How to solve a problem like the ‘triple lock’

Few subjects are as touchy as the annual increase in the state pension. My own view is that it would be right to tweak the ‘triple lock’ this year, but wrong to scrap it completely – at least until we have come up with something better.

Just in case you have been on the Moon, the ‘triple lock’ is a commitment to raise the state pension every year by whichever is the highest of consumer price inflation, average earnings growth (a measure of wage increases), or a guaranteed minimum of 2.5%.

Since it was introduced in 2010, the ‘triple lock’ has typically resulted in annual increases of between 2.5% and 4%. However, if the standard formula is applied this year, the state pension could rise in April 2022 by at least 8% – providing an unintended windfall.

This is because the economic fallout from the Covid pandemic has distorted the earnings data in ways that no-one could have anticipated. The usual benchmark for the ‘triple lock’ is the change in average weekly earnings in the three months to July compared to the same period a year earlier. In the three months to June, this measure was 8.8%. The July figure might be a little lower, but could still be around 8.5%.

The main reason is a jump in the average number of hours that people work each week as the economy has reopened and more come off the furlough scheme. This in turn has boosted weekly pay relative to a year earlier (a ‘base’ effect).

In addition, the jobs lost over the past year are more likely to be lower paid. This means that the average earnings of people still in work have increased compared to those employed before the pandemic (a ‘compositional’ effect).

At this point, anyone still reading might be thinking ‘so what?’. The Conservative government made a manifesto promise to retain the ‘triple lock’, warts and all. But some sort of fudge could still be justified, in four ways.

First, the distortions due to the pandemic mean that the average earnings figure is not doing what it is supposed to do, which is to ensure that the state pension at least keeps pace with the typical pay increases for those in work.

A temporary switch to some underlying measure, such as the average annual growth in earnings over the last two years (likely to be about 3.6%), would therefore still be in line with the spirit of the manifesto commitment.

Second, such a change might also be consistent with the letter of the commitment. The relevant legislation does not actually specify which measure of average earnings should be used, allowing Ministers to use their discretion.

Third, there are the issues of fairness – and cost. Increasing the state pension by, say, 8.6% rather than 3.6%, would add about £4.5 billion to annual spending, both in 2022-23 and in every future year. This cost would mainly land on younger taxpayers who have suffered the bulk of the economic hit from the pandemic.

Put another way, suppose that average wages had fallen 20% last year then rebounded by 25% this year. Would supporters of the ‘triple lock’ really think it fair to insist on a permanent 25% increase in the state pension? It certainly seems to odd to argue that it would be ‘unfair’ for pensioners to miss out on X thousand pounds of retirement income if they don’t get an 8.8% increase – when they never would (or should) have expected such a big rise in the first place.

Fourth, there is a precedent. The government has already broken the manifesto commitment to spend 0.7% of national income on overseas aid, citing the impact of the pandemic. If the principle of sticking to your promises is what really counts, it would seem odd to support one breach, but not the other.

Nonetheless, these arguments are not necessarily good ones for scrapping the ‘triple lock’ permanently. The earnings link serves a useful purpose in making sure that older people continue to benefit from rising prosperity in the economy as a whole (in a way that just indexing to inflation would not).

The point about intergenerational fairness is also weaker when considering the longer-term future of the ‘triple lock’. Today’s young people will, of course, be the pensioners of the future, and hopefully all will live long enough to benefit.

That said, the ‘triple lock’ is not sustainable, indefinitely. It has a ‘ratchet effect’, because pensioners participate in any upside during booms when wage growth is strong, but are protected on the downside during recessions when wage growth is weak. As a result, the share of national income spent on paying state pensions will inexorably increase over time. And this is on top of all the other fiscal pressures from an ageing population, including the rising bill for health and social care.

Some supporters of the ‘triple lock’ are also overplaying their hand by arguing that the UK’s state pension is relatively low to begin with. It is true that OECD data suggest that, on average, UK pensioners might have to get by on just 28% of their previous income.

But this figure is misleading because it ignores non-mandatory arrangements, notably the government-backed auto enrolment scheme and the UK’s relatively well-developed system of private pensions. Including these, the UK data are far higher and only just below the OECD average.

It is right to be most concerned about those on the lowest incomes who cannot afford to top up their pensions. But here, the UK’s pension system is actually slightly more generous than the OECD norm. In any event, there may well be better ways to target pensioner poverty (including pension credit) than a blanket increase in the state pension for all.

So, this is what I would do. This year, use the flexibility already available to switch to an alternative measure of ‘average earnings’. Ideally this would be based on some underlying measure that strips out the base and compositional effects, or a direct measure of pay settlements.

But since this would be hard to do objectively, a simpler approach would just be to take a two-year average of the current headline measure. This would be preferable to dropping the average earnings component altogether, partly because that would be a clear manifesto breach, and partly because this link still has some merit.

I would then revert to the usual measure next year and keep it at least until the next General Election. However, the government should also undertake a fundamental review of the future of the state pension. This would address the genuine concerns both about pensioner poverty and about intergenerational fairness, as well as the long-term affordability of the ‘triple lock’ itself.

This article was first published by the Daily Telegraph on 19th August 2021

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