UK Politics

Time to break promises to pensioners?

older couple in Italy Image copyright Thinkstock

Has the time come for the government to break pledges made to pensioners, asks Paul Johnson, the director of the Institute of Fiscal Studies.

What should government do when things turn out to be rather different from what was expected? That's often a question politicians have to deal with when things go wrong. But what about when things go too well?

That might seem like an odd question, but when things go well for one group of people it can often be at the expense of another group. In part, at least, that is what has happened for the so-called baby boom generation - those born between the mid-1940s and mid-1960s.

The fact that they have much improved life expectancy, and much higher levels of income and wealth than any generation before them is a fantastic achievement. Those reaching retirement now are better off than any other age group. This is a historic first.

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Image caption Pension warning: Danger, more changes ahead

The worry is that the generations coming up behind them may end up rather less well off.

Earnings are stagnating. Home ownership rates have collapsed for younger generations over the past 20 years. And the generous occupational pensions enjoyed by many baby boomers are simply unavailable to younger people unless they are lucky enough to work in the public sector.

At age 30, those born in the early 1980s have only half the wealth of those born a decade earlier at the same age.

Part of the problem is that the older generation has been lucky at the expense of the younger generation. They have enjoyed enormous increases in the value of their homes, and a remarkable number have been able to buy second homes while younger people can't afford to buy.

On top of this, many older people enjoy generous occupational pensions that guarantee them a fixed income in retirement no matter how long they live.

Most younger people are unable to access these "defined benefit" schemes. Instead most pay into a "defined contribution" saving scheme, creating a pension pot that may have to be stretched thin to see them through their retirement.

The generous occupational pensions enjoyed by older people are in significant part being paid for by younger people who will never benefit from them. Yes those benefiting made some contributions but, as it has turned out, they were nothing like enough to pay for the promised benefits. Someone has to make up the difference.

In addition, while a decade of interest rates close to zero has kept up the value of assets - owned by and large by the old - it has made it almost impossible for the young to accumulate substantial savings of their own.

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Image caption Home ownership is a distant dream for many young people

This concentration of wealth in one lucky generation, and more specifically among the better off part of that lucky generation, will have profound consequences for generations to come.

The wealth won't disappear, it will be passed on to their children and grandchildren. Increasingly people's economic wellbeing, especially in retirement, will be determined more than at any time for 100 years by the wealth of their parents.

If you were born in the 1980s and want a comfortable retirement, to own an expensive house, to have financial security, you had better make sure you were born to wealthy parents.

Here lies the dilemma. Where we are has created a clear inequity.

But 60- and 70-year-olds with valuable houses and generous pensions have them as of right. They have done the right things. They may have been lucky, but they have been made promises, they have entirely legitimate expectations that those promises will be honoured.

To break them is surely inconceivable?

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Image caption Will the baby boom generation be content to give up some wealth?

Well, even ignoring the consequences of not breaking them, it's worth asking what these promises actually mean. Nothing is forever in public policy.

We generally think it is reasonable for governments to change rates of income tax and VAT even if we have made our choices on the assumption they will stay much the same. State pension ages are rising, and nobody seriously thinks you can increase them only with 50 years' notice to ensure nobody currently working will be affected.

Governments can and do and must change policy from time to time in ways that disadvantage some people. Yet there seems to be a presumption that anything that affects pension rights or house values would involve unreasonable "retrospection".

In fact there is nothing different in kind in making changes that affect these things as opposed to anything else. Indeed we have been here already.

I and millions of others who have spent some time in the public sector have seen our occupational pension rights cut entirely retrospectively as a result of a change in the basis of uprating from the Retail Price Index to the - more accurate but lower - Consumer Price Index.

Similar changes to private sector occupational schemes should at least be on the table. As should small additions to taxes on such pensions in payment. As should other flexibilities for occupational pension schemes. As should changes to the taxation of housing.

As with anything else in public policy, there are tough trade-offs to make. And any changes need to be gradual and manageable for those affected.

But we just can't assume that there is one group and one set of rights that must never be touched, while all others are up for grabs.

The costs of that presumption are too high.

Radio 4 Analysis: Breaking Promises is available now on the BBC iPlayer.

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