By Willis Towers Watson senior consultant, David Robbins
Boris Johnson began by saying “we’re going to meet all our manifesto commitments” but added “unless I specifically tell you otherwise”. He proceeded to list some promises that, he says, the Government will keep, but did not mention pension uprating. By answering (or not really answering) the question in this way, he avoided saying anything that will prove untrue if the Government does scrap the Triple Lock, but also avoided creating headlines about its abolition during a difficult week.
Fielding a similar question at the daily coronavirus press conference on 14 April, the Chancellor, Rishi Sunak, refused to be drawn into “writing future budgets here today”. The Department for Work and Pensions got the message loud and clear: answering a parliamentary question about the Triple Lock on 26 May, the pensions minister, Guy Opperman, said the Government was “committed to ensuring that older people are able to live with the dignity and respect that they deserve” but did not articulate any commitment to the uprating mechanism itself.
The manifesto may therefore have been overtaken by events, with decision-makers at least wanting to keep their options open.
“Unlockdown” could provide a big pension rise in 2022 under current uprating policy
Most obviously, those events include a transformed outlook for the public finances. Under a “reference scenario” designed to illustrate how the coronavirus pandemic might affect tax and spending, the Office for Budget Responsibility (OBR) puts public sector net debt in March 2021 £412 billion higher than in the forecast that underpinned the Budget delivered on 11 March.
The consequences of the pandemic for wages growth might also call current policy into question.
For pension uprating purposes, the Government by convention looks at how average earnings have changed, comparing the three months to July with the same period a year earlier. For example, the percentage increase in average earnings between May-July 2018 and May-July 2019 determined the pension increase that took effect from April 2020.
Now, imagine that an employee had an annual salary of £25,000 and received the corresponding monthly pay cheques in May, June and July of 2019. 12 months on, they have been furloughed and receive 80% of this, equivalent to £20,000 a year. Their pay reverts to £25,000 per annum when they return to work and is still at this level throughout Spring and Summer 2021. The change in this individual’s pay is therefore -20% between May-July 2019 and May-July 2020, and +25% over the following year. The experience of employees like this will feed into economy-wide average earnings growth. With 8.4 million employees furloughed, average earnings growth might be negative in 2020 and strongly positive in 2021.
Another potential cause of fast earnings growth in 2021 might be GDP recovering faster than employment. In the OBR scenario, employment is 1.2 million lower than previously forecast in 2020 and still 0.8 million lower in 2021, but the level of GDP in 2021 matches the pre-lockdown forecast. In other words, the UK economy is assumed to produce as much in 2021 as previously thought, but with 800,000 fewer people producing it. It’s not obvious why the pandemic would cause people who remain in work to become that much more productive; but if they did, and if the share of output going to the workforce stayed the same, this would push up average wages.
Average earnings measure total pay divided by the number of employees. They will therefore increase not only when pay rates go up or when more hours are worked by people who are employed continuously, but also when employees on low earnings fall out of the average. If lost jobs are disproportionately low paid, average pay can rise without any individual earning more.
For whatever combination of these reasons, the OBR scenario shows average earnings falling by 7.3% in 2020 and rising by 18.3% in 2021. These numbers are for calendar years. If they also applied over the 12 months to May-July, Triple Locked Pensions would rise by 2.5% (provided inflation is lower than this) when wages fell by 7.3% and then by 18.3% when wages rose by 18.3%.
Over a two-year period, Triple Locked pensions would then have risen by 21.3% while wages grew by 9.7%. And to the extent that average pay growth reflects people moving from low wages to no wages, even people who remained employed would usually have seen their incomes rise by less than this.
In 2020-21, the full Basic State Pension is £134.25 per week. Under this path for average earnings, the Triple Lock would increase it to £162.80 per week in 2022-23. The New State Pension would increase from £175.20 per week in 2020-21 to £212.45 per week in 2022-23.
Importantly, this is only one scenario, and not even a forecast. Other, far less dramatic, illustrative scenarios are available; the Bank of England’s shows average earnings falling by just 2% in 2020 and rising by just 4% in 2021. Others doubt whether we will see the sort of V-shaped recovery that both the OBR and the Bank illustrate.
What could ministers do?
If ministers believed that current policy could significantly increase State Pensions relative to earnings in a short space of time, and if they did not want that to happen, what options would they have?
Under current legislation, the Basic State Pension and New State Pension must rise at least in line with average earnings, as determined by a review by the Secretary of State. The inflation and 2.5% components of the Triple Lock are discretionary. So, without changing the law, the Government could freeze weekly pensions in April 2021 if earnings growth were negative. The legislation does not appear to allow ministers to cut State Pensions when earnings fall even if, improbably, they were minded to.
To avoid increasing pensions in line with rebounding earnings, ministers would probably need to change primary legislation. (Alternatively, they could seek legal advice on precisely what the current law requires them to do – for example, whether a requirement to review in each tax year whether pensions have retained their value in relation to the general level of earnings means that the period reviewed must itself be a year in duration. If there were flexibility here, and if it were also judged that the review period could overlap with a period previously reviewed, ministers might be able to argue that pensions had retained most of their value relative to where they had been before the pandemic and apply a smaller increase. Or they could explore whether, because the law allows the Secretary of State to estimate the general level of earnings as she “thinks fit”, they could in some way strip out the effect of furloughed employees returning to work. But changing the law would be more transparent and less open to challenge; the changed law could also be designed with the increase the Government wanted to award in mind.)
In designing a State Pension uprating policy, there have historically been three pressures on policymakers. First, there is a wish to ensure that State Pensions do not come to represent a smaller share of earnings over time, which would alter the relative living standards of pensioners and working age people. Second, there is a desire to protect the purchasing power of pensions year-on-year. Third, and less rationally, politicians have been reluctant to defend low cash-terms increases even when inflation and earnings growth are low or negative, remembering the outcry over the 75p per week increase that took effect in April 2000.
The Triple Lock achieves all three objectives. Alongside the obvious political difficulties with taking away something valuable (and, indeed, something which sounds valuable even to people who could not identify the Triple Lock’s three components), this helps explain why it has survived for a decade, outlasting the Liberal Democrat politicians who first championed it. The Triple Lock also ratchets up State Pensions relative to earnings over time. Some may think this is desirable, but it’s hard to maintain that the pace and extent of any such change should be driven by unpredictable fluctuations in earnings and inflation of the sort we might be about to see.
If the Government wanted to continue to meet the three objectives that the Triple Lock scores well against but without progressively ratcheting up the value of State Pensions relative to earnings over time, one option would be a modified Triple Lock: each year, pensions would rise at least in line with inflation and by at least a given cash amount or percentage, and they would never be lower than if they had been indexed to earnings from a suitable starting date. Provided that earnings grow faster than prices over the long term, any increases in pension values relative to earnings in individual years would then be temporary.
What change, if any, the Government actually makes will depend on how much the pandemic has changed what it wants to achieve. For example, targeted fiscal savings may now take greater priority.
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