Jeff Salway: Osborne has made a rod for his own back in bid to cut pension and benefit payouts

HE’S only been Chancellor since last June, but the list of things that George Osborne would do differently if he could have that time again is growing by the week.

The most obvious is his rigid defence of an austerity regime with no room for growth stimulus, an oversight that is now coming home to roost. That was politically motivated, rather than economically, but his incessant talking down of the UK’s economy last year is now looking as foolish as it sounded at the time, with business and consumer confidence at rock bottom.

He also made a rod for his back by changing the measure by which annual benefit payments are increased. The significance of the switch to the consumer prices index (CPI) measure of inflation from the retail prices index (RPI) version, which is usually higher, in uprating pensions and benefits has been widely underestimated.

The government’s Office for Budget Responsibility (OBR) has predicted that CPI will rise by 11.2 per cent and RPI by 17.7 per cent over the next five years. The gap was narrower last month, when CPI hit a high of 5.2 per cent – meaning the government faces paying out £1.2 billion more in benefits next year than it had expected.There is ominous talk of the government applying a lower rate of inflation to the increase in pensions and benefits next April, denying millions of people a rise in line with last month’s CPI level of 5.2 per cent.

In any other year there might be room for manoeuvre. But not this time. The switch to CPI has already cost public sector and final salary scheme members dearly and will hit pensioners from next year. The government has somehow got away with that, thanks to a lack of awareness over exactly how a change of inflation measure will hit people’s pockets. It should count its blessings, remember the savings already being achieved through a lower uprating measure and resist any temptation to renege on the commitment to raise benefits and pensions in line with inflation.

Don’t forget that pensioners typically face a higher rate of inflation than younger age groups, as a higher proportion of their income is spent on items that have risen in price the most, such as energy and basic foods. Research by Prudential this summer found that pensioner living costs are rising at a rate 44 per cent faster than the headline rate of inflation.

Retired people have also been hit hardest by the erosion of savings deposits since interest rates began plunging three years ago. The savings income on which so many depend to supplement their pension payments has been ravaged by inflation, denying millions the funds on which they depend to stay afloat.

And don’t forget that the Chancellor has already chiselled away at benefits and credits, not to mention increased VAT, a measure with a disproportionate effect on lower income households.

The government and its supporters will doubtless steer the debate into one about benefit recipients, exploiting the unfortunate tendency in this country of demonising anyone on benefits as a scrounger or a cheat. Reneging on the inflation promise would also set the government on course for another collision with the unions, as it has implications for public sector pensions too.

In the aftermath of last week’s inflation announcement, it was largely forgotten that the amount by which public sector pension payouts rise each year are also linked to inflation. Like state pensions, these will rise in line with the lower CPI. The government desperately wants to reduce this, as a 5.2 per cent increase for a £30 billion public sector pension payout amounts to an extra £1.6 billion in payments next year. With the debate still swirling around increased contributions and other public sector pension changes, it may be that Osborne has to roll with this particular punch.

He will be tempted to move the goalposts, of course. But there’s another reason why he should resist. While the increase in benefit payments could add £1.2 billion to the OBR’s forecast, gilt yields are well below the OBR’s forecast, meaning the government will save more through lower debt interest repayments that it would need to fork out in sticking to its commitment to CPI increases. Osborne’s made a rod for his back and it’s one he would be unwise to break.