Select Committee on Work and Pensions Minutes of Evidence

Examination of Witnesses (Questions 82 - 99)




  82. Ladies and Gentlemen, may I open this morning's formal evidence session and welcome Andrew Dilnot and Tom Clark from the Institute of Fiscal Studies. Andrew is a valued colleague who has helped us enormously with our inquiries in the past. We are studying the Government's proposals for the State Pension Credit. The IFS have submitted a very useful and thought-provoking piece of written evidence for which we are grateful. You are a seasoned campaigner in this game; I do not need to tell you what we are looking for from you this morning. We have a series of questions, which we should like to run through, but perhaps you would just set the scene a little and introduce the work you have been doing and in particular what Tom Clark has been doing. Most people have given a qualified welcome to what the Government is doing. What we are really interested in at the beginning is what the upsides are and, what the downsides are, as you see them, as briefly as is possible in an issue as technical as this.

  (Mr Dilnot) Thank you very much. It is lovely to be here again. Tom Clark, a Senior Research Economist at IFS, is with me and he has done an enormous bulk of the work in the paper we have submitted on the Pension Credit. The Government introduced the Pension Credit and needed to introduce something like it because of the very significant increase in what has become the Minimum Income Guarantee (MIG)—for the sake of clarity let us call it the Income Support line for pensioners. The single most progressive, in terms of income distribution, change that the Government introduced in the last Parliament was the very, very large increase in the Income Support level for people over retirement age. The consequence of that was that the gap between the Basic State Pension and means-tested benefits grew very significantly from £6 or £7 a week to more than £20. That meant that the problem, which had always existed in a system that combined both universal and means-tested benefits, of the consequences of such a regime for people's private saving became much more severe and was likely to become more severe still as the Government had committed itself in the short term pretty strongly to increasing the Income Support line, whatever it is now called, in line with earnings. Whereas the Basic State Pension went up in line with prices, meaning that the gap between the means-tested benefit and the flat rate benefit would continue to grow. What are these problems? Really two. The first is a problem of fairness, that the Government and others are concerned that if you have two pensioners, one of whom has managed through painful thrift to acquire a small amount of savings and therefore has a small private income and another who, despite having had the same circumstances chose not to, in the regime with much more generous means-tested benefits and 100 per cent taper there is no difference in their final income in retirement and that just seems unfair to the Government and many others. The second concern was more an efficiency concern that if we have a regime like this where the means-tested component is growing and growing very rapidly, then the incentive for people who are only going to be able to achieve a small amount of saving may be taken away and that does not seem desirable either. The Government has announced a reform, it has had many names, the components of it I fear, I confess, I even give the wrong name to from time to time. The best way of characterising it is that we have seen a big increase in the Income Support level and we are now seeing a reduction in the Income Support taper for pensioners, from 100 per cent to 40 per cent. Instead of being a world where the means-tested benefit has a 100 per cent withdrawal rate, we are moving to one where it has a 40 per cent withdrawal rate. There are some associated complications and changes to the capital rules. Adjustments to the means-tested benefit make sure that people benefit in full, even if they are on Housing Benefit and Council Tax Benefit but essentially we are increasing the generosity and reducing the taper. The consequence of that is spending quite a lot of money; it is roughly twice as expensive as Tom's initial estimates because the initial estimates he produced last year were based on the assumption that the Government would not be really, really generous and make sure people on housing and Council Tax Benefit gained in full. The Government is now doing that and the consequence of that is a cost of about £2 billion. The consequence of that is increases in income; increases in income for those on lower incomes, which are much higher than increases in income for those higher up. It is the case that this will be fairer in the sense that people with a certain amount of private income will now keep more of that private income than would otherwise have been the case. It is not absolutely clear what the impact on the savings behaviour will be, partly because by being more generous we are spreading means testing further up the income distribution, so although on average we are reducing withdrawal rates, we are introducing higher withdrawal rates for a smallish group further up the income distribution. Also, because by offering people a higher income if they save a certain amount we may lead to a world where people say they do not need to save quite so much, they are being guaranteed a certain amount of income from the state, we cannot be sure what the impact upon savings will be. We are going to see a growth in the number of people entitled to means-tested benefits and in the end it means the question of compulsion in pension saving will rear its head because otherwise governments will face the concern that people will simply choose not to save as much as they otherwise would.

  83. That is very useful. I was struck by the fact that your submission was one of the few that really majored on the effect on women because of the 60 to 64 age gap. Could you just say a little about your view on that, what you think the Government's rationale is and just how serious a problem that might be for women in that age group?
  (Mr Clark) Looking at the long-term projections the Government published, it says in there that there is this age 60 Minimum Income Guarantee from now but it will be raised to 65 for both men and women in 2020 to match the increase in the retirement age.

  84. Is it 2020?
  (Mr Clark) I do not know whether it is published Government policy but in the work officials did on estimating the long-run costs they have made that assumption. (Which might be indicative of what is planned for the long term.) One clear reason to restrict it to people of 65 and over is that if you have a long-term means test—a once-every-five-years type of means test—and you try to assess pensioners as soon as they get to 60 for that and leave their income fixed, then there is a danger that people might reduce their income by leaving the labour market at the age of 60. A lot of people at that age might still have labour market connections. For example we could think of supply teachers who could retire at 60 then leave their formal job and go back on a supply basis with a much higher income after using the interim period, in effect, to give themselves five years' of fixed Pension Credit entitlement. If you really want a simple and once-every-five-years means test it seems to me that you have to try to focus that on people who are well above the age where they are likely to have strong attachments still to the labour market and that seems a strong argument for doing it at 65 rather than 60.

  85. But women would be the principal group who would be caught because they did not have the National Insurance contributions or whatever. Explain to me why you think it is a particular problem for women.
  (Mr Clark) It is more of an issue for women in the sense that the state retirement age is 60 for women at the moment so more women will leave work at 60 and therefore will not be working. At the moment, if there were no need to treat men and women differently, it might be that people would want to introduce this thing and say let us have it at one age for men and one age for women until we have equalised the retirement age. There is European legislation which means that might be a problem, so you have to pick one age and, for the reasons I mentioned, maybe 65 looks a better one so that you do not get people artificially reducing their income.

Ms Buck

  86. A lot of questioning is going to focus on the savings incentives but obviously the objective for the Pension Credit is to tackle pensioner poverty as well as promote the saving incentives. The National Pensioners Convention were quite critical of that objective, how realistic it would be for the Pension Credit to tackle pensioner poverty, in fact they explicitly said that it is "not the sole or even the main aim" of the Pension Credit. Your memorandum seems to imply that it would have the effect of roughly halving the number of pensioners living below the unofficial poverty line. So can you explain why you think the National Pensioners Convention has got it wrong and just talk us through your analysis of how the Pension Credit is going to contribute to tackling the pensioner poverty side of the dual aim?
  (Mr Clark) In order to tackle pensioner poverty, where poverty is defined as having an income below a particular line, you need to increase the incomes of people below that line. If the Pension Credit does what it is really intended to do, then a lot of people with low incomes are going to see their incomes increase, so some of them would be moved over the line, and poverty as measured by the semi-official line will be reduced. The estimates we produce in here assume that the system works as it should and everyone who is entitled to this benefit is going to claim it. That is quite a strong assumption. We know that around one quarter or perhaps slightly more, I forget the numbers, of pensioners who are entitled to some income support at the moment do not claim it. If that persists into the future, then the effect on pensioner poverty is going to be commensurately smaller. The Government has come up with a few suggestions about how it might simplify the means test. I have already mentioned a move to a once-every-five-years test rather than a weekly test and that might perhaps encourage more people to apply. It might also be the case that if we move from a world in which it is only the poorest third of pensioners who are on means-tested benefits to one in which more than half the pensioners are on means-tested benefits, then the old idea that stigma deters people from applying for those benefits might cease to be applicable. It will no longer be seen as something which marks you out as an impoverished case. These are really big, open questions and it is very hard to come up with robust evidence one way or the other.

  87. The robust evidence you have produced in your own memorandum is that the distributional effect will be heavily skewed towards the poorest pensioners. Is that right?
  (Mr Clark) Yes, that is right, assuming that —

  88. Yes, based on assumptions. I understand that. Have you done your own analysis? Just comment briefly on this non-take-up question in terms of who you believe are the people who were not making the claim. That clearly is central to this whole point and to the point about Pension Credit. Is it the poorest pensioners who are not claiming because of ignorance? Is it people who would only benefit by a very small amount who are not claiming because the means- test process is not worth the candle? Who do you think is not claiming and therefore who do you think would be most at risk possibly of not taking up the Pension Credit?
  (Mr Dilnot) We have not done anything very recently on this. Work we, and others, have done in the past suggests that not taking up is related to a range of things, for example age. The older you are the less likely you seem to be to take up. In the case of pensioners that is strongly related to widowhood and gender; very elderly women are particularly unlikely to take up. It is also related to the size of entitlement. The smaller your entitlement is, the less likely you are to take up and therefore the more complex the system is, the more benefits there are trying to deliver a given level of benefit, the less likely you are to take up. One of the key issues here is, therefore, the structure of the means test and the idea of initiating a means test when people get to the age of 65 and then doing it once for a five-year period. This means that at least once people are in the system it will not be a matter of re-applying and complexity every year and that should help. The fact that it should be occurring to everybody at the time that they hit 65 should help as well; the particular way in which Government manages to initiate claims from people will matter a great deal there. One would hope that once people get into the system, they should not fall out. There may be an issue that people may become entitled as they go through retirement. You could imagine a world where somebody retired on what seemed like quite an adequate pension, certainly a private income which was enough to take them beyond the Pension Credit regime were they to live for 20 years in retirement, and their private retirement income were, say, only price indexed, while the Pension Credit thresholds were earnings indexed, and over 20 years that could significantly increase that level. So finding structures to capture people who become newly entitled during their retirement will be very important.

  89. If you had a message to give the DWP about how to reach the poorest pensioners and make sure that this works for pensioners, what would it be?
  (Mr Dilnot) The very poorest pensioners are currently Income Support recipients and the take-up amongst the very poorest pensioners does seem to be quite high. The key thing is to try to move the initiative for initiating claims as much as possible to the Department, which knows who old people are and, by and large, ought to know where they live and avoid getting into a situation where particularly poor or very elderly pensioners are trying to have to work something out for themselves. Having a programme of five-yearly assessments makes it far more plausible for the Department to have the resources to do that reasonably accurately.

  90. This Pension Credit has a dual aim but just concentrating on the pensioner poverty, if you had to devise an approach which would help tackle pensioner poverty, is this a reasonable way to do it?
  (Mr Dilnot) You have to see the Pension Credit in the context of what used to be called Income Support, which is now called Minimum Income Guarantee, that is going to be rolled up into the Pension Credit. A strategy which says we want to help the very poorest pensioners by increasing the basic means-tested benefit line, where the Government has now done a great deal, is certainly the most effective way of increasing the incomes of those on low incomes. One of the consequences of that is you do then have some equity and efficiency problems associated with the scale of that means testing. I certainly think if we are going to have means testing, which delivers an income that is much higher than the flat rate Basic State Pension, then a 100 per cent withdrawal rate looks quite difficult to sustain. A corollary of a big increase in the means-tested benefit level is thinking very hard about reducing the taper, whether 40 per cent is the right taper or not. If it were 50 per cent then you could be more generous or it could be cheaper. If it were 30 per cent you would be less generous and it would be less generous at the bottom but take it further up the income distribution. One cannot say with certainty what the right rate is but, as a general strategy, it seems to be coherent if the way forward is to go down the means-testing route.

Mr Mitchell

  91. I should know the answer to this but I do not. Perhaps you can just help me. If I understand correctly the number of people who are going to be part of the means-testing regime was, in about 1979, getting towards 60 per cent—55-57 per cent. It then went down to about 38 per cent by 1997 and it is now heading up towards 57 per cent again. Can you just remind us what the figures are?
  (Mr Dilnot) Is this amongst the post-retirement age population?

  92. Yes.
  (Mr Dilnot) I do not have that.
  (Mr Clark) What I have here are the numbers who are entitled rather than the actual numbers.

  93. I just very quickly want to get a feel for the scale.
  (Mr Clark) The reform, which is due to come in in 2003, increases the number of people aged 65 or over in families who are on Income Support or its successors from about 32 per cent to 52 per cent and the total number on any means-tested benefit or entitled to any means-tested benefit, that is Council Tax Benefit and Housing Benefit as well, increases from 53 per cent up to 61 per cent as a result of this reform.

Mr Dismore

  94. Is that both MIG and Pension Credit as it is now? At the moment roughly three million pensioners are on MIG or entitled to MIG. Afterwards it will be five million entitled to MIG or five million roughly entitled to MIG, plus Pension Credit.
  (Mr Clark) That sounds very roughly right. This is just people aged 65 or over, rather than people aged 60 or over, because I was just trying to get at the effect of this reform.
  (Mr Dilnot) MIG and Pension Credit is five million.

  95. So in rough terms around five million.
  (Mr Clark) It comes out at 52 per cent of the 8.5 million population aged 65 or over, so it is around 4.3 million people in this age range.

Mr Stewart

  96. May I touch on incentives to save? Figures you produced in your memorandum for the effect of the Pension Credit seem to show that there will be a very positive effect on individuals' effective marginal tax rates, by which I mean how much an extra pound of pension/savings income is lost through loss of means-tested benefit. Do you agree with the Department that in future it will always pay to save for retirement?
  (Mr Dilnot) We need to be very careful here. The Department necessarily wants to make the point that if you have saved you will have a higher income as a result of it and that is true, that is the consequence of having a lower taper rate. It definitely is the case that if you have saved you will have a higher income than you would have done, if you had not saved. That is not always true at the moment because the 100 per cent taper can mean you do not have a higher income than you would have done if you had not saved. It is true that overall the impact on marginal deduction rates seems to be that they fall and certainly people facing 100 per cent marginal deduction rates fall very dramatically. Two more points need to be made. The first is that a range of people who are not at the moment entitled to any means-tested benefit, as a result of the introduction of the Pension Credit which spreads means-testing further up the pensioners' distribution, become entitled to a means-tested benefit and that number may well grow in the future if the MIG is earnings indexed, so will take it even further up the income distribution. The consequence of that is that better and better off pensioners will find themselves in the position where if they reduce their saving by one pound the reduction in their future income will be lower than would be the case under the current regime. Particularly amongst the potentially better off pensioners we are actually reducing the incentive to save in that way. So that might be particularly important in terms of the overall aggregate level of saving that pensioners do, because they are likely to do more saving than those lower down. We cannot unambiguously say what the overall impact on the incentive to save will be, while we can unambiguously say that pensioners who do save will in future be better off than they would have been if they had not saved, which is something you cannot say now.
  (Mr Clark) The only thing I would add is that when I first looked at this, before we knew what the Government were going to do to Council Tax Benefit and Housing Benefit, we had an awful lot of pensioners who ended up being on a 91 per cent effective marginal rate because they were in receipt of all three means-tested benefits at once. By the increases they have announced in Housing Benefit and Council Tax Benefit, for the moment, they have largely got rid of that group: very few people are going to end up being on all three benefits at once. The immediate impact on marginal effective rates, the money people actually get from the saving they have done, is broadly speaking positive, although looking forward into the longer term that is much less obviously the case because we expect the number of pensioners who are entitled to means-tested benefit overall to grow in the long run quite rapidly because of this reform and people who are brought into the system are going to face disincentives to save that they would not otherwise have faced.
  (Mr Dilnot) This is just another reminder of the inevitable trade-off. The Government saw that had it not done what it has done over Housing Benefit and Council Tax Benefit, there would have been some very high marginal tax rates. What it has therefore done is spend more money. Spending more money means raising some tax elsewhere, which necessarily means some increase in marginal tax rates, although very slightly elsewhere, but also spreading lower but still much higher than now marginal tax rates further up the income distribution. There is no free lunch here.

  97. There is a displacement effect somewhere down in the system.
  (Mr Dilnot) Yes.

  98. Are there any other exceptions, for example those without a full Basic State Pension?
  (Mr Dilnot) Yes.
  (Mr Clark) It is possible that someone who for one reason or another had only got a total income before means-tested benefits of £50 a week would, both before and after this reform, have an effective marginal rate of 100 per cent because the reduction in the withdrawal rate is only on the income you have over and above the full Basic State Pension.
  (Mr Dilnot) So under the current regime our estimate was that 32 per cent of the population faced 100 per cent marginal tax rates and that falls to 5.6 per cent. So there are still some but very few. Our sense is that that is a number which should decline as the proportion of the retired population, which is not entitled to a full Basic State Pension or the equivalent of it one way and another through State Pension, through SERPS, through partner's entitlement, is declining very rapidly. That should not be a problem in the long term.

  99. Would it be simplistic then to conclude that the Pension Credit will encourage-longer-term savings or are other factors involved here?
  (Mr Dilnot) We cannot say it will encourage any particular form of saving. We can say that it will reward saving much more than the current regime does, people who would under the old regime have faced 100 per cent marginal tax rates will by and large now face some increased incentive to save. That is particularly the case if they are not saving at all at the moment. The one group we can unambiguously say faces an increased incentive to save is people who at the moment, or under the current regime, would not choose to save at all. They are unambiguously encouraged to save. It is not obvious what people who under the current regime would have chosen to save a bit, let us say somebody who was on one of the Housing Benefit tapers, so faced a taper which was not 100 per cent, will do. They might face a reduced taper as a result of some of this but they will also face a higher guaranteed income and that might lead to their deciding to save less. It is hard to see how people who at the moment are not entitled to any means-tested benefit and now become entitled to a means-tested benefit and face a higher marginal tax rate have an incentive to do anything other than save less. It is not easy unambiguously to assert what will happen to savings as a result of this but it is relatively easy unambiguously to say that people will keep a larger proportion of any savings. If the "fairness thing" is the problem, I think the Government is on a very strong wicket. If the Government wanted to assert that this is a way of significantly increasing the incentive to save, then it is on a much more difficult wicket. I do not think one can say that.

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