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FLIGHT Howard 2Lord Flight was Shadow Chief Secretary to the Treasury from 2001-2004 and led for the Opposition on the FSMA.  He is now chairman of Flight & Partners Recovery Fund.

The Public Service Pensions Bill is
currently going through its Committee Stage in the Lords.  Its content and arrangements reflect “the
deal” done by Francis Maude with the Public Sector Unions, in turn based on the
Hutton Report.  Given the long-term
nature of pension arrangements, there is clearly a case for having cross-party
agreement as far as possible and agreement with the Unions; and Lord Hutton’s
Report was, in principle, balanced and reasonable.  The draft legislation also gives the Treasury
large powers to intervene, going forward, where Clause 11 of the Bill provides
a legal framework for the proposed system of cost control.

For most of the Public Sector — i.e. Health, Education, Civil Service (other than Local Government, academics
and police) — Public Sector pensions remain unfunded, pay as you go, (PAYG)
defined benefit schemes, with inflation indexed increases.  By contrast, in the private sector, most
Defined Benefit Schemes have now been closed, on the grounds of costing too
much, so placing the investment risk on the individual members, and without
scope for automatic inflation indexation. 
I believe it would be impossible, at least for the present, for PAYG public sector schemes to change to being funded largely because of the
“pay twice” problem – contributions would be required both to meet pensions in
payment and to credit employees’ funded personal accounts.


The fundamental issue, which I
believe will make the Hutton framework unsustainable going forward, is the cash
flow shortfall cost.  In 2005/06 the PAYG
cash flow shortfall was a modest £200m but, since then, it has grown rapidly
and is forecast by the OBR to reach £15.4bn by 2016/17.  This forecast, however, was before last
December’s ONS Report on Mortality, to the effect that people are now living 6
years longer than pension, life expectancy projections.  If this is the case, it adds a further £7.2bn
to the cash flow shortfall.  The
Government has also now announced its Single Tier Pension proposals.  The key cost control/funding source for this
is the abolition of the State second pension and, with it, the abolition of
“Contracting Out”, – under which the relevant amounts of employer and employee
National Insurance Contributions have been transferred to individuals’
occupational pension schemes.  For Public
Sector Schemes, the ending of Contracting Out payments must, inevitably,
increase the cash flow shortfall yet more, albeit that it is to be phased out
over time.  The result of this, together
with the additional cost of 6 years’ underestimated longevity, is a cash flow
deficit not of £15.4bn p.a. but in excess of £25bn p.a.
I simply do not believe the public
finances can afford to finance an increase in the cash flow deficit of this
order.  It is also manifestly unfair for
the 23 million tax payers in the private sector, whose pension arrangements
have mostly deteriorated dramatically, to be obliged to provide a subsidy of
this size to sustain Public Sector, Defined Benefit Pensions.

There are 4 ways, or a mixture of
them, which could, in principle, reduce or eliminate the cash flow deficit; –
higher employee contributions but these would have to rise to some 35% of
salaries if they were to cover the true economic cost of the pensions promised,
which is clearly impractical:  the
pensionable age could be increased, which is likely to happen; reducing
accruing pension rights, which is provided for in Clause 11 of the Bill: but
the Government has so far set its face against any measures to reduce pensions
in payment, on the grounds that this would amount to breach of contract.

In the wider context, as and when
QE is phased out because of its growing, future inflation risks, and the
Government has to sell gilts (at a higher rate of interest than at present) to
finance its large, on-going deficit, (rather than printing the money to do
this, which is what QE amounts to), there is the catch-22 question as to
whether or not it will be possible to sell £100bn-odd of gilts each year,
without, at the least, a major rise in gilt yields and thus the cost of
servicing the growing debt.  The pressure
will then be to cut the huge on-going Government deficit, further and faster.  Against such a background, I do not see that a
public sector pension cash flow deficit, increasing from £5.8bn last year to around £25bn in 4 or 5 years’ time, is politically or financially
viable.

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