BLOG: Two solutions to avoid an intergenerational bust-up over the triple lock
The pandemic has put many of the UK’s systems and institutions under considerable stress over the last 16 months or so, and in recent weeks, the state pension has emerged as the latest source of political tension.
According to the latest official figures, and depending on experiences over the next three months, state pensioners could be on course for an 8.4% increase in payments come April 2022. This would cost the chancellor an estimated £4bn extra in the coming year and every future year.
When compared to far lower recent public sector pay deals, this could create major intergenerational tensions. Remember, today’s state pensions are paid from National Insurance contributions of today’s workers.
The bumper increase stems from the way the state pension’s triple lock uprating mechanism works. Aiming to increase state pensions in line with finances of the working population, with a safety underpin, increases are based on the highest of ‘national average earnings’ growth, price inflation or 2.5%. But the formula was created in a world before the Covid-19 crisis and could never have predicted the dramatic shocks we’ve seen to the labour market since the pandemic hit.
The earnings growth element is based on ONS national average earnings data. This, as the ONS highlights, has been distorted by furlough. As many individuals suffered a temporary 20% cut in earnings starting around March / April 2020, average earnings figures fell sharply.
Now, as furlough is gradually ending, many in this group are seeing a bounce back to full time earnings, pushing up year on year earnings growth just to regain lost ground. Alongside this, but working in the opposite direction, a disproportionate number of lower paid jobs were lost, meaning the composition of remaining jobs now includes a higher proportion of better paid jobs, increasing the ‘national average earnings’.
If, as lockdown ends, we see these lower paid jobs returning in the coming months, that will put downward pressure on national average earnings. Taken together, these distortions mean the headline growth in ‘national average earnings’ bears little resemblance to what those who kept their job, without furlough, are likely to have seen in terms of a pay-rise.
To illustrate the extent of distortions, the latest earnings data show an 8.4% increase in wages from April last year to this year or a 5.6% increase if you look at the average from February to April. But ONS reckons a truer underlying increase is far lower at around 3%.
The earnings component of the triple lock is based on how the average figure for May to July 2021 compares to the same period in 2020. A lot will depend on what happens over the next three months, but an outcome of 8.4% or even more is certainly possible.
At a time when the chancellor is keen to get the nation’s finances on a sounder long term footing, and having taken difficult decisions around public sector pay, I’m sure this is a dilemma he’d rather do without. And either maintaining the manifesto commitment or amending the triple lock are likely to prove controversial.
The working age population have been hardest hit by the pandemic from an economic perspective and yet face picking up the tab for the increase while many pensioners are likely to argue that the triple lock is a commitment they expect the government to keep.
While the government maintains it’s committed to the triple lock, I see two possible options to resolve this dilemma, if they are looking for a compromise.
The ONS data show that once recent labour market anomalies have been stripped out wage growth has been closer to 3%. This is more in line with the original intentions behind the triple lock and might be accepted by many as an acceptable way forward.
However, the increase in April 2021 was based on figures which hadn’t had the distorting effects removed. At that point, earnings had actually fallen by 1% year on year and pensioners received the minimum 2.5%. If last year’s distortions were removed, might state pensioners been granted a higher increase based on adjusted earnings?
The other route, which we recommended last summer, is rather than looking at earnings growth and price inflation year-on-year, to smooth out peaks and troughs caused by the pandemic, why not average things out over two or three years. Both these solutions involve technical changes, but do follow the principles behind the triple lock.
The other option of blindly following the state pension triple lock formula, which was never intended to cope with the extraordinary times we’re going through, would grant state pensioners what could be seen as a windfall win from the chaos the pandemic has brought to those of working age.
No doubt the chancellor will have many more difficult decisions to make as we get on the road to economic recovery. Ideally, he’ll make these decisions through a lens of intergenerational fairness.
Steven Cameron is pensions director at Aegon UK