The Chancellor’s surprise Commons announcement of radical policy reform doesn’t come without serious risks, writes John McTernan
WHAT do you get when you cross a sociologist with a member of the Mafia? An offer you can’t understand. That is what Wednesday’s Budget was. The first two-thirds was standard stuff. Boasting about the strength of the recovery. A few well-trailed giveaways and then … the rabbit pulled from the hat.
Except it wasn’t a rabbit. It was pensions policy – the modern day Schleswig-Holstein question, which Lord Palmerston said was “so complicated, only three men in Europe have ever understood it. One was Prince Albert, who is dead. The second was a German professor who became mad. I am the third and I have forgotten all about it.” And there were blank faces all round the Commons as Osborne ploughed on and on with detail that only one or two MPs understood and none of the lobby journalists did.
This wasn’t just a presentational disaster, it was an appalling betrayal of the Commons and the country. What George Osborne did yesterday was to tear up British pensions policy. In one move he has probably destroyed the pensions industry – he has certainly done for the annuity industry.
Now, hold on, don’t turn away because I mentioned pensions. I know it always seems complicated but it is in essence simple.
The pensions challenge for us as individuals is this. When the welfare state was created in the 1940s the average worker worked from 15-16 until 65-70 and died by their mid-70s. So a pension – at most – had to support ten years of retirement, and it was financed by 50 years of savings. Now, we start work full-time in our 20s and retire in our 60s but we expect to live until we are in our 80s. So in 40 years of work we have to save enough to live on for another twenty.
Our greater life expectancy is the single greatest glory of the last century – but the savings seem daunting. The clue is to save hard and save early and let compound interest do its magic. We have generous tax breaks to save into pensions and the deal is that those savings aren’t raided during our life and we use them to buy a pension income in retirement. Interference in our lives and how we spend our own money? For sure. But the aim is a private and a public good – pensioners with enough income to live long and independent lives. And to avoid dependency on means tested benefits.
So far so consensual. And that’s a key word. Decisions today on pensions policy affect people for the next 20, 40, 60 years. Future governments have to commit to them because workers are making long-term decisions and cannot afford to have the framework chop and change.
The striking fact about yesterday’s changes are that they were not consulted on in advance. They were bounced on the opposition, the industry and the public with no warning. I understand from Treasury sources that this was a decision made by the Chancellor, not by the Pensions Minister.
The risks are all too obvious. Behaviour will change. People who no longer have to buy an annuity will not do so but will then be left with a pile of cash. What to do with it? Spend it? Invest it? There are many new risky choices. But the biggest of all can be summed up in one fact: when we retire our life expectancy continues to grow. For every day we live after 65 it increases by six and a half hours. That’s right – an extra two- and-a-half years every decade.
The glory of an annuity is it pays you an income for every year you live – no matter how long. The problem with cash is that it runs out. Already the respected Institute for Fiscal Studies (IFS) has said that the reform “depends on highly uncertain behavioural assumptions about when people take the money”. And that “there is a market failure here. There will be losers from this policy”.
There will certainly be losers, but they will be a long time in the finding. Raiding your pension savings at 65 will give you something you need now but the consequences will only land in 20 years time when you hit your late 80s. Osborne and Cameron will be long gone then, but you may well end up on means-tested benefits.
That raises the issue of what economist call “moral hazard”. What it describes is action taken by individuals or organisations that creates a risk but one for which they will not pay the price. The best bet in public policy is that pensioners will never be rendered destitute because of the decisions they have made during their life. Bad investment or spending decisions don’t leave older people without an income – the state steps in, as it should in a civilized country. What we have done until now is to steer people, though a combination of incentives and sanctions, towards securing and ensuring a life-long income. The Osborne reforms rip that up for no discernible gain but with a very clear risk.
It is of a piece with the rest of the Budget which has a peculiarly contradictory set of values running through it. Osborne lauds the benefits cap of £26k but then introduces a cap of £300k for the childcare subsidy. He not only caps benefits but has a strict regime of conditionality to make people seek work while on the dole. Which is right – his aim is to reduce the welfare bill. But at the same time he changes pension rules to increase potential welfare dependency. Osborne talks incessantly about “hard decisions” but he has, according to the IFS implemented lasting tax cuts but introduced only temporary measures to cover the lost revenue.
If there is a theme in the Budget it is buying votes at all costs. Which makes trashing pensions an even stranger choice. Perhaps the answer is simple. George Osborne has, once again, been too clear by half.