Money’s too tight to mention
Oh mo-ney mo-ney mo-ney mon-ey
Mo-ney’s too tight to mention
I can’t even qual-i-fy for my pension
Many public sector workers will be striking on November 30. Notionally the dispute is about proposed changes to public sector pension arrangements which will lead to workers being required to work for longer, make larger contributions and, in many cases get lower levels of benefits when they retire. On that basis it looks very much like a lose, lose, lose situation so that it is hard to argue with the discontent felt by many public sector workers.
Realistically it is also likely that many who support the strikes do so not specifically because of the particular changes to pensions but because of a more generalised disapproval of the cuts (or more accurately overall, reductions in rates of increase) in public spending and perhaps a belief that there is a better more painless way of dealing with the UK’s economic problems.
Some of those who oppose the strikes do so on the basis that it is a bit rich for public sector workers who had 13 years of unprecedented growth in jobs and improvement in pay and conditions to seek to maintain pension benefits which are contributed to by private sector workers who have no such security to look forward to. This usually meets with the riposte that instead of looking to bring public sector workers down, the Government ought to be looking to improve private pension provision.
What happened to private pensions?
How could private pensions be improved though? This is the difficult question that tends to get pro-strikers to start to shuffle their feet and mumble something about “perhaps they ought to have joined unions to put pressure on their employers”. Unfortunately, this is not a helpful answer. This is because it wasn’t really employers who led the charge to minimise pensions for their employees even if they could have decided to carry on investing in them after the wind changed against this being so highly beneficial.
Up until the mid-1990s the UK had the most generous private sector pensions in the EU. Although this is anecdotal, as I started to look for work ahead of graduating in 1993 (in the depths of another recession) most large private sector employers offered final salary pension schemes and the fact that the civil service and other public sector employers also did so was not a particular positive differentiator when choosing where to work. A significant contribution to this was the tax treatment of share dividends which was beneficial to shareholders and so of great importance to pension funds which are traditionally amongst the largest institutional shareholders. Another beneficial element of the tax regime was that companies could avoid paying tax on profits by investing them in their employee pension funds.
The potential for using contributions to pension funds as a tax avoidance method was known about and Nigel Lawson as Chancellor of the Exchequer did a small “raid” on private pensions to attempt to switch the balance of incentives to encourage businesses to invest productively rather than squirrel money away in pension funds with large surpluses.
Advance Corporation Tax
The main tax instrument benefiting pension schemes was Advance Corporation Tax (ACT). This meant that share dividends were deemed to have already had tax paid on them up to the basic rate of income tax to avoid the same money being taxed twice (first as corporation tax for the company issuing the dividends then as income tax for the shareholders). This was of great benefit to shareholders like pension funds which did not pay tax on their shareholdings as they were then able to reclaim the ACT that had already been deemed to have been paid. Effectively ACT was a subsidy to private pensions.
As part of the tax increases implemented by Ken Clarke in the 1993 Budget following the disaster of Black Wednesday and the UK’s exit from the ERM the rate of ACT was brought down from 25% to 20% so that even basic rate taxpayers would have to pay some tax on share dividends (although by 1997 the basic rate had itself been cut to 23% so the level of tax payable fell to 3%).
Gordon Brown Killed Our Pensions!
OK, being completely fair and balanced he didn’t completely do so, but the two main decisions that together led to the collapse in value and availability of pensions for private sector employees were his. The first, which has resulted in almost all private employer final salary pension schemes closing in the past 14 years, was a change to the rules as to when a business could put more money into its company pension scheme. This was, at least partly correctly, seen as a tax avoidance measure if companies could shield their profits from corporation tax by diverting them into pension funds. Apart from avoiding tax this was also, again, partly correctly, seen as an economically inefficient use of profits when it would be better to reinvest them into the business itself. The solution was seen to be to change actuarial rules as to how pension fund surpluses were calculated so that it would not be possible for employers to put additional money into pension funds which were in surplus (ie were projected to have more money than needed to pay out the expected level of benefits). This was coupled with tax incentives for businesses investing in research and development so that the businesses would be encouraged into more productive use of profits.
The second policy change was the abolition of ACT in Gordon Brown’s first Budget in 1997 (when the current Shadow Chancellor, Ed Balls was his chief economic adviser). This meant that at a stroke, pension funds lost the “subsidy” of being able to reclaim the 20% corporation tax that had already been deemed to have been paid on the dividend on the shares they held. Brown knew that this would have an adverse impact on pension funds (see the Evan Davies article linked to above) but that it would also yield around £5bn in additional tax revenues and was part of a broader rebalancing of the relationship between corporation and income tax. It has been estimated that the impact on private sector pension schemes in the ten years from 1997 was around £100-150bn with 120,000 private sector workers losing some or all of the benefits of private final salary pensions in that time.
So, how can private pensions be improved?
One way might be to reverse the changes brought in by Gordon Brown. However, this might not work as businesses might be rather wary of the risk of future changes to the tax system which would remove the benefits of investing in pensions. In the current state of the economy it would also be very odd to take measures which changed incentives away from businesses investing in increasing capacity, taking on employees, or developing new products and towards providing for their employees future needs on retirement. A windfall subsidy to pension funds by reinstituting ACT would also look to be a rather peculiar measure as it would involve making cuts in broader public spending to fund it.
An alternative would be to raise other taxes to pay for this subsidy – perhaps this could be the tenth new use for a Financial Transactions Tax or “Robin Hood Tax” (leaving aside that such a tax would be likely to bite equally on the transactions carried out by pension schemes). Or the top rate of tax could be raised further (I’ve seen suggestions of raising it from 50p to 70p for incomes over £150k) although it is unlikely that this would raise anything like enough and would involve a redistribution from top earners to pension schemes and future private sector pensioners rather than to the many who are finding life difficult today.
I’m not known for being a fan of Gordon Brown’s but I mentioned earlier that his policies which so adversely impacted on private pensions were partly right. He was right in concluding that favouring employers’ pension schemes was a drag on the economy. Investing in pension funds, particularly when they were projected to be in surplus did divert investment away from productive matters and towards benefiting employees at the time when they were no longer being productive as workers. The same applies in respect of public sector workers. Nothing I have written is to diminish the importance of the work being done by many of those in the public sector. The issue is whether it is a better use of the limited resources we now have to provide people with valuable benefits in retirement than to use them in ensuring that the maximum amount possible goes towards todays public services. Businesses have been pushed towards focusing on that balance for 14 years.
Realistically it is hard to see how private pensions could be encouraged by government action now even if it might be feasible to take such measures at some point in the future when the economy is growing strongly. Even if they were to become suddenly heavily unionised it does not look credible that private sector workers could seek to force their employers into investing in new pension provisions by strike action. Even if they did, how could they guarantee that this would not be at the expense of the productive investments in R&D and so on that are needed rather than by cutting profits? Cutting profits would itself depress the value of dividends on those companies’ shares and so harm the performance of the pension schemes that employers would be being encouraged to invest in.
So, while I have some sympathy on an individual level with public sector workers who perceive that through no personal fault they are being unfairly “picked on” to pay more for their pensions, in practice, there is not a more attractive alternative. Nothing can presently be done to help private sector workers to get better pensions and those workers should not be called upon in the circumstances to safeguard public sector pensions which even after the proposed changes would be far more generous than those they could access themselves. As the adverse changes to private pensions were also used in part to fund the expansion in public sector jobs, increases in their pay and to maintain things like the pension arrangements, private sector workers have already been called on to look after their brethren in the public sector first for 14 years.
Perhaps, had private sector pensions not already been raided and killed there would have already had to have been a reckoning on public sector jobs, pay and pensions. It will come as little comfort to the strikers on November 30 but they really have been protected too long.