Hamish McRae: They can't force us to boost our pensions, but they can give us a nudge in the right direction

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The Independent Online

The Pensions Commission, a committee chaired by Adair Turner, a former director-general of the Confederation of British Industry, will unveil its interim findings next Tuesday. Any changes in legislation will be postponed until after the election next year, as will the final report, but the political reaction to this paper will be an indication of the way the wind is blowing.

It is not difficult to piece together the elements it is bound to tackle. If people are to have adequate pensions, they have to be persuaded to work for longer and save more. That's it. There is no magic wand. How to do it is another matter.

We know a lot about what not to do. A machine-gun battery of changes in legislation, plus weak equity markets, have undermined one of the better occupational pension systems in the world. Nearly 10 per cent of the world's pension fund assets are in UK funds (see pie chart) and about half of the people in the country have some cover. That is not nearly enough but it is not a bad starting point.

We also have less adverse demographics than other European nations (see bar chart), though it is also true that our basic state pension is unacceptably low.

Instead of trying to improve an existing structure by, for example, making pensions more flexible, governments have been undermining it. The raid on company dividend flows into pensions has pulled something like £50bn out of the funds, raising the shortfalls many people face. A tax change that was designed in the bull market made the bear market worse.

Other changes in savings incentives have had disappointing results. There has been a fall in the proportion of income saved in individual savings accounts vis-à-vis the old personal equity plans. And the Government's Individual Pension Accounts have been a flop.

Now further changes are in store. The present limits on the proportion of salary that can be put into a pension fund are to be swept away in 18 months' time, and instead a cap of £1.6m is to be put on the total amount that can be paid into a plan. This, in theory, gives more flexibility but in practice takes away the simple rule that many salaried people follow - of putting the maximum additional contribution into their pension whenever they can afford it.

You can have a debate on whether the Government has been well-meaning or not in all these changes. I'd like to think it has tried but just does not understand enough about private pensions to get policies right. After all, the civil servants framing the legislation have chosen careers that give them a state pension, not a private one.

But there can be no debate about the Government's performance, which has been disappointing.

Welcome Adair Turner. The first issue is how to get people to work longer. Raising the retirement age, say to 67 or 70, is an obvious option but that would be politically difficult.

Whatever the Turner report calls for, my instinct is that tax incentives to encourage people to work longer will be more acceptable than raising the retirement age. At the moment, many European countries have tax disincentives to work longer. In Britain, the tax position is fairly neutral but it would not be hard to tip the balance so that people who worked longer kept more of their income. My choice would be to halve income tax rates on earned income for anyone over 65. The state would still gain, for the Treasury would get some revenue instead of none.

The second matter is how to get people to set aside more money. The Turner report will tackle the thorny issue of compulsory savings. The problem is partly that this is really a form of taxation, however it is dressed up, and partly that it may reduce voluntary saving.

National insurance was originally presented as a compulsory savings scheme. It wasn't, of course, but that was how it was sold politically. In wartime, compulsory savings made sense, for it took demand out of the economy when the supply of goods was insufficient to satisfy the demand. But in peacetime, only a few examples, such as Singapore's scheme, have been successful. Besides, some future government could always steal the money. You could argue that Gordon Brown has done that, for he has changed the tax basis on which savers entered a long-term contractual arrangement. Who is to know what the political composition of the government will be in 2050, when people now joining the workforce will retire?

For all these reasons, I suspect that compulsion would be deeply unpopular. Better to use savings incentives. Here we do have some experience of what works. Incentives for people to save to buy their homes have been so successful for two generations that they are no longer needed. There used to be good incentives for people to take out life assurance but these were ended. What is probably needed is a period of relative stability, coupled with a series of limited schemes to boost saving for pensions. If something succeeded, it could be reinforced.

Something, too, will have to be done about the company pension mess. If businesses have to put pension liabilities on their balance sheets (and there are good accounting reasons for thinking they should), then no company can sensibly have a defined benefit, or final salary, scheme. It is too big a risk. Legacy schemes will continue but they will be run off. So all company plans will be on a defined contribution basis, where employees will each have a pension pot into which they or their employers pay. Force companies to put more in? Good idea - except that in practice it does not matter whether the company or the employee puts the cash in. Money paid into a pension is money not available to be paid in salary. So this is much the same as any compulsory savings scheme.

All private pension providers can do is to be honest about what they can offer, invest the funds available as well as they can and hold their costs down. Have they done so? Well, not really, for they have over-sold their products and been lax about their costs.

All governments can do is to make explicit the implicit choices people make and behave honourably in their own financial management. Making things clear runs against the tail-covering that private pension fund providers now have to do. They have to put in pages of caveats to fulfill regulatory requirements. Behaving honourably? On a 50-year view, we have not been well served by either side. But one thing may become clearer next week. It is that all of us will have to take more responsibility for our living standards in old age. I think we all know that, don't we?

Could we be too rich to join the euro club?

The British rebate at the EU is about to become a hot topic. The Britain currently pays Europe about 0.25 per cent of gross national income. If the rebate were scrapped, this would rise to 0.6 per cent, but under the European Commission's proposals, it would rise by a little less: to about 0.5 per cent.

Legally, the rebate goes on for ever. Why is it to be changed at all? An intriguing little paper by Goldman Sachs explains what is happening. When the rebate was negotiated by Mrs Thatcher in 1984, Britain was one of the poorest EU states; then, only Ireland and Greece had a lower gross domestic product per head. But things have changed. On the Commission's figures, GDP per head is now one of the highest in the EU: only Luxembourg, Ireland, Denmark, Austria and the Netherlands are higher.

If you look at GNI, a slightly different measure of the size of the economy from GDP, the performance of the UK is even more remarkable. We are the second richest after Luxembourg, which has only 460,000 people, who benefit from doing Germany's offshore banking and transfers to EU institutions. Of the normal economies, Britain is now the richest. Not many people know that - indeed, I don't recall Gordon Brown boasting of it yet, though no doubt he will shortly.

Which is the better measure, GDP or GNI? The first measures the domestic economy, the goods and services produced in the country. The second measures the total income available to the country to spend, including income generated from overseas. We go up the ladder a little as a result of our earnings from foreign investments. Some other countries, notably Ireland, go down because of the profits that are repatriated to other countries that have invested there.

If you are the Commission, trying to argue the UK should pay more, the GNI figures are clearly the ones to go for. But if you are trying to argue that Britain is losing out by not being a member of the eurozone, the fact that Britain has become, in effect, the richest country in Europe makes that a bit tricky.

From our perspective, having such a high national income may make the rebate negotiations tricky too. So maybe the Chancellor won't make so much of this intriguing little fact, after all.

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