“Should we pension off the state pension?” asks Robert Colville. The answer is: emphatically no. Quite the opposite. There’s a case for increasing it.
Robert is right that the cost of the state pension will rise over time. The OBR expects it to rise from 5.3% of GDP now to 7.3% in 2060 if the triple lock continues.
But this is irrelevant. Unless we euthanize people in their 60s, we’ll have to pay pensioners an income. The question is whether this comes from taxes in the case of a state pension or from dividends in the case of a private pension financed by stock market investment. Whichever it is, there’s a burden upon future working people.
And I reckon there’s a good case for pension provision to be done by the state more than via individual private pensions.
I don’t say this merely because some people are too short-sighted or poor to save, important though this is. It’s because even the most prudent saver will struggle to provide a private pension for herself.
One reason for this is that the costs of private pensions are eye-wateringly high. It’s common for fund managers to charge £1500 a year on a £100,000 pension pot - which is a fortune for what should be a simple administrative job.
But there’s a bigger reason. It’s impossible to know how much we should save. This isn’t just because we don’t know how long we’ll live or because stock market returns are volatile. It’s also because we don’t even know what long-run equity returns should be.
Of course, we know they’ve been high in the past: 5.7 per cent per year in real terms since 1900. But we can’t be at all sure this is relevant. For much of the 20th century, investors feared there was a chance of something really nasty happening: military defeat, nuclear annihilation, revolution or severe depression. For the most part, these risks didn’t materialize and so returns were good, at least in the US and UK. But we can’t be sure that our luck will continue, and it’s not obvious that stock markets now are so under-priced as to offer decent long-run returns.
In fact, if we add the equity premium (pdf) estimated by Mehra and Prescott to current real bond yields, we get negative prospective real returns on equities.
I suspect this is too pessimistic. But that’s not my point. The point is that we cannot know how much we can save for a pension. And remember – the costs of misjudging savings cut both ways. Under-saving gives us an impoverished retirement. But over-saving means we deprive ourselves of nice experiences in our youth, and so have a depleted stock of happy memories in our old age.
A good state pension is the solution here. The state is better able to bear risk than private citizens.
This isn’t just because tax revenue is more predictable than equity returns. It’s also because the state can better pool some risks. For example, whilst individuals face longevity risk (the danger of outliving our assets) this is not so troubling for the state; aggregate life expectancy isn’t so uncertain as individual life expectancy.
And there are some types of equity risk the state can bear. Retired savers face distribution risk: the danger that profits and dividends will fall as wages rise. This isn’t a problem for governments which can tax labour as well as capital. Equity investors also face creative destruction risk – the danger that future growth will come from as-yet unlisted companies rather than from listed ones (as happened in the 70s (pdf)): insuring against this risk by holding private equity funds is difficult, as these expose us to considerable fund manager risk. But again, this needn’t trouble the state as it can tax profitable firms whether they are listed or not.
You might question how much fiscal space governments have. But they have a damned sight more than individuals do.
For me, all this argues for the state undertaking the job of pension provision far more than it does. This isn’t to say there’s no place for private provision: insofar as doing so involves investing overseas, we can get future pension incomes from foreign workers not just UK ones, which is sensible risk-pooling.
I suspect there are simple reasons why this case is rarely made. One is that people tend to fetishize the public finances, and forget that some jobs need to be done and the question is only how to pay for them. Another, of course, is that low state pensions suit the parasitical fund management industry very well – and it has considerable influence over politicians and journalists.
There is, though, another point here. Given that future pensions must be paid by future workers, it is imperative that they produce a pie big enough to feed future oldsters as well as themselves. This means that policies to increase productivity are essential not least as a way of better providing future pensions.
While I agree with much of this argument it doesn't do much to persuade me that state pensions should increase now. Pensioner poverty is at historic lows and any increase now has huge deadweight cost of adding to the wealth of those who have benefited from high returns on housing and stocks, either directly or through generous DB schemes that were supported by these high returns.
My view is the worst suffering we see in this country is due to low incomes for those of working age and lonliness and isolation for older people. Higher state pensions will do nothing to address either issue.
Posted by: Toms | July 25, 2017 at 02:18 PM
«Unless we euthanize people in their 60s, we’ll have to pay pensioners an income. The question is whether this comes from taxes in the case of a state pension or from dividends in the case of a private pension financed by stock market investment.»
Well, there is a third and a fourth way:
* Reduce the standards of living of most pensioners to the point their barely survive. The state pension is not an either/or issue: the level matters a great deal too.
* Leave it to voluntary charity, and if voluntary charity is not forthcoming, declare that the will of the people has been democratically enacted by their own choices.
Posted by: Blissex | July 25, 2017 at 05:53 PM
«This means that policies to increase productivity are essential not least as a way of better providing future pensions.»
If you know the location of a giant oilfield within UK waters or onshore, please let the Treasury know, almost nothing like extracting from one boosts productivity.
Alternatively if you have just invented a new source of energy which is cheaper and more energy-dense than oil, please let the world know, nothing like the diffusion of adoptio of a new better fuel boost productivity.
:-)
Posted by: Blissex | July 25, 2017 at 05:58 PM
I get a bit tired by the endless and often biased debates about state and private pensions etc., the only issues that matter are:
#1 Self insurance against old age and poverty is phenomenally expensive and wasteful.
#2 Pooled insurance against old age and poverty via state-run schemes is very cheap.
#3 It takes saving around 30-40% of gross income to have a decent pension of around 60-70% of career average income, and somewhat more if one includes a survivor pension for a non-working spouse.
The big deal is #3 of course. That means that on average the savings rate for pensions should be around 25-35% of GDP just for pensions. Indeed countries who provide decent pensions do that, and if they do it via the state because of #2 have a share of government in GDP of over 50%.
Posted by: Blissex | July 25, 2017 at 06:05 PM
The Tories have already limited the private pension contributions and will go further.
This applies to George Osbourne and Philip Hammond.
http://www.cps.org.uk/publications/costly-and-ineffective-why-pension-tax-reliefs-should-be-reformed/
Abolish the Pension Tax Relief and you will abolish the private pensions industry, as it is dependent on this public subsidy to the wealthy.
http://www.telegraph.co.uk/finance/personalfinance/pensions/11716178/Pension-tax-breaks-this-is-why-theyre-about-to-be-cut.html
(Monday 24 July 2017)
"At more than £50bn, tax relief on pensions exceeds government expenditure on defence."
[...]
"Or you could cut the numbers this way: while 1.6 million savers, earning up to £15,000, shared pension tax relief worth £1bn, 186,000 savers earning £150,000 or more shared relief worth £6.3bn. "
[...]
"When an annual pension management charge of 0.5pc applies, the end-value of the pot drops to £610,000. When an annual management charge of 1.5pc is applied – as is typical if not lower than many charges in Britain’s pension industry – the end-value of the pot falls to £465,800.
In other words, a taxpayer-funded subsidy to the insurance company of more than £200,000 over the saver’s lifetime."
Posted by: aragon | July 25, 2017 at 11:16 PM
The administrative costs of private retirement programs add up. EPI finds that if Americas social security system were privitized it would result in 26% less benefits for the same cost. Chile and the U.K. both privitized retirement programs and the results were a 30% decrease in benefits.
Posted by: Oakchair | July 26, 2017 at 08:45 PM
The state pension is politically different to other forms of welfare, it isn't presented as an insurance policy if you cannot work enough for some reason. It is presented as an entitlement that is earned, and millions of people have paid taxes for decades on the basis they will get a state pension in return. That is in effect the contract successive governments have entered into with the electorate and there is a major element of political legitimacy resting on honouring such commitments.
There are arguments about whether recipients pay enough in to meet what they get out (many past and present recipients did not), just as there are arguments about policy choices and decisions of successive governments that have directly and indirectly had positive and negative affects on private and state pension provision. There are arguments about the viability of a Ponzi model of state welfare, just as how things like nuclear weapons, foreign wars, bailouts for fat cats and subsidies to certain political clients are affordable when pensions might not be.
But we still come back to the point that governments have entered into an understanding with the public, and backing out involves a suicidal lack of political legitimacy. It's one thing for wealthy politicos and assorted wonks representing sectional interests (that basically don't want to pay taxes) float such views, but it's another convincing the public in the era of corporate welfare and billion £ bungs for the DUP.
Posted by: MJW | July 27, 2017 at 09:51 AM