Comment: Pension reform will test the government's resolve

John O'Connell is deputy research director at the Taxpayers' Alliance
John O'Connell is deputy research director at the Taxpayers' Alliance

Stubbornness and inertia should not stand in the way of radical reform to public sector pensions.

By John O'Connell

John Hutton's interim findings on public sector pension reform are a welcome first step towards tackling one of the toughest challenges facing Britain today.

It's no secret that the disparity between public sector and private sector pensions has increased rapidly. In 2008, our research paper The UK Pensions Crisis found that occupational pension schemes lost between £150 and £225 billion in growth, as a result of the abolition of Advanced Corporation Tax relief on pension funds in the 1990s. Partly as a result, the number of active members of private sector occupational schemes has fallen by 41 per cent in the past 12 years.

Public sector pensions have not suffered from the tax rises that have hurt private sector schemes, and instead are increasingly being propped up at taxpayers' expense. There are over 17,000 retired public sector employees with retirement benefits worth £1 million each.

Additionally, the Public Sector Pensions Commission recently estimated that a huge 94 per cent of public sector employees are still on unsustainable defined benefit schemes, compared to just 11 per cent in the private sector. Public sector pension liabilities are now estimated to be upwards of £1 trillion - around £40,000 for every household in the country. Even the funded Local Government Pension Scheme is running a deficit over £50 billion.

The scariest thing is that all of this is kept off the balance sheet, meaning that national debt figures hide even bigger debts than we thought. That's one of the first things that need to change. Taxpayers deserve to know the whole picture and keeping liabilities like pensions and PFI off the balance sheet is disingenuous.

Thankfully Hutton's main findings today echoed many of the TPA's recommendations in past reports, books and consultation submissions. First, asking employees to increase contributions is overdue and can save lots of money. We argued that there should be an increase of employee contributions to all unfunded public sector pension schemes by a third. This is not as large as it sounds - typical contributions would only go up from 6 to 8 per cent of salary. This move could save as much as £2.5 billion.

Second, we have long called for a shift from defined benefit to defined contribution schemes. Final salary schemes are unfair to lower paid workers as they disproportionately benefit public sector executives. Today's proposals have hinted at career average schemes and this would be a good start.

There are other proposals the commission should consider for the long term. In some funded schemes in the Netherlands pension assets are not allowed to drop below 80 per cent of liabilities. If they do then they are given the flexibility to make temporary amendments to their conditions to get back up to scratch. We found that Council pension assets were often lower than 50 per cent of liabilities in our report Council Pensions: The £53 billion black hole.

It's these kinds of ideas that the Hutton Commission needs to consider between now and the publication of their full report in spring 2011. Good reforms will need tough political resolve though, as public sector unions will fight major change. Today's document says that many of the features of modern pension schemes like accrual rates, pension ages and linking them to final salaries date back 200 years. It would be grossly unfair to ask future generations to pay off the huge liabilities we are building up because of a stubborn refusal to modernise an old and broken system.

John O'Connell is deputy research director at the Taxpayers' Alliance

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