Sunset for pensions

No politician dares suggest that depriving a chunk of the country of its retirement prospects is a f

The biggest debate in British politics in 2010 will be how to cut the size of government. With annual borrowing heading for £178bn in this fiscal year, whoever is in charge will have to wield the axe. One obvious target for the government and opposition is proving to be retirement. The consequences of removing pensions benefits, though painful, are felt later rather than sooner. But as we saw with Gordon Brown's dividend-tax raid on private pension funds in 1997, such measures can have hugely damaging effects.

Alistair Darling's December 2009 pre-Budget report was filled with pension cluster bombs. By far the most important was the decision to postpone implementation of New Labour's landmark "personal account" pensions reform, with a saving to the state of £2.3bn by 2014-2015, making it one of the largest identified cuts. Darling insisted on the delay despite a spirited fight by the Work and Pensions Secretary, Yvette Cooper.

The impending political battle over the costs of retirement was signalled by the Conservative shadow chancellor, George Osborne, in his October 2009 "austerity" speech to the Tory party conference in Manchester. Osborne was accused of betraying the elderly and failing to think through the consequences of raising the retirement age to 66 from 2016.

But the Tories were also recognising that, for much of Labour's 13 years in office, pensions have been an issue that dare not speak its name (though it has been at the core of Labour's value system since the Attlee government steered the National Insurance Act through the Commons in 1946). Over the first decade of New Labour, differences over pensions came to symbolise divisions between Tony Blair and Brown. Blair was a long-time advocate of pensions reform. But Brown saw any efforts to fiddle with state, public- or private-sector pensions as an intrusion on his territory at the Treasury.

The result was years of stalemate, bungled decision-making and the impression that no one really cared. It was only after heated meetings at N0 10 between Brown, the then pensions secretary, John Hutton, and Blair in 2006-2007, that agreement was reached on sweeping changes to retirement provision, based on the recommendations of the Blair-appointed Pensions Commission, led by Lord (Adair) Turner.

In an effort to phase out the need for widespread means testing, state pensions would be linked again to rises in average earnings from 2012 onwards. This would be paid for by raising the state pension age to 66 from 2026 (ten years later than the Tories), 67 in 2036 and 68 in 2046. All private-sector workers would be automatically enrolled in a new, government-organised scheme of "personal accounts" (just renamed the National Employment Savings Trust), similar to others in Australia and Sweden. This should have been operational in 2012.

It was the delayed implementation, if not destruction, of these plans that Darling sneaked through in December.

Deep in debt

The need to do something about the Budget deficit is clear: for every £4 the government will spend in the next financial year it will raise just £3 in taxes. As a result, borrowing in the current financial year will surge to 65 per cent of national output, the highest figure in peacetime (with the possible exception of a short period in the 1970s).

Without sharp rises in taxation and spending cuts, borrowing could rise to 78 per cent of GDP by 2014-2015. But these numbers tell only part of the story. Britain has enormous hidden liabilities that are not included in the Budget. Among the biggest of these burdens on future generations is the nation's unfunded pensions promises to employees in the public sector.

The number of state workers has surged under Labour as more than a million people have been added to the payroll.

The last published figures show that civil ser­vice pensions liabilities climbed 40 per cent - from £84.1bn to £119.4bn - in the three years to March 2008. However, if you count the total liability across government, including the NHS and education, the figure rockets to £750bn. Local government funds alone will have a deficit of £60bn next year, according to new data collected by the Liberal Democrats. Despite this, reform of public-sector pensions is one of the great unmentionables of the political debate. So far, no politician has dared suggest that depriving a large chunk of the country of retirement prospects is a fiscal necessity.

This, however, is precisely what has been happening in business. Britain's defined-salary pension scheme, not so long ago the best funded of all those in the western democracies, has been in decline ever since Labour came to office. The retreat is a product of several factors.

In 1997, Gordon Brown, in his first Budget, abolished the tax break for dividends invested in pension funds, removing an estimated £125bn of income. Extra regulations have also hugely increased the cost of running such schemes. Pile on the additional burdens of changing mortality as people live longer, and more than a decade of turbulent stock markets - culmin­ating in 2008's crash - and the gold-standard final-salary pension becomes an unbearable weight for many companies.

Generous package

It used to be said that the baby-boomer generation - with its inflation-proofed final-salary retirement plans - was the "pensions aristocracy". That may have been the case, but the most fortunate are now in the public sector, where many are in non-contributory plans that pay out inflation-proofed pensions at the age of 60.

Generous retirement arrangements for state employees were seen as compensation for lower wages. However, during the recession, average pay in the state sector has caught up with pay by private companies. In fact, this clash of reward structures, if not addressed, could damage social cohesion and the de facto contract between taxpayer and state.

The Confederation of British Industry has been among those leading the calls for reform. The employers' group proposes that the retirement age be raised to 65 for younger state workers. More realistic employer contributions should be deployed and mortality assumptions altered in line with practice in the private sector.

The Chancellor unveiled changes, aimed at capping public-sector pensions, in December. But with estimated cost savings of just £1bn, these barely scrape the surface. At the very least, public-sector retirement ages should move in step with those for state pensions, thereby cutting back the burden for future generations of taxpayers. However, a bolder solution would be to bring future public-sector employees under the umbrella of the "personal account" system, if it gets off the ground.

There is no reason why the government, setting an example to the private sector, should not contribute more than the minimum. Unfortunately, that is not going to happen. All too often, when it comes to pensions, obfuscation and complexity are preferred to bold thinking.

Alex Brummer is City editor of the Daily Mail