pensioners have an adequate income in retirement to lift them clear of the poverty line.
We want people to be adequately rewarded and incentivised for saving for retirement and to ensure that tax and benefit regimes do not interact to undermine incentives. In addition, the policy settlement must be both fair and seen to be fair, ensuring good levels of public support. Crucially, the pension framework needs to be as clear and simple as possible so that people can understand their entitlements and plan for their future. Policy needs to be workable and it needs to be affordable.
The package of policies which best supports these objectives is to raise the basic state pension to the level of the Mig and index it in line with earnings.
This will help to end pensioner poverty and will reduce unpopular means-testing. It will dramatically simplify the environment and improve incentives to save.
Setting the basic state pension at £100 in 2003/04 prices will give all those with a full contribution record a non-means-tested income at around the “low-cost but acc-eptable” benchmark for the incomes of the elderly.
It will satisfy the objective of securing adequacy, albeit at a level of income few will regard as overly generous. With nearly everyone retiring in future with entitlement to a full basic state pension, we get round the problem of the inadequate take-up of benefits and provide a significant boost in income to the very poorest pensioners.
We would pay for these reforms by phasing out the state second pension and associated National Insurance reb-ates. Under our proposal, the basic state pension would be higher than the Government's planned level for the combined basic state pension and state second pension. The opportunity then arises to simply close the state second pension, which simplifies the pension system considerably and rem-oves the cost of rebates.
As discussed in this column two weeks ago, we should also increase the official retirement age to 67 by 2030. This means that (along with the abolition of rebates) the policy is affordable but also reflects the fact that people are living longer.
Our proposal scores highly in terms of improving the clarity and transparency of the overall pension settlement. The proposed new settlement would make it much easier for advisers and companies to give their clients advice.
In terms of the impact of the proposed reform package on incentives, the greater clarity and transparency of the system and the reduction in the prevalence of means-testing should give better incentives for people to save for their own retirement. This is particularly important for small savers, many of whom are making their provision through small company schemes.
The overall reform package favoured here also passes the affordability test, as we have tried to make the package broadly revenue neutral.
The overall costs to the Exchequer rise from 5 per cent today to around 6 per cent of GDP by 2050, which is the same as the projected costs of the Government's currently proposed settlement, including the pension credit. This is radical reform which is attractive, workable and affordable.
Richard Brooks is a researcher at the Institute for Public Policy Research