From the TUC

Decent pensions for all

09 Sep 2009, by in Economics, Pensions & Investment

Today’s TUC report on pensions has got a good show in the Guardian, Independent and from Kevin Maguire in the Mirror. Our aim was to carefully go through all the arguments used by the shrink-the-state right against public sector pensions. Then we could explain where they mislead and  where they misrepresent, thus exposing their basic argument –  private sector employees have suffered big cuts in their pensions, so now public sector staff should suffer too.  Along the way, when we started looking at how much the state spends on pensions, we realised that no-one had ever compared the costs of pensions tax relief – astonishingly skewed towards the super-rich – and  the annual cost of paying public pensions.

Of course this hasn’t stopped the critics hitting back. One of the most common attacks is that the many ‘unfunded’ public sector pensions are Ponzi schemes, defined by Wikipedia thus:

A Ponzi scheme is a fraudulent investment operation that pays returns to separate investors from their own money or money paid by subsequent investors, rather than from any actual profit earned. The Ponzi scheme usually offers returns that other investments cannot guarantee in order to entice new investors, in the form of short-term returns that are either abnormally high or unusually consistent. The perpetuation of the returns that a Ponzi scheme advertises and pays requires an ever-increasing flow of money from investors in order to keep the scheme going.

Ros Altman – always a favourite source of controversialist quotes in pensions coverage – repeats that charge in the Guardian’s piece today.

But it’s rubbish. Public sector pension critics have seized on this word unfunded, and misrepresent what it means.

Unfunded does not mean that no-one is paying contributions or that the future commitments of a scheme are not carefully valued. It simply means that the pension is not backed by a separate investment fund. Instead contributions are paid into general public finances and pensions are paid out of it. These contributions are assessed using a very similar process to that used in funded defined benefit schemes.

Not all public sector pensions are unfunded in this way. Indeed the public sector scheme with the most active members – the Local Government Pension Scheme – is funded. (Though if its members feel left out of  spurious criticism, they have their own special attack.) And of course they are not possible in the private sector because no-one could guarantee an employer would be around far enough in the future to guarantee the pension promises made to staff.

But where there can be a guarantee of continuity, as with the state, unfunded schemes make a lot of sense. That’s why other countries such as the USA have similar arrangements.  Why should governments pay fund managers to look after member contributions – especially as they would inevitably lend much of these funds back to government – and the tax payer would have to pay interest on this?

The best way to understand that unfunded pensions are not that different from funded schemes is to think about their whole life cycle.

When they are first set up there are no pensions in payment. Instead the government (and taxpayer) gets the benefit of all these extra contributions in their general fund, and means that they do not have to borrow these funds elsewhere. The staff are effectively loaning their contributions to the state, expecting them to be paid back when they retire, not unreasonably expecting some interest as well.

When the scheme is more mature the income from contributions will be maintained, but expenditure on pensions will increase. Just as in a private sector scheme, actuaries will assess what contributions need to be made. But it is quite right that the state continues to pay interest on the boost to public sector funds caused by the continuing lag between when people make their contributions and when they are repaid as pensions.

Ponzi schemes are fraudulent because growth in the fund is oversold and pay-outs instead depend on an unsustainable flow of new contributions. It might come as a shock to anarchists and their mirror-image on the small-state-right, but the state will carry on. It will be able to continue to levy taxes. It is also not unreasonable to assume that the economy will grow over time, in turn producing more tax  from the same tax rates. And while pension funds depend on picking the right investments in the hope of keeping up with economic growth, unfunded pension schemes can rely on GDP growth producing a growth in tax income. This is why the Treasury is confident that while there is some increase in the share of GDP required to pay pensions between now and 2017 – hardly surprising in an ageing society – it then settles back to less than 2 per cent of GDP on a stable basis.

Public sector pensions are affordable – and the real scandal is the lack of decent pension in the private sector. Cutting public pensions back to private sector levels would have provoked my mother to say that two wrongs don’t make a right.

2 Responses to Decent pensions for all

  1. Pensions Company Aviva join call for cut to higher rate pension tax relief | ToUChstone blog: A public policy blog from the TUC
    Oct 7th 2009, 12:29 pm

    […] tax relief Posted at 12:29 pm on 7 Oct 09 by Nigel Stanley The TUC made the headlines with our analysis of the cost of higher rate tax relief on […]

  2. From the department of the bleeding obvious | ToUChstone blog: A public policy blog from the TUC
    Nov 6th 2009, 5:05 pm

    […] private sectors get paid more or less than each other, but other studies – quoted in our Decent pensions for All (pdf) show: Highly skilled workers in the public sector earn 5.5 per cent less than they do in the […]