Ros Altmann: At long last, public sector pensions move on to the agenda

Public sector workers do a tremendous job, often under difficult conditions, and are entitled to decent pay and pensions. However, as most private sector final salary

schemes are now closed, and employees are being moved on to much less generous pension arrangements, there is a growing disparity between public and private sector pension provision. Is it sustainable, following the Budget, to expect taxpayers to fund far more generous pensions for other people than they themselves can expect?

An official inquiry is to be established to assess the situation and make recommendations. This thorny issue has been rumbling in the background as public sector pension liabilities have been building up. Worryingly, most public sector schemes are completely unfunded, with today's contributions just going into general Government spending and tomorrow's taxpayers having to pay out however much is required to keep paying the pensions.

Unfortunately, for many years, Ministers have hidden the true costs of the public sector pension liabilities building up. They were not included in the official "fiscal rules" and have been kept off the Government's balance sheet.

Perhaps because the problem is so large, or perhaps because of the vested interests involved, there has never been an official impartial assessment of the amounts that will have to be found. The public was just told that these pensions were "fully affordable". Using fiddled figures and dodgy accounting, the scale of the looming liabilities has been consistently hidden away.

But now the cat is out of the bag. The new Government has exploded this myth of affordability and the debate has suddenly moved on from asking whether reforms are required, to assessing what changes are needed. About time too.

The looming extra costs are enormous. In its recent report, the newly-created "Office for Budget Responsibility" (OBR) suggests that the extra cost of public sector pensions accrued in just one year is 26bn and net public sector pension spending will rise by an average of 20 per cent each year for the next five years. But that is not even the full story.

The report is based on the Government's own assumptions. Using more appropriate calculations, approved by independent analysts, the actual annual extra cost is more than double that figure! So, every year, the value of public sector pensions being earned for the future – which taxpayers will have to find in full in years to come – is more than 50bn.

Public sector pension schemes offer very generous benefits. That is not to say that all public employees receive huge pensions. The average has been around 6,000 a year, and is now rising to nearer 8,000. This is much more than will be paid to most private sector workers. In addition, it is taxpayer guaranteed, fully inflation-linked and paid from a much younger age than the state pension. Even when state pension age rises to 68, most of today's public sector workers will still be able to start their pensions at 60.

It seems difficult to imagine that such disparities will be tolerated easily, especially as public sector spending will have to be substantially reduced in coming years. So what changes might be considered? Firstly, it is important to point out that any pension entitlements already earned should not be affected, so those close to retirement should be least impacted.

Public sector workers could be asked to contribute more to their pensions. At the moment, workers contribute only a tiny fraction of their salaries – for example teachers and NHS staff pay six per cent. Official estimates suggest that these pensions are worth an extra 20 per cent of workers' pay, but the independent experts calculate that the true value is nearer 40 per cent, so taxpayers have to make up the difference.

The inflation-linking could be cut, or pension rights might build up at a slower rate with workers having to work for more years to get the same pension. The future pension calculation could be based on a workers' average salary during their career, rather than their final salary.

Some have called for far more radical reforms, with public workers moving on to much less generous pensions that most private sector employers now provide. These defined contribution schemes do not promise any specific level of pension. Employers simply pay contributions each month, alongside employees, and the actual pension paid out will depend on investment returns, any fees charged and the annuity that is purchased at retirement.

These are complex decisions and there are no easy answers. Now that the costs of public sector pensions are coming under proper scrutiny, however, we will need to decide what taxpayer burdens are acceptable, how much the workers themselves should be expected to pay towards their pensions and what changes can be made so

they are both fair and affordable for the future. The easiest part is to admit the problem. The real challenge is to find a good solution. Let's hope it can be done without too much trouble.