House of Commons - Work and Pensions

Select Committee on Work and Pensions Fourth Report

9 HOW MUCH WILL THIS COST AND WHERE WILL THE MONEY COME FROM?

Projected total state spending on pensioner benefits

316. The White Paper set out projected spending on pensions and on all pensioner benefits (which includes items such as housing benefit and council tax benefit) from 2008-09 through to 2050-51 under current policy, current policy with earnings indexation of the Pension Credit Guarantee, and under the White Paper proposals. The figures for spending on pensioner benefits as a share of national income are reproduced in Figure 2 (the White Paper also provides the costings in nominal terms, and in constant 2006-07 prices).

317. Figure 2 shows that, under current policy, spending on all pensioner benefits would decline from 6.3% of national income in 2008-09 to 5.2% of national income in 2050-51. Were the Pension Credit Guarantee to be indexed in line with average earnings - which would ensure that changes in the income of those lower-income pensioners receiving this benefit kept pace with those in paid-work - then state spending on all pensioner benefits would be projected to rise to 7.2% of national income by the middle of this century. Figure 2: Projected costs of UK State Pension reform

Source: data drawn from White Paper, Volume 2, p 128

318. Under the White Paper proposals, and assuming that the Basic State Pension is indexed in line with average earnings from April 2012, total spending on all pensioner benefits is forecast by the DWP to be higher than it would otherwise have been throughout the forecast period, reaching 7.8% of national income in 2050-51. This shows the extent to which, on average, the package represents an increase in generosity of state spending on pensioners relative to that implied by current policy. The reductions in state spending resulting from the proposed increase in the State Pension Age, and the changes to the indexation of the State Second Pension and the Pension Credit Savings Credit, are not sufficient to offset fully the increases in spending implied by the earnings indexation of the Basic State Pension and the reforms to the contributory system. The Committee welcomes the fact that the proposals set out in the White Paper would increase state support for pensioners relative to that implied by current policy.

319. To date the DWP has not published a breakdown of projected spending into each of its constituent parts. This would show the extent to which the proposals imply an increase (relative to current policy) in forecast spending on the Basic State Pension and the State Second Pension and a reduction in spending on means-tested elements such as the Pension Credit. The Committee recommends that the DWP publishes a breakdown of its spending projections into forecast spending on the Basic State Pension, the State Second Pension and means-tested elements such as the Pension Credit and Housing Benefit. These figures should be inclusive of additional spending on the State Second Pension arising from the abolition of contracted out rebates for Defined Contribution schemes and the savings from the planned increases in the State Pension Age. The Committee also recommends that the DWP publishes separate estimates of the impact of its proposed reforms on (a) spending on working age benefits such as incapacity benefits arising from the increase in the State Pension Age; (b) Income Tax and National Insurance receipts from the increase in both taxable benefits and the State Pension Age and (c) National Insurance receipts from the abolition of contracting out for Defined Contribution schemes.

The affordability question

320. One of the Government's five tests for pensions reform is affordability: "Any system needs to be affordable to taxpayers and the economy as a whole. As the nation ages there will be pressures to spend more on pensions, but also on related issues such as healthcare. The Government has an obligation to continue to manage public expenditure prudently and responsibly, and will not put the long term stability of public finances at risk."[412]

321. In his oral evidence the Secretary of State said:[413]

"We have got to find a way of providing for affordability between now and 2020, but I think largely the increase in the matching of State Pension Age between men and women does that, it broadly funds the reform package, but we have got to find a way of funding it beyond, and in a way that does not involve the suggestion that taxes would have to rise to do it."

322. The DWP projections suggest that state spending on pensioners would, under the White Paper proposals, remain roughly constant as a share of national income between 2008-09 and 2020-21. As a result - at least over this period - the DWP forecasts imply that additional resources from higher borrowing, higher taxes, or lower spending in other areas, will not need to be identified to finance the proposed reformed system.

323. Over the period beyond 2020-21 the DWP projections imply that state spending on pensioner benefits would increase and therefore additional resources from higher borrowing, higher taxation or lower spending elsewhere would need to be identified. In evidence to the committee, prior to the publication of the White Paper, Professor David Miles, Managing Director and Chief UK Economist at Morgan Stanley and visiting Professor of Financial Economics, Imperial College, University of London, said "My understanding of the current Treasury, or Government, projections of spending is that overall public spending around about 40% of GDP now is projected to go up to 42% or 43%. Therefore, the overall tax take of the public sector will continue to rise from where it is now."[414]

324. The Final Report of the Pensions Commission stated that, with respect to the costing of their proposals for 2050-51, "this is not significantly higher than the expenditure suggested by the Long-Term Public Expenditure projections presented by HM Treasury in the Pre-Budget Report of December 2005, which suggest that expenditure [on pensioner benefits] will rise to 7.6% of GDP by 2050, but this would still carry significant implications either for tax or National Insurance contribution rates, or for other categories of public expenditure".[415]

325. The Final Report added that "It is now for the Government to bring forward proposals which balance the needs of pensions policy against other claims on public expenditure and against concerns about overall taxation levels at different points in the coming decades".[416]

326. We note that DWP forecasts suggest that the White Paper proposals would pass the Government's affordability test over the period to 2020-21 and recommend that, in order to clarify the tax consequences of the proposals for the period beyond 2020-21, the Government publishes updated projections for total public spending as a share of national income that take into account the proposals set out in the White Paper.

Projected per pensioner spending on pensioner benefits

327. Over the period from mid-2004 to 2050 the number of individuals aged 65 or over is projected by the Government Actuary's Department to increase from 9.7 million (or 16% of the overall population) to 17.5 million (or 25.3% of the overall population).[417] Were the level of state spending per pensioner relative to income in society not to decline over this period then, as set out in the White Paper, state spending on pensioner benefits "would need to rise from its current level of 6.3% of GDP to around 9.7% of GDP by 2050".[418]

328. In evidence to the Committee Alison O'Connell, Director of the Pensions Policy Institute, defined an appropriate range for public spending on pensions as follows:[419]

"There are two extremes, really. One is that you keep the level of spending per pensioner constant and as the number of pensioners increases therefore that means a higher share of GDP; or you say, 'No, we're going to keep the share flat and we're going to raise the State Pension Age', in order to make sure that for a smaller number of pensioners they get the same spent on them, on average. The Pensions Commission proposal is essentially a middle way, so it raises State Pension Age a bit, to 67 or 68, and then it does not have to increase the share of GDP to what you would have to do in the absence of new changes to State Pension Age. From the numbers we have done on different scenarios and all the different definitions, and so on, I think we would say that the Pensions Commission got it about right. We would be looking at the higher end of their range rather than the lower end of the range, but I think general agreement would have it that somehow the percentage of GDP on pensions or pensioners has to go up in future".

329. The DWP projections suggest that total public spending on pensioner benefits would increase to 7.8% of GDP. While this is less than the 9.7% of GDP that would be required to keep the per pensioner generosity of state spending constant with an unchanged State Pension Age, the White Paper also proposes that by 2050-51 the State Pension Age be increased to 68 for both men and women. This would reduce the growth in the number of pensioners. As a result the White Paper argues that this will "sustain the generosity per pensioner of the State Pension", although actual figures verifying this have not yet been published.[420]

Contracted-out rebates

330. One possible source of additional revenue for the Government is from the abolition of contracted out rebates. Removing the contracted-out rebates would increase receipts of National Insurance contributions. It would also increase future state spending on the State Second Pension, since those brought back into the state scheme would accrue greater rights. The White Paper sets out both the increase in revenue, and the increase in state spending, as a result of abolishing contracting out for Defined Contribution pensions. This is shown in Table 5.

Table 5: State Second Pension and rebate savings due to the abolition of contracting out for Defined Contribution schemes, £ billion 2006-07 prices

	2012	2015	2020	2030	2040	2050
State Second Pension (£ billion)	+0.0	+0.0	+0.1	+1.3	+3.8	+5.4
Rebates (£ billion)	-4.0	-4.2	-4.3	-4.3	-4.3	-5.1

Source: Figure 3.viii of White Paper, Volume 2.

331. There were differing views over the appropriate use of the increase in Government revenues that would arise from the change. Howard Reed, director of research at the IPPR, and Alison O'Connell, Director of the Pensions Policy Institute, both argued in favour of an increase in state support for current pensioners.[421] In contrast other witnesses, such as Adrian Waddingham (Association of Consulting Actuaries), Deborah Cooper (Actuarial Profession) and Professor David Miles (Managing Director and Chief UK Economist at Morgan Stanley and visiting Professor of Financial Economics, Imperial College, University of London) argued that it did not really free up new resources because of the increased liability arising in the future and stated that the most appropriate use of the additional revenue would be to run down Government debt.[422]

332. In its report on The Future of UK Pensions the then House of Commons Work and Pensions Committee stated that "Abolition of the contracting-out NI rebates [for both Defined Contribution and Defined Benefit schemes] would provide an immediate increase in NI revenue of around £10 billion (1.0% of GDP). But this would be at a cost of a near equivalent increase in the state pension bill for future generations of pensioners who would otherwise have contracted out and so cannot really be regarded as a method of financing an increase in state pension rights. The case for and against contracting-out needs to be considered separately from options for financing an increase in state pension rights".[423]

333. It is clear that it is not possible to spend the same resources twice: increased tax revenues from the abolition of NI rebates cannot be used to both increase state pensions of today's pensioners and finance the implied increase in future rights to the state second pension. However, as pointed out by Alison O'Connell, Director of the Pensions Policy Institute, "in all the projections of future state pension cost it has been taken into account that S2P will be run down, or whatever is happening to S2P, but nowhere is the fact that there is this short-term change in the contracted-out rebates taken into account."[424]

334. As a result some of the increase in state spending on pensioner benefits that was presented in Figure 2 will be due to the abolition of contracting out for Defined Contribution pension arrangements. This part of the increase in state spending could be financed from using the increased receipts of NI contributions (as suggested by Professor David Miles).

335. Figure 2 suggests that state spending on pensioner benefits would increase by 1.5% of national income between 2008-09 and 2050-51. Of this increase £5.4 billion (in 2006-07 prices from Table 5) is directly due to the abolition of contracting out for Defined Contribution schemes. This is equivalent to just under 0.2% of national income in 2050-51, which suggests that the remainder - 1.3% of national income - would need to be financed from increased borrowing, increased taxation or cuts in spending elsewhere.

336. The Committee believes that the Government should be explicit about how it intends to use the increased revenue arising from the abolition of contracting out for Defined Contribution schemes. In particular, if the revenue is not being used to reduce Government debt in order to part-finance the resources needed to implement the White Paper proposals over the longer-term then the Government should explain why it has deemed this course of action to be appropriate.

Tax relief

337. The Pensions Commission's Second Report stated that "Pension tax relief is costly, poorly focussed and not well understood".[425] Much of the evidence received by the Committee supported this view, and argued that reform of tax relief would be desirable.[426]

338. The net cost of tax relief is estimated by the HM Revenue and Customs as being £12.3 billion per year, with a further £6.8 billion from employer relief on National Insurance Contributions.[427] The Pensions Commission also argued that "the calculation is complex and it is possible to argue that the figure is an overstatement since it fails to reflect fully the timing differences between tax relief given (on contributions) and tax imposed (on benefits). But it is clear that the cost is significant, as it must be since many people benefit."[428]

339. The evidence to the Committee suggested that there were two components of tax relief on pensions that could be better targeted: the tax-free lump sum and the relief given to individuals who are higher-rate taxpayers when they are making pension contributions and not higher-rate taxpayers when they receive their pension income.[429]

340. The Rt Hon Frank Field MP, Chairman of the Pensions Reform Group, argued: "I would also hope it would be something the Committee might consider in that if one looks at the tax concessions to pension savings, which overwhelmingly benefit the richest - we have something like 5% of the population gaining over half of all the tax revenue lost through tax concessions on pension savings - to allow all of that at the standard rate again would give us very substantial sums of money to play with."[430]

341. Philip Davis, Professor of Finance and Economics, Brunel Business School, said that in his view "I think the tax-free lump sum is an anomaly and I do not really think it is appropriate. In a sense, it is the Exchequer giving away money; it will otherwise get the tax back on the pension, instead it just gives it away. Furthermore, further to my earlier point, we are [not] annuitising the asset, so it is not being used for retirement income. I do not think, if we were inventing a pension system, we would invent a tax-free lump sum, at least not against the background of the argument that annuitisation is appropriate."[431]

342. The overwhelming consensus, and the view of the Pensions Commission, appeared to be that the resources currently allocated to tax-relief could be focussed better. Indeed, were additional resources required to finance the White Paper proposals (for example over the period beyond 2020-21) one possible source could be through reductions in the generosity of tax-relief for private pension saving.

343. We recommend that the Government responds to the Pensions Commission view that "pensions tax relief is costly, poorly focussed and not well understood", highlights whether it believes the relief could be targeted better, and whether some of the resources devoted to tax relief might be used to finance the increases in state spending on pensioner benefits.

412 Ev 370 Back

413 Q 358 Back

414 Q 5 Back

415 Pensions Commission, Final Report, April 2006, p 15 Back

416 Pensions Commission, Final Report, April 2006, p 16 Back

417 Ev 369, para 30 Back

418 White Paper, Annex D, para D.31 Back

419 Q 5 Back

420 White Paper, para 3.35 Back

421 Q 139 [Howard Reed] and Q 30 [Alison O'Connell] Back

422 Q 184 [Adrian Waddingham and Deborah Cooper] and Q 31 [Professor Miles] Back

423 Work and Pensions Committee, Third Report of Session 2002-03, The Future of UK Pensions, HC 92, para 156 Back