Public sector pensions aristocracy
by Dr. Ros Altmann
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Pensions have been in trouble for years. Over 80% of employers have closed their final salary pension schemes, replacing them with much less generous alternative arrangements. The credit crisis has now caused more damage to most people’s pensions. Meanwhile, public sector workers are unaffected. Their pensions are becoming increasingly more generous than private sector pensions. Retirement at 60, unlimited inflation-linking, a taxpayer 100% guarantee are hugely valuable benefits. In fact, latest estimates show that contributions to private sector pensions are now lower than the costs of paying public sector pensions.
It is not for me to judge whether this is right, but I am concerned that the Treasury is not accounting for public pensions properly. The Treasury simply says that the year by year costs are ‘fully affordable’ without proper budgeting! As many public sector schemes are either totally unfunded, or only partially funded, this lack of transparency is unacceptable.
In particular, public sector pension liabilities are inescapable. They cannot legally be changed. In fact, the Government could cut the Basic State Pension tomorrow, but cannot reduce accrued pensions of the public workforce.
The original justification for better pensions was that public employees earned less than private sector workers, in return for better pensions on retirement. This rationale no longer applies. Official statistics show median public sector weekly pay is now around £500 compared with £440 in the private sector.
Another worrying fact is that, apart from earning more, and having more generous pensions, public employees also pay less National Insurance (NI) than private sector workers without final salary pension schemes.
State NI pensions have two parts – a Basic State Pension (BSP) and State Second Pension (S2P). Both of these depend on people’s NI contributions, but workers can ‘contract out’ of the second element of the state pension (S2P). Anyone contracted out, pays only 9.4% NI, instead of the normal 11% of salary and their employers only pay 9.1% national insurance, rather than the usual 12.8% of salary – a total saving of over 5% of salary each week. These lower NI contributions are supposed to go into an approved pension scheme that will replace S2P payments on retirement, thus saving state pension costs for future taxpayers.
Paying lower NI now to save money on future S2P payments sounds reasonable. However, for workers in unfunded public sector pension schemes, this is nonsense. There is no fund building up, so future taxpayers will still have to pay, as public pension schemes replace S2P anyway.
Therefore, public sector workers and employers are just paying lower NI contributions today via a hidden subsidy. In effect, they are not paying for their S2P at all, but the complexity of our system means they do not actually realise this. Public employees probably think only paying 9.4% NI instead of the normal 11% each week, is all they need to pay. Until everyone recognizes what is actually happening, we cannot properly assess how to finance the costs.
Public sector employees do marvellous work for the nation and without them our country could not function. Public sector unions have done an excellent job in improving their members’ remuneration. I am not judging whether this is right or wrong. But I do believe the Government must be honest about the true costs and properly account for them.
What can be done? Transparency is an essential first step. At the moment, the Government hides the costs and is leaving everything to future politicians and taxpayers to deal with. Unlike the state pension, the law does not permit any changes to public sector pensions already accrued, yet the Treasury is not budgeting for them.
We need an urgent independent inquiry to establish the real facts about public sector pay and pension costs relative to the private sector. The Pensions Commission was specifically told not to consider public sector pensions in its remit. That was a disappointing omission.
If the independent inquiry determines that the burdens on future taxpayers will be intolerable, there are a few options, including radical changes to future pension benefits, much higher contributions from workers to better reflect the value of their pensions or reduced public sector employment. These would not be popular and no politician wants to deal with the issue, which is why an independent assessment on behalf of future taxpayers is essential.
At the very least, I think we should immediately end the nonsense of allowing workers in unfunded public sector schemes to contract out of S2P and pay lower NI. In fact, ending contracting out altogether would raise many billions each year in extra NI contributions to help reduce public debt. The Government could also be encouraged to issue more long-dated inflation-linked gilts to help fund the costs. Real yields are so low that this seems an excellent time to issue such paper and would help private pension schemes to improve their funding position too.
Public pension costs will not disappear, they are real and must be accounted for. The sooner we face up to this, the better.