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Britain’s annual earnings growth update last week was significant not only because, at 8.5 per cent, it was the highest on record outside the pandemic. The data point is also meant to be the benchmark for uprating state pensions next April. A “triple lock” — which has been in place since 2011 — means state payments to retirees are guaranteed by the government to rise annually by the higher of total pay growth, inflation, or 2.5 per cent.
Protecting the spending power of the elderly, who receive fixed incomes from the state, makes sense. Otherwise gaps in spending power would grow between these groups and those in work whose pay is more likely to be maintained in line with economic conditions. But the question of how much pensioners ought to be protected is a political one.
The Conservative party’s triple lock has meant the government now spends an additional £11bn per year on state pensions, compared to a rise in line with prices or earnings, according to the Institute for Fiscal Studies. It can result in a ratchet effect, which means the state pension grows at a faster rate than the rewards of work over time, accounting for an ever greater share of national income. Indeed, the state pension has risen by about 60 per cent in cash terms since 2010, compared with 40 per cent for average earnings.
For younger workers, whose salaries have suffered in the past decade of economic volatility and low productivity growth, this is an unfair outcome. Before the triple lock was introduced, earnings growth typically exceeded inflation and 2.5 per cent. The policy means increased prosperity is shared but the costs of economic stagnation is concentrated on younger groups. Pensioners form a large part of the electorate, however, making reform a political hot potato. Britain’s state pensions are low by international standards too, though the country has a more developed private system.
The triple lock is nonetheless unsustainable, particularly as other demands on government spending rise. Alongside an ageing population, the upward ratchet means the state pension will balloon, reaching close to 9 per cent of UK gross domestic product in 50 years. The IFS reckons the additional spend on the state pension could range between £5bn and £45bn a year by 2050. The large range derives from uncertainty in forecasting the triple-lock variables, which also hinders fiscal, and retirement, planning.
A reported plan to remove bonuses from the earnings calculation for this year at least makes sense. Earnings have been boosted by one-off pay settlements to the public sector. Last year’s suspension of the triple lock was also necessary, given the extraordinary rise in earnings after the UK’s Covid-19 furlough scheme was wound down. But the system needs more than tweaking. It needs to be retired.
One option is to uprate pensions only by earnings growth. With earnings closely aligned to productivity and tax revenues, that means worker, pensioner and government incomes ebb and flow with the economy. If inflation rises significantly above wage growth, pensions could be topped up if there is political support over other demands. A clawback mechanism could be used in future years to avoid a compounding effect. Any system that tracks earnings growth over the long term would be fairer and more fiscally sustainable.
Reforming the triple lock should extend to exploring how the private pension system could also provide more support. Auto-enrolment into private pensions could be extended to cover more workers for instance, to provide more independence from the state pension. The status quo needs to change, to avoid the government falling deeper into a fiscal hole. It is time to unlock the triple lock.