Steve Webb is a Visiting Fellow at the Institute for Policy Research and former UK Pensions Minister.
When a government undertakes its annual review of the rate of state pensions, what factors should it take into account?
Should the state pension rate keep pace with the rise in prices, to avoid those in retirement facing a cut in their real living standards? Should it keep pace with earnings, so that older people do not see their income fall off a cliff when they move from wages to pensions?
And what if a link to prices or earnings creates a cash increase that is simply politically unacceptable? In 2000 (when the policy was simply to link to price inflation) the formula generated a 75p increase in the rate of the state pension. Although the government weathered the political storm at the time, a huge £5 increase was awarded in the following (election) year, almost by way of penitence for the insulting increase of the previous year. Some minimum cash increase or percentage increase might therefore be thought necessary as an underpin.
These three factors led to the creation of the state pension ‘triple lock’. This requires the annual increase to be the greatest of the rise in prices or earnings, but with a floor of 2.5%. Although this policy is not written into law (where the legal minimum requires only an earnings link), it has been implemented consistently since 2010 and was in the 2019 manifesto of the current Conservative government.
The ‘triple lock’ comes in for a lot of criticism. The main objections are:
- It is seen as an unjustifiable sop to the ‘grey vote’ and is regarded as intergenerationally unfair; although pensioners have done much better economically than the working age population in recent years, they are a growing proportion of the population and have a high tendency to vote; the triple lock is therefore dismissed as simply being about ‘political expediency’;
- It generates arbitrary increases from year to year; there is no underlying principle at work which targets a particular rate of state pension; over the last nine upratings, each element of the formula has been applied three times;
- It could create particularly perverse results in the current crisis; in April 2021 the formula will generate a 2.5% increase even though wages have fallen and inflation is close to zero; and, if earnings bounce back next year from their suppressed levels of 2020, the April 2022 uprating could be more like 5%; at a time of huge strain on the public finances, this does look like remarkable largesse to pensioners.
But I would argue that the triple lock has performed an important function in the last decade and its work may not yet be done.
In 2010, the incoming government faced a substantial imbalance between public spending and tax revenues. Against that backdrop, there was a risk that an already inadequate basic state pension could have been squeezed further. Instead, having a formula-based approach to state pension increases meant that the state pension was protected from annual haggling with the Treasury. The upward ratchet implied by the triple lock helped to build the state pension to a more meaningful level after 30 years of linking just to prices between 1980 and 2010.
With regard to intergenerational fairness, it is easy to forget that today’s young people also need a meaningful state pension. Whilst it is often pointed out that traditional ‘final salary’ pensions have largely died out in the private sector, and that contribution rates into new-style ‘defined contribution’ pensions are often woefully inadequate, the logic of this situation is rarely drawn out. Unless something dramatic happens to pension contribution rates (which seems unlikely for years to come), a firm state pension foundation will be vital to today’s younger generations who would not thank you for watering down its value.
In terms of gender equality, the state pension also plays a crucial role. Private sector pensions, by definition, tend to mirror in retirement the inequalities between men and women in the labour market. By contrast, the state pension – and especially the new state pension introduced in 2016 – radically redistributes. Not only is the new pension paid at an essentially flat rate, regardless of pre-retirement earnings, but there is also an extensive system of ‘credits’ for carers and the low-paid, two groups heavily dominated by women. The same amount of state pension is now generated by a year at home bringing up a young child as a year in a top job running a large company. Weakening the role of the state pension by cutting annual indexation and makes it less effective at correcting for the inequalities of the labour market.
There may well come a day when the triple lock has to end, and there is a case for some flexibility in the application of the principle in the current extreme situation. But with the UK state pension still one of the lowest in the developed world, there is still work to be done.
All articles posted on this blog give the views of the author(s), and not the position of the IPR, nor of the University of Bath.