An unnecessary gamble with all of our futures

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Professor Patrick Minford, the noted Thatcherite economist and former adviser to the Treasury, has had a very satisfying week. The ink had barely dried on a paper by the Professor in which he called for the basic state pension to be privatised when the Prime Minister stepped up to tell the world that this plan would be enacted if the Conservatives win the election.

Forget council housing, telephones, even water and gas. To bring down one of the pillars of the post-war welfare state - the concept of basic pension provision paid directly by the state - must seem a momentous achievement to John Major. Rarely has the symbiotic relationship between right-wing libertarian ideology and government practice appeared so stark.

But there is one important difference between this privatisation and the ones that preceded it. This may be the mother of all privatisations but it will not pay for a shower of tax cuts. The reverse is in fact the case. The cost of the transition from a pay-as-you-go system to a private one, called the Basic State Pension, will rise by pounds 160m annually to pounds 7bn a year by 2040. In total, the cost to the exchequer over the next 44 years will be pounds 150bn.

If Tony Blair had announced a similar spending commitment, Labour's electoral chances would have vanished in a puff of smoke. Surprisingly, Peter Lilley, Secretary of State for Social Security, has been able to offer up his plans as common sense ideas that only the churlish wouldconsider opposing.

Basic pensions are Mr Lilley's greatest debt to Professor Minford's right-wing radicalism. For more than a decade, the Government has persistently rejected demands by pensioners and poverty campaigners to restore the link between state pensions and average incomes, first broken in 1980. As a result, today's basic pension of pounds 61.15 a week is worth 15 per cent of average pay, down from 19 per cent in 1979. Experts believe its value will drop to less than 10 per cent of earnings within 30 years. This amount, equal to about pounds 35 a week at today's levels, means that millions of people without personal or company pensions and with chequered employment histories will face grinding poverty when they retire.

CHANGE of some kind is necessary. It has been forced by the "demographic time-bomb", the fact that Britain's population is gradually getting older. The number of people of pensionable age will rise from 8.9 million in 1991 to 13.5 million by 2030. Meanwhile, the number of people in work, and therefore able to pay taxes to support those in retirement will shrink proportionately. Five working people supported one pensioner in 1948. By 2030 five people will be paying for three people in retirement.

Meeting the cost of the basic state pension, plus welfare top-ups for those, mostly women, whose work history means they do not receive the full pension, presently costs about pounds 42bn. This is met almost totally out of National Insurance contributions, a 10 per cent tax on incomes between pounds 60 and pounds 465 a week.

Mr Lilley is proposing that by the end of the next parliament, the basic state pension should be scrapped, along with Serps, the earnings-related pension set up in 1978 by Barbara Castle during the last Labour government. In place of the basic state pension, the Government will pay pounds 9 a week to young people as soon as they start work. This will go into a personal pension of their choice. Serps, which aims to give people a retirement income linked to the annual average of 20 years' earnings, will be replaced by a 5 per cent rebate of National Insurance Contributions, also to be paid into a personal pension.

The Department of Social Security says investment returns of 4.25 per cent will enable these combined contributions to grow to a personal fund of pounds 130,000, which would ensure a pension worth pounds 175 a week.

It sounds great but in fact it's not as simple as that. The 4.25 per cent is a "real return"above inflation, currently 2.5 per cent, which means that even if VAT stays at its present level, fund performance would have to be 6.75 per cent a year until 2040 for the target to be reached.

There is also the cost of looking after the funds to be taken into account. Even the cheapest fund managers charge about 1 per cent a year, which means investment returns would have to come close to 8 per cent a year almost in perpetuity. Many investment managers in the life insurance industry, which is salivating at the prospect of this wall of pensions money coming its way, warn, privately of course, that this rate of return may not be achievable over the long-term. Instead of a fixed payment for all, the prospect opens up of successive generations reaching pensionable age and retiring with vastly different amounts of money, depending which pension fund they chose, its charges and investment performance.

Mr Lilley's plan to farm out the management of these billions to the private sector appears also to ignore completely the behaviour of the financial services industry over the past decade.

Despite repeated warnings, the Government gave the green light to the mass marketing of personal pensions. The result was a mis-selling scandal involving up to 1.5 million people. Now, we are being told that these same companies, which have so far compensated barely 7,000 people out of the 500,000 identified as "urgent cases", will be entrusted with more of our money.

This time, so they say, tight controls will be enforced by the Personal Investment Authority. Yet it has proved spectacularly inept at forcing members to toe the line on the mis-selling scandal. Nor did the Government even bother to consult the the authority about regulating the new breed of privatised pension providers.

And the entire privatised edifice will be paid for with our taxes. Everyone now working will be expected to continue paying for those currently in retirement. But when we retire, there will be no one left to pay for us.

Young people will be expected to pay for their own retirement, leaving the present generation to meet a double bill out of their taxes, for their own pensions and for those of people who have already retired. The cost of doing so will reach pounds 1.5bn a year in a decade, double that in another 10 years, and rising to pounds 7bn in 2040. And that assumes the Government's optimistic estimates about rising economic performance and investment returns are correct. Even for a population used to seeing its government boost the private sector at the expense of the welfare state, this is an amazing set of proposals.

But the problem for Labour, as is so often the case, is what it would put in their place. Talk coming from the office of Harriet Harman, Labour's social security spokeswoman, is reassuringly of a strategy of "choice", based on retaining the existing state pension. That would be backed by a more tightly interwoven web of "second-tier" provision, in which Serps, private and company pensions would all figure, alongside new industry- wide "stakeholder" pensions operated by unions or employers.

This, however, ignores the fact that millions of people are reaching retirement age without one of these second-tier pensions. For them, as for tomorrow's pensioners, the issue is still one of a decent first-tier retirement income. There is no escaping the need to increase the basic state pension substantially.

Could the cost of doing so really not be met out of government coffers? The perhaps surprising answer is "Yes, it could."

National Insurance Contributions are at present levied only on the first pounds 24,180 of income. Thereafter, those earning over this amount contribute nothing. So the better-off pay less as a proportion of their income than those with average earnings. Scrapping this contributions ceiling for the employed and self-employed would raise up to pounds 7.5bn a year.

True that would be a new tax, something Gordon Brown, for Labour, has pledged not to impose after the election. Perhaps someone should point him to his predecessor, John Smith, whose proposals showed he would have had no such qualms about raising the money this way.

Until then, millions of pensioners will continue to live in ever-more desperate poverty. And it will still be possible for people like Professor Minford to put forward solutions to the scandal which could condemn today's teenagers to a very uncertain fate 50 years hence.