Alex Wild: The gold-plated millstone that muddies golden pond

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WE have known for a long time that public service pensions need dramatic reform. As if the Government’s £1.1 trillion estimate for unfunded pension liabilities wasn’t enough, new research by the TaxPayers’ Alliance has revealed this figure to be a huge underestimate.

The real number is in fact some £610bn higher. To put that in perspective, the total tax take by the Government last year was £557bn.

This colossal liability is on top of the official £1.2 trillion national debt, unfunded state pensions, RBS and Lloyds debts and numerous other items that we’re on the hook for.

This huge underestimate has come about because the Government doesn’t use a market “discount rate” to determine the true extent of our liabilities. Instead it decides a more flattering rate by committee which fails to fully account for how little money is growing with low interest rates and gilt yields.

Hiding the real extent of our debts doesn’t really help anyone other than politicians and trade unions who don’t want us to realise how big they truly are.

The generous defined benefit pension schemes in the public sector were historically a means of compensating public sector workers for the lower pay they received compared with their private sector counterparts. But public sector pay has since soared above that in the private sector, turning these pensions into a gold-plated millstone around taxpayers’ necks.

Final salary schemes have become prohibitively expensive for the private sector, with many of the surviving ones closed to new entrants.

This is for the simple reason that life expectancy is increasing faster than the retirement age and they are no longer affordable.

Unlike private sector pension schemes, public sector schemes are almost exclusively unfunded. No money is saved or invested to pay for future expenses, with new contributions immediately dispersed to pay for retired members’ benefits.

In this sense, current public sector schemes are like a Madoff-style Ponzi, doomed to collapse as contributions eventually fail to cover payments to retired members living longer and longer. The necessary reduction in our enormous public sector headcount only makes the need for major reforms more pressing as the number of members paying to the scheme falls.

A glance at the latest Treasury figures shows that next year taxpayers will have to stump up an extra £11bn to cover this funding shortfall. All in all, we 
will spend more than £37bn on public service pensions next year – about what the Government raises in Corporation Tax.

To its credit, the coalition has adopted many of the recommendations made by Lord Hutton in his review of public service pensions. From next year, benefits will be based on a career-average salary and retirement ages will rise.

But the coalition made some very expensive concessions by exempting people within 10 years of retirement from the reforms, and leaving already accrued benefits untouched. Even Lord Hutton has admitted that his proposals were based on overly optimistic assumptions and probably don’t go far enough.

A teacher retiring today on a final salary of £40,000 after 35 years’ service can expect to receive more than £17,500 a year for the rest of their life. A typical private sector worker would need a pension pot of around £400,000 to enjoy the same level of comfort in retirement.

Indeed, PricewaterhouseCoopers has estimated that a private sector worker would need to put 37 per cent of their salary into a pension to equal the retirement income of a public sector worker on the same money.

Yet teachers went on strike a couple of weeks ago, citing pensions as one of their grievances.

By resisting moderate reforms and spending cuts, public sector unions are essentially demanding that taxpayers cough up so that their members can enjoy more comfortable retirements than the vast majority of private sector workers could ever afford.

Not only that, but they are asking future generations to cough up too, even though they haven’t been born yet.

But the share of the economy that the Government gobbles up in tax has been static at around 38 per cent for 15 years. This appears the maximum amount that is politically acceptable or economically sustainable.

So it’s obvious to all but the most blinkered activist that public sector pensions will only remain viable with major reforms and/or significant additional cuts to other areas of public spending.

A good first step would be facing up to just how much it’s going to cost.