The odd thing about the triple lock – the pensions formula which has become so expensive that the government is now considering ditching it – is that it was never expected to be all that costly.
When the coalition government introduced it in 2010, their models suggested it would rarely get triggered.
To understand why, let’s start at the start.
For most of modern history, state pensions were increased in line with inflation. The upshot was that between the 1970s and the early 2000s, pensioner poverty became a big problem for the UK. Gordon Brown attempted to make amends – first by introducing the Winter Fuel Allowance, then by promising that in due course (for which read: after we’re out of office) the state pension would be increased in line with earnings rather than inflation.
The distinction doesn’t sound all that significant, until you recall that inflation (at least, as measured by the consumer price index) tends to rise by 2% a year and earnings tend to rise at about double that rate (in normal times, at least). The upshot is that over 30 years, a pension uprated by inflation will go up about 80%, a pension uprated by earnings will go up by about double that, 160%.
Such numbers are difficult to predict, of course. Over a few decades, there are often years when inflation outpaces earnings, or when both are very low. But the key thing to note is that the switch from inflation to earnings uprating was a Big Deal. Which is why Mr Brown fought so hard to avoid it for so long.
When George Osborne took over, with the LibDems looking over his shoulder, he made a dramatic shift. Not only did he say pensions should increase by either inflation or earnings – whichever was the higher – he said that if either dropped down low, the government would still pay out a minimum increase of 2.5%. Thus was born the triple lock.
As I’ve said, at the time it was introduced, there seemed little likelihood of the triple lock bit (the 2.5% minimum) being triggered all that much. Indeed, in no year between 1990 and 2009 were earnings and inflation simultaneously below 2.5%.* But fate has an odd way of surprising Chancellors who set targets such as these. In the following years, both earnings and inflation lurched around, with the event that the triple lock was triggered three times.
In the meantime, the amount spent on pensions has ratcheted ever higher while earnings for working age households have more or less stagnated. The upshot is that not only have pensioners caught up with non-pensioners in terms of their earnings (after you take account of housing costs), they have now exceeded them. Additionally, the extra costs have caused government spending to gallop higher, with pensions now accounting for more than half the total welfare budget.
All of which is why the Government is thinking about ditching the triple lock in its manifesto this year.
But what to replace it with? The Guardian reported this morning that one idea is to scrap the triple lock and bring in a double lock: make pensions increase by either or earnings or inflation – whichever is highest.
This sounds compelling in theory, but in practice it will make little difference. Consider our pension illustration (remember that such things are rules of thumb since making long-term predictions is a mug’s game): over 30 years, the triple lock would increase the state pension by 197%. A double lock would still increase it by a whopping 189%.
The Institute for Fiscal Studies has an alternative suggestion, a kind of adjusted double lock (an idea which has since been taken up by the Work and Pensions Select Committee):
“The state pension would be uprated with earnings, but with temporary price-indexation when inflation exceeded wage growth. Price indexation would continue once earnings growth again exceeded inflation, but only for as long as the value of the state pension remained above [an] original fixed minimum proportion of average earnings. Indexation would then revert to earnings.”
To translate: this would ensure that while pensions would not be unduly hit in the event of a big leap in inflation, nor would they gallop ahead of everyone else’s earnings in the coming years (which is more or less what has happened in recent years).
But the key thing is that whichever of these policies the government goes for, there is no magic solution that will dramatically reduce pensions costs. Which raises another question: how else do you cut pensions costs? The short answer is you raise the retirement age even further. In the end, that may be the only way to make pensions provision affordable. Just don’t expect it to come up in this year’s election campaign.
* Well, more precisely: in no September was CPI below 2.5% and in no July were earnings below 2.5% – those are the months whose figures are used for the uprating.