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It has not been a good week for Rachel Reeves, with the UK’s economic growth being downgraded in the latest IMF forecasts, the war in Iran predicted to hit us harder than other major economies, and her inability to provide additional funding to rebuild our forces. There is, however, a way forward, if she were to take it.
It is not quite a get-out-of-jail-free card, but it would clear another path where she could rebuild the government’s finances. If she could do so, it would make the country’s fiscal position vastly much more manageable.
It is to loosen the triple lock on the state pension. The argument against the triple lock – the mechanism by which pensions increase by whichever is highest of average earnings, inflation, or 2.5 per cent – comes in two parts. That it is unaffordable; and that it is unfair.
The case for it being unaffordable is the result of the growing numbers of people of retirement age relative to those still at work, the volatility of earnings, and the surge in inflation. The Office for Budget Responsibility (OBR) calculates that the annual cost of the policy is three times what it was expected to be when it was introduced in 2011, and that this additional charge is estimated to reach £15.5bn by 2030. So despite its popularity among the huge numbers elderly voters, the pressure is on for the Government to abandon it.
But there is a problem. Rachel Reeves doesn’t have a £15bn hole she needs to fill. It is more like £140bn. The deficit in 2024-25 was over £150bn, and while it may have come down a bit in the financial year just ended, on her projections she has to get it down to something like £60bn a year by 2030-31.
Given the need for increased defence spending, ending the triple lock would help but isn’t nearly enough to change the outlook.
As for the fairness argument, the issue is partly that national insurance is sold to voters as people paying for their medical care and saving for their pensions, when actually it is just a tax like any other. You could see it as a transfer of wealth from working people to retirees, and in a very real sense it is.
But the present generation of pensioners did the same for the previous generation of retired people when they themselves were at work. They stumped up for other people’s pensions; why shouldn’t younger people, who in real terms are paid much more than they were, stump up too?
It is not that pensions are particularly generous. The basic state pension is about 20 per cent of average earnings, while the new state pension introduced from 2016 is about 25 per cent of earnings. There are many other benefits for older people, and about half UK retirees have private pensions on top. But our state provision is relatively low by international standards.
Given all this, why might ending the triple lock be the solution to the Chancellor’s plight? Three reasons.
One, the cost is worth saving. It was the US senator, Everett Dirksen, who famously declared: “A billion here, a billion there, and pretty soon you’re talking real money.”
Second, pushing through an undoubtedly unpopular fiscal measure would help convince the financial markets that Reeves is indeed being responsible about the country’s finances, and thereby cut the cost of financing the national debt. At the moment the yield on 10-year gilts remains around 4.75 per cent, by far the highest of the G7 countries, with the US next at 4.25 per cent.
Cutting the cost of government borrowing would not just improve public finances; it would also enable the cost of fixed-rate mortgages to come down too. It is perfectly plausible that another £15bn a year could be trimmed from the government’s interest bill, which was around £111bn last year.
And third, cutting pensions, or rather slowing their growth, would make it politically possible to trim other benefits. If you simply linked pensions to earnings, that would seem fair to most people, and it could be linked to other cuts in benefits on the grounds of shared pain.
Everyone – young, old, employed, unemployed – would be playing their part in putting the country’s finances on a sustainable footing.
Need to know
The story that emerges most powerfully from this debate about the future of the triple lock is the grinding need to get the cost of financing the national debt under control.
The total debt is around £2.9trn, and I expect the OBR estimate that interest was a little over £111bn in the financial year just over will prove too low. There are three main determinants, and none of them look good.
One is the short-term interest rate, as set by the Bank of England. Whereas even a few weeks ago it looked as though there would be one or two further cuts this year, now the markets are pricing in at least one increase. The government can finance some of its debt by issuing Treasury bills – but the rate of those is heavily influenced by the Bank’s decisions, so help that it had expected from rate cuts has rather evaporated.
Two, about one quarter of the national debt is index-linked, and to the Retail Prices Index (RPI) rather than the Consumer Prices Index, which is lower than the RPI. Since inflation this year will be much higher than expected, I am afraid that pushes up the cost too.
And three, there are gilt yields, the most important determinant of all. This is a global story, for all governments benefitted when yields went to near zero in the late 2010s. Our 10-year gilts were below 3 per cent right through from 2011 to 2022, and actually went down to below 0.2 per cent in 2020. In Europe, German bonds actually went negative. People had to pay the government to be allowed to lend to it. That looks mad now, and actually I thought it was nuts at the time, but it was a universal phenomenon – you could say a universal policy error of gigantic proportions.
Anyway, that is all over now. We cannot control, or even affect, global yields. But we can influence the premium or discount we pay relative to other governments. For most of this century we were middle of the pack, never with the lowest rates (that was Japan) but not with the highest ones either. Now we are an outlier, paying far more than anyone else.
This is a failure of policy, and I think we have to be honest about that. The Liz Truss episode hasn’t helped, but for most of the period under Tony Blair and Gordon Brown’s Labour, the coalition and then Tory governments, we did not have to pay more than other comparable countries. Now we do, and that really is the fault of Rachel Reeves and her colleagues in Cabinet.
She could turn it round, by following the policies sketched above. Will she? I fear not. But maybe her successor will.
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