Why has Government policy to encourage saving failed?
by Dr. Ros Altmann
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Has it ever struck you as distinctly odd that, after seemingly endless consultations and Government intiatives to reform pensions and encourage savings, the savings ratio has hit an all-time low, borrowing levels are at record highs and a pensions crisis has developed? How could policies, designed particularly to encourage ‘moderate earners’ to contribute to pensions, have gone so badly wrong that they seem to have had the opposite effect to that supposedly intended?
Could there possibly be a more macchiavellian explanation? For example, is it possible that, while paying lip service to the desire to encourage middle income groups to contribute more to pensions, the Treasury is actually determined to ensure that only the top earners (who would save anyway) are really encouraged to do so.
If we hypothesise for a moment, the following scenario could be suggested. Let us assume that the Chancellor is determined to preside over a strong economy, and to go down in history as the Chancellor responsible for the strongest and longest period of sustained economic growth. In that case, the last thing he would want, would be for more people to suddenly start saving. Consumer spending is needed to keep the economy growing, but if people suddenly start saving, consumer demand will fall and economic growth would falter. The UK economy’s relatively strong performance in recent years has been supported by a housing boom and also, particularly more recently, by Government spending on job creation in the public sector. In fact, public sector employment has consistently been rising, even though the Treasury has announced on various occasions that the Government plans to cut huge numbers of public sector jobs.
Is this all part of the Treasury’s plan? Rising house prices have a positive wealth effect, increase consumer spending on housing related items and fuelling sharp rises in borrowing, all adding to short-term economic strength. The Treasury also seems unusually keen to prolong the property boom. For example, last year, almost immediately after the Bank of England Governor warned of the risk of falling property prices, the Treasury rushed to reassure investors that it did not see particular weakness on the horizon. Furthermore, of course, the latest pension reforms to be introduced from 5th April 2006 (‘A’-day), are likely to encourage even more investment in property, since residential housing will be allowed as an investment in personal pension plans which could previously not hold property – or could only invest in commercial real estate. Regardless of the numbers who will be putting residential property into their pensions, the expectation of increased demand is underpinning property prices and keeping prices higher than they would otherwise be.
If the Chancellor really does have a ‘growth at all costs’ agenda, aiming to keep the economy strong as long as he is Chancellor, then policy will continue to encourage unsustainably high consumer spending and borrowing and will continue to discourage saving among middle-income groups. This will carry on until someone else takes over the keys to Number 11 and Gordon Brown leaves the Treasury. However, the inevitable unwinding of accumulated debt will be painful for the economy in the longer term, but that would be someone else’s problem.
Of course, I would not seriously suggest that such a scenario is realistic, but it does seem really strange that the large number of pension reform initiatives which we are told were designed to help encourage middle income groups to save, do not seem to have worked for the ‘target group’, but have actually proved a very attractive proposition for higher rate taxpayers (the top 10% or so of taxpayers). For example, the introduction of stakeholder pensions. These were said to be designed to get average earners contributing more to pensions, but most stakeholder schemes are empty shells, and they have only really been good news for top income groups. Wealthy grandparents saving for their grandchildren and high earners providing tax sheltered saving for their non-working spouses. The 1% stakeholder charge price cap also led to a fall in charges across all pension products, which again allowed the higher earners who were the ones continuing to contribute to pensions to benefit from reduced costs. However, the existence of the price cap, coupled with increasing demands on advisers by the Financial Services Authority (FSA) regulatory regime (also introduced by this Government to restore confidence in long-term savings) has locked middle income investors out of the advice process, because advisers cannot afford to advise them within the 1% charge. This is particularly dangerous, because we know that most people are unable to manage financial decisions on their own. These issues are very complex and most people need someone to help them, but the new regime in recent years has meant that financial advisers are only really focussing on advising the top earners. This, of course, means that most people will be unlikely to save, because no-one is encouraging or helping them to do so. Pensions and savings products are ‘sold’, they are not really ‘bought’, but without an adviser people are less likely to invest.
In addition to the problems already discussed, there is also the issue of occupational pensions. Employer pension provision has been falling sharply, despite policies introduced to help increase coverage. Defined benefit, final salary schemes – the traditional type of UK employer pension – have been closing at a rapid rate and employers are struggling with large deficits. When moving to money purchase alternatives, employer contributions are being cut. In fact, employers are seriously questioning the rationale for providing pensions these days and many smaller and medium sized companies are not convinced that pension schemes are essential any more. As responsibility for pensions has passed from the Human Resources director, to the Finance director, companies have been questioning the value of pensions. Since many employees have lost interest in pensions and confidence has been undermined, employers are increasingly viewing pensions as a company ‘cost’, rather than a company ‘benefit’ and are considering whether to continue to offer pensions at all. Stakeholder pensions were the great new idea for getting workers to join an employer scheme. But, although all employers had to set up a stakeholder arrangement for their staff, they did not need to contribute to it and, indeed, the FSA regulations were assumed to mean that employers could not promote or encourage membership of the scheme either. If the Treasury did not actually want huge numbers of employees to start contributing, then the policy has worked extremely well.
The lack of advice is bad enough, the reduction in employer pension coverage is very worrying, but the most damaging of this Government’s policies for private pension coverage is the Pension Credit. If there is one policy that has been introduced that has caused major disincentives, to the very people who were supposed to be encouraged to save more in pensions, this is it. The Government said that the pension credit was designed to ‘reward saving’ and to ensure ‘it always pays to save’. However, in reality, this is simply not true. Pension Credit actually undermines pension saving for the majority of the population. It is fine for today’s pensioners, giving them much higher state pension payments and allowing them to keep some of the pension savings they made in the past. But these are not the people who need to be helped to save for the future. It is too late for today’s pensioners, but, in trying to alleviate poverty among today’s older people, the Government is ensuring that tomorrow’s pensioners are far less likely to put money into private pensions. In fact, no financial adviser – if these people did actually ever manage to find one to speak to – could safely advise most basic rate taxpayers to contribute to a personal pension. About 70% of future pensioners will be entitled to Pension Credit, which means that they would lose at least 40% of their pension income in the future when they retire. In fact, the way the policy works, those not entitled to full Basic State Pension (which is most women) will lose all the first part of their savings, pound for pound. For these people, even if there is an employer’s contribution, it still makes no sense to contribute, since they could lose their entire pension income on retirement. So this policy means that many of the Government’s ‘target group’ should not actually put money into a pension at all. If the pension credit had been introduced as a temporary measure, and given a life of, say, 5 or 10 years, then the disincentives for younger people would not be there, but the Treasury insisted that this policy was a long-term solution to pensioner poverty and that it would not be changed. This has, therefore, meant that pensions have become an ‘unsuitable’ product for huge numbers of potential investors. So much for encouraging pensions!
If the Government is really serious about getting more people to save, where are the new incentives? There have been plenty of policies to improve ‘supply’ – encouraging cheaper, simpler products – but where are the policies that will actually increase demand? The reforms so far, such as informed choice, stakeholder pensions, the ‘A-day’ simplification and increased regulation are all ‘supply side’ measures. But giving people cheaper, simpler products, decision trees and leaflets will not get them to save if they did not save before. If people do not want to save, or have lost confidence in the savings industry – because of market falls and constant scandals – they need encouraging and incentivising.
The only incentive for pensions is tax relief which is fine for high earners, but nowhere near enough for the other 90% of the population. Using tax relief as an incentive mechanism ensures that we give the highest level of incentive to those who need least. For every £3 a higher rate taxpayer puts into a pension, they receive an incentive payment of £2, but for every £3 anyone else contributes to a pension, they receive an incentive of only 85p. Most people do not understand tax relief anyway, it is unfair and opaque and, therefore, a very inefficient incentive. It is, however, extremely expensive and costs over £11billion each year. Is this the best use of taxpayers’ money? I believe we need much more powerful and effective incentives and proper access to advice, in order to really encourage people to start saving in pensions again. In particular, it is vital that pensions are encouraged in the workplace, to benefit from economies of scale, rather than trying to sell personal pensions one by one. But, so far, there have been no new incentives to encourage employers to contribute more to pensions (other than their own after A-day!)
The bottom line is that recent pension reforms will not achieve the goal of encouraging more people to contribute to pensions. However, if the aim is actually to ensure that only top earners keep contributing and that those who are not currently saving will continue to borrow and spend to keep the economy growing, then the policies put in place so far are likely to be very successful.