Women Against State Pensions Inequality (‘WASPI’) are using the general election to wage a very successful campaign pressuring candidates to sign the ‘WASPI pledge’ to support compensation for women born in the 1950s who find that their state pension age is not 60, as many had expected. But though WASPI complains about the short notice of the increase in pension age for this generation of women, it has been a long time in the making. Hugh Pemberton has written a background piece for the History and Policy website which traces the long history of equalisation. That history goes back to the late-1970s (when Barbara Castle was put off by the staggering cost of equalising downwards to age 60) and the early-80 (when Margaret Thatcher was warned that it was an awful lot easier to give a benefit to someone than to take it away). Legislation finally came in 1995, but history indicates that it was both understood as a step towards gender equality and much more publicly discussed than WASPI alleges.
What are the lessons of history for the Treasury’s proposals to change the basis of UK pension taxation? The experience of the 1980s signals trouble ahead for both consumers and the state if the changes are implemented.
In its July consultation paper (Strengthening the incentive to save) HM Treasury outlined its plans to change the basis of UK pension taxation. It proposes to abolish the present system in which people saving for a pension are given tax relief on their contributions but the pension, when it is eventually taken, is taxable. Instead the Treasury proposes to tax contributions but for the pension in payment to be tax free. (Thus moving to a so-called Exempt-Exempt-Taxed or EET system to a Taxed-Exempt-Exempt, or TEE, system). In the Treasury’s view this will simplify the system, increase incentives to save and boost tax revenues.
But history suggest the proposed change is unlikely to achieve its professed long-term aims. Instead it is likely to reduce tax receipts, result in lower pensions for consumers, complicate the system, and decrease saving (in turn producing pressure for higher state spending). The short- to medium-term tax revenue gained by the shift will be vastly outweighed by the long-term costs to the state and to individuals.
Anybody familiar modern British political history will know there is a consistent pattern of short-termist political decision-making that turns out to have unwelcome long-term consequences. Of all areas of policy, pensions are the most long-term and the proposals set out by the Treasury risk repeating such mistakes.
For an example from history, take one of the changes being examined by the AHRC’s Thatcher’s Pension Reforms project: the then Conservative government’s decision in 1980 to link increases in state pensions to the rise in retail prices instead of the rise in average earnings. This alteration, made entirely for reasons of short-term economy, looked small at the time but over the long-term the change, compounded annually, served to slash the value of the state pension from an already meagre 26% of average earnings in 1979 to just 16% within 20 years.
The present proposals will have similar long-term consequences.
- The loss of tax relief will remove an important incentive for people to save into their pension and so we can expect levels of pension saving to fall.
- Because contributors will lose the capital growth on the value by which the tax relief raises their contributions their final pension pot will be smaller.
- Receiving the pension tax free will probably not make up for this shortfall. On reasonable assumptions, a 25-year old today will find their pension will be 7% lower.
- Over the long-term the initial revenue gained by initial tax relief on contributions will be significantly less than the tax revenue lost by paying the pension tax free (in our modelled example the total tax taken from this individual drops from nearly £40,000 to just £8,600).
- Finally, the promise of simplification held out by the Treasury consultation document is an illusion. Like virtually every change to the UK system since 1945 implementation of this proposal would complicate not simplify the system – because pension contributions pre-dating the proposed tax reform will continue to yield a taxable pension and so there will actually be two parallel tax regimes.
We conclude that the Treasury’s consultation documents is an attempt to dress up a policy aimed at bolstering tax revenues over the short- to medium-term as a long-term reform to incentivise pension saving and improve the level of income replacement in old age. It is inconceivable that it will achieve either long-term aim.
We recommend that government should look to the long-term security of British pensioners and resist the temptations of a short-term boost to public finances from abolishing tax relief on pensions. If the Treasury is determined to reduce the cost of tax relief on pension contributions it should instead consider removing higher-rate relief, a costly subsidy to those least in need of an incentive to save into a pension.
Read the full version of our response to the Treasury consultation.
Journalists, policy-makers, etc. please contact Dr Hugh Pemberton if you want a further briefing.
After around six months research by our project Research Assistant (Aled Davies) and PhD student (Thomas Gould) we are in a position to issue some early (and inevitably provisional) findings about Thatcher’s Pension Reforms:
- Portable personal pensions provided the Conservatives with a solution to the problem of early leavers from occupational schemes left with inadequate pensions.
- But the 1980s pension revolution was also bound up with the ideological polarisation of the 1970s.
- Occupational pensions were seen by the Left as a potential source of investment in Britain’s ailing industrial base.
- Portable personal pensions therefore met a practical need whilst also fulfilling an ideological function in both promoting individual initiative and providing a defence against state control of occupational funds.
- The actuarial profession was profoundly concerned about the resulting transfer of risk to individuals, potential mis-selling, and the introduction of more complexity into the overall system. It also opposed the abolition of the State Earnings Related Pension Scheme (SERPS), which it saw as a vital component of a state/private partnership.
More details can be found in AHRC TPR Project Briefing Note 2.
The weekend edition of the Financial Times has a debate on pensions between Alan Higham of Fidelity Worldwide Investment and the the Thatcher’s Pension Reforms project.
,Alan Higham, putting the view of some but by no means all in the industry, says the government’s reforms, dubbed ‘Pension Freedom’, give savers a chance of a better income in old age. ‘Retirement has changed, just like society has’, he argues, and the people need more freedom to manage their finances in this more complex world. A reformed financial advice profession, he thinks, can be trusted to guide them in making the necessary choices. [Read the article here]
In the same issue of the FT, I take a rather different view, one that comes directly from the work being done by this project on the pension reforms of the Thatcher era. I’m all in favour of freedom in principle, but people also need security. That need has lain at the heart of pensions for as long as they have existed. People need to understand that in embracing ‘freedom’ they may (on reflection I would say almost definitely will) reduce their security in old age. This is mainly because by going it alone they will abandon the benefits of risk pooling, will lack the information and expertise to make the right decisions, and, sadly, because recent history suggests many of them are going to be sold inappropriate and/or costly products by unregulated firms. [Read the article here]
Principal Investigator, Thatcher’s Pension Reforms project.
Thatcher’s Pension Reforms has received a gratifyingly large amount of traffic over the past week as the budget loomed. The project has only been going a few months and is very much in ‘information gathering’ mode at the moment, so we did not feel able to contribute directly to that debate in any detail. However, we do hope to issue some interim findings within a few weeks, so please sign up for email notifications, or follow us on Twitter at @tpr1980s. In the meantime, here is an initial statement of intent.
Nonetheless, looking more generally at more than a century of pension reform in Britain it is easy to highlight at least two key ‘lessons of history’ to be borne in mind when reading the Chancellor’s 2015 Budget Statement.
First, there is always a tension between ‘freedom’ and ‘safety’ when it comes to pensions. Freedom for the individual consumer has its virtues but the experience of many decades is that many (if not most) consumers are ill-equipped to understand the complexities of ensuring a constant stream of income from retirement to death. The findings of the First Report of the Pensions Commission in 2004 (pp. 208-9) have not been magicked away over the past decade: people are not good at estimating probabilities or understanding risk, they shy away from complexity and from products they don’t understand, and when they don’t they are easily influenced by those who present their options to them.
Bearing in mind this lesson, ‘pensions freedom’ (i.e. the freedom to cash in an existing pensions annuity coupled with the Chancellor’s removal of the 55% tax constraint on doing so) could prove unwise over the long term and the warnings from pensions professionals about this should be listened to. This is not about buying Masaratis with the proceeds, it is about people making important financial decisions about complex issues that they are ill-equipped to grasp and the risk that they will be taken advantage of. Much will turn on the quality of independent advice on offer from the new Pensions Wise service.
Ultimately, however, what people want is the security of knowing they will not suddenly find themselves without adequate income at the end of their life: i.e. what they want is an annuity, they just want a better rate than they’re getting at the moment as a consequence of quantitative easing. To this extent ‘pensions freedom’ is something of a red herring.
Second, choices on pensions are the most long-term of all public policy decisions and this exceptionally long-run horizon does not sit easily with the short-run priorities of day-to-day politics. Decisions made for the short-term can have unexpectedly large long-term effects. The change from indexing the basic state pension to prices rather than earnings is a case in point. Introduced in 1980 to get the State off the hook of mounting costs at a time of concern about public spending levels it had marked distributional effects over time – as can be seen in this graph from the IFS’s History of State Pensions in the UK, 1948-2010 (p. 13), the value of the BSP relative to earnings falling by about 40% over the ensuing quarter of a century.
In this context, the Chancellor’s decision to reduce the lifetime allowance from £1.25 to £1 million and then to index that sum to CPI from 2018, if sustained over many years and if we return to a world of consistently rising real incomes, would over time work substantially to reduce the value of that allowance relative to earnings (real incomes growth of 3% p.a. over a quarter of a century would nearly half this ratio). In short, the Chancellor may turn out to have introduced a measure that will over time effect a surprising number of people.
Principal Investigator on the AHRC Thatcher’s Pension Reforms project and Reader in Contemporary British History at the University of Bristol, UK
Throughout the research project we will produce regular project briefings to report on our activities and findings. Our first briefing describes the purpose of our research into the Thatcher pension reforms, and discusses some of the key issues which we hope to address over the next three years.
Based at the University of Bristol, and funded by the Arts and Humanities Research Council (AHRC), this three-year research project will explore the roots, implementation, and consequences of the Thatcher governments’ reforms, and reveal the ways in which they contributed to Britain’s twenty-first century ‘pensions crisis’.
It will mine a rich seam of hitherto unexplored records and data: a combination of newly released archival material available as a result of the government’s decision to move from a 30-year to a 20-year rule for record release backed up by additional freedom of information requests, oral history interviews, ‘witness seminars’, and a rich array of other primary sources.
The project will be led by Dr Hugh Pemberton from Bristol’s Department of Historical Studies in the School of Humanities, with Professor Roger Middleton as co-investigator. Dr Pemberton is an expert on the history of postwar Britain. Formerly a business analyst in the life and pensions industry, he has published on the history of Britain’s system of pension provision, both public and private, as well as on the history of postwar British governance.