Lilley the radical guesses 40 years ahead

The Government's proposals to privatise the basic state pension and scrap the earnings-related scheme, announced yesterday, is one of the most audacious plans for almost 20 years.

Peter Lilley, Secretary of State for Social Security, described his plans as "enabling pensioners to share in future economic growth ... and ultimately, to relieve taxpayers of their biggest burden."

Mr Lilley's department claimed the Basic Pension Plus plans, which involve paying young people pounds 9 per week towards a personal pension from the moment they start work, will eventually save up to pounds 40bn from the public spending bill by 2040. Department of Social Security officials argued that the cost of paying the basic state pension, plus income support to those on the poverty line, costs about pounds 42bn a year. This figure is rising fast as more people reach retirement age and then go on to live longer. By implementing this scheme, the total state-pensions bill would be reduced to about pounds 10bn in 40 years or so.

But Labour's pensions spokesman, John Denham,seized on DSS figures showing the cost of paying pounds 9 weekly to young people's pensions would rise by pounds 160m each year, spiralling to pounds 7bn a year in about 40 years, to claim that existing taxpayers would be forced to foot the bill for this largess.

The proposals are the latest stage in a retrenchment over funding of pensions. The retreat from a generously funded state scheme, which began barely a year after the Tories took office in 1979, has continued unabated for more than 15 years.

The most significant initial step taken in 1980 involved reining the basic pension only in line with inflation and not earnings. Because pay generally rises faster than inflation, the value of a basic state pension has dropped from 20 per cent of average earnings in 1979 to 15 per cent today. It is predicted to fall to 10 per cent in 25 years. The second step taken by the Government has involved the whittling away of Serps, the state-earnings-related system. When it was first introduced by Barbara Castle in 1978, at the end of the last Labour government, Serps was intended to add a further 25 per cent of average wages at retirement.

This too has been gradually stripped away, again by linking Serps to inflation and not earnings. A further measure has involved pegging the upper income limit, beyond which Serps is not payable, to inflation too. In effect, the maximum earnings that can be counted towards a Serps pension - about pounds 23,600 at present - will drop relative to people's incomes.

Peter Tompkins, actuary at the accountancy firm Price Waterhouse, has estimated that someone on typical earnings of pounds 16,500 might expect pounds 3,500 a year in addition to their state pension if Serps were fully linked to earnings. By 2040 this will fall to pounds 1,400.

Although initial reports focused on the Government's abolition of Serps and its replacement with a 5 per cent National Insurance rebate, once again payable into a personal pension, this has been virtually accomplished already.

The real debate is over whether it is cheaper for taxpayers to provide existing benefits to pensioners under the proposed new system.

Mr Lilley argued that the rising costs of meeting the pounds 9 weekly commitment to young people would be funded by a combination of two factors. Whereas at present, for every pounds 100 of contributions the Revenue pays pounds 24 for basic taxpayers (pounds 40 for those on the marginal rate), this will not happen in future.

The Government claims young people will gain from not having their pension taxed when its is finally paid. But most governments' tax promises have tended to be at variance with the facts a year or two after being made, never mind 40 years' time. In any case, what happens if new priorities mean that pounds 9 weekly spending commitment cannot be met?

Mr Lilley also hopes minor economic growth - ahead of existing targets - will meet the remaining bill. Again, this depends on whether such growth can be maintained for 40 years. Moreover, the point at which state pension costs will finally be cut - about 2040 - is when the ageing population finally stabilises anyway.

A DSS spokesman said: "The rising costs are nothing to be scared of. We have already shown we are capable of cutting the cost of pension provision, by our previous reforms of Serps and by the equalisation of state pension ages at 65. Assuming normal economic growth, we can afford the changes."

There is the additional question of charges. It costs at least 10 times more for a private firm to collect its members' contributions than it does for the Government to collect National Insurance payments. Confidence in this new private sector involvement, coming after the massive pensions mis-selling scandal of recent years, will not be very great.