Public sector pensions are not such a burden

Anthony Hilton
12 Mar 2010

There are two views about public-sector pensions.

The popular and often populist view is that they are far too generous and threaten to become an unsupportable burden on future taxpayers.

In addition they are grossly unfair because at a time when more and more private-sector pensions are being closed down or cut in value in order to reduce the cost, public-sector pensions soldier on much as they have ever done.

The alternative view is that taking bald figures about the cost of pensions out of context serves merely to scare people and presents a wildly distorted picture.

In the context of the wider economy, public-sector pensions are eminently affordable and not at all generous. Cutting them would save nothing because — deprived of this income — many of the recipients would have to fall back on other state benefits.

What is agreed is that there is a dearth of reliable, objective information, and that is why the National Audit Office (NAO) has rushed in where angels fear to tread.

This morning it published the first independent and objective assessment of the current and future cost of unfunded public-sector pensions, and in particular the four largest schemes covering the armed forces, the NHS, the civil service and the teachers.

At present payments to the 2 million pensioners in these schemes cost £19.3 billion a year, though the net cost to the taxpayer is less at £14.9 billion because it is offset by pension contributions paid by those still in employment.

By 2050, the NAO says this figure in real terms will be £79 billion a year — before allowing for employee contributions.

Now that seems a huge amount and a massive burden, but in fact it is not. Pensions in payment at the moment — the £19.3 billion figure —take the equivalent of 1.7% of UK annual output or GDP.

In 2050 the £79 billion figure will still take just 1.7% of UK annual output, because by then economic growth will have made the entire economy that much bigger.

This, too is a growing figure, which will be offset not only by contributions from those then working but also from the income tax paid on the pensions by those receiving them.

So the “burden on future generations” which politicians love to scare us with, will be no greater than the burden on the present generation.

However, there is a snag — as there so often is with pensions.

The forecast of future costs depends on all sorts of assumptions. Some of these — such as life expectancy and earnings growth — the National Audit Office can live with comfortably enough, while it wants to do more work on issues such as the increase in employee contributions and the higher retirement age for new entrants.

But it is seriously concerned about one other which holds that though the economy and the overall workforce will grow significantly over the next 40 years, the number of public-sector workers will stay the same — meaning that as a proportion of the overall economy the public sector will shrink.

This may be true, but it seems counter-intuitive given that as countries get richer they tend to want more education and health — which is why these sectors tend to expand faster than GDP.

What is therefore needed — says the NAO — is more work from the Treasury to see how the sums come out with increasing numbers of public-sector employees.

This matters because understating the number of public-sector pensioners clearly understates the cost and there is no point in coming up with a number which is affordable if it can only be achieved by making ridiculous assumptions.

However, these things do cut both ways. One could also say there is no point in coming up with a pension cost number for 50 years hence which assumes that the retirement age will still be 65, given that there are already proposals in place to increase it to 68, and many think 70 is a more realistic number.

So perhaps we should stop thinking in terms of one number but rather have a range depending on the underlying assumptions.

Then taxpayers might be in a position to make an informed choice about what they are willing to pay.