Demographic changes mean that reform of the welfare state is inevitable. Families and individuals have to take more responsibility for themselves, but the government must avoid crude taxation of pensions and other disincentives to save
Everybody knows that the population is getting older. Not only are the baby boomers (people born between 1946 and 1964) starting to retire in large numbers, but fertility rates are falling and people are living longer. As a result ‘dependency ratios’, the number of workers per dependent member of the population, will worsen in years to come.
There should also be no surprise that population ageing will present fiscal challenges. Spending in areas like health, pensions and long-term care is growing as the share of the population of working age who fund this spending falls. These changes will impact on governments’ spending plans, tax bases and fiscal headroom; limit the degree to which future fiscal policy could respond to major shocks; force reform of the funding of the welfare state; and force changes to the delivery of public services, with, for example, health systems needing to focus more on long-term conditions.
As a Reform report released today shows, these demographic and fiscal changes mean that reform of the welfare state is inevitable. The question is when – not if – change must take place. And as Reform also showed, undertaking reform soon would mean the overall costs of change would be less and disruption to families would be reduced.
Any reform must recognise the need for families to take more responsibility for themselves. Often this extension of responsibility is seen as a negative development, but the lesson from countries like Australia and New Zealand is that this can be good news.
By reducing pressure on the public system, more private funding can make programmes more affordable in the long-run. The greater use of private savings and products like insurance and equity release can also mean families have more options. They can make arrangements that reflect their circumstances, rather than having to just rely on what the state provides.
Yet creating a better environment for private funding provides challenges. On this, the recent experiences in Australia and New Zealand can provide valuable lessons for the UK. One lesson is the importance of clarity and consistency. Decisions regarding savings and the purchase of private income support policies are by their nature long-term ones. The more uncertain the environment, the harder it will be for families to make the decisions that are in their longer-term interests and for private providers to complement State programmes.
This debate is especially relevant given current suggestions that pension tax relief will be targeted for savings in the Autumn Statement on 5 December. Reform to the system of pension tax relief is a good idea. As the Pensions Policy Institute has noted, this relief in the UK is expensive and is equivalent to around 2% of GDP.
The international evidence on tax relief also suggests that pension tax breaks are likely to mostly go to wealthier people who would have saved anyway and fail to significantly lift national savings. There is a case for considering reform to this system on value for money grounds.
Yet our concern is that rather than a coherent package of reform, any changes to pension tax relief may be little more than a crude tax rise on the wealthy. This approach will risk double-taxing savers and lead to a more uncertain environment and discouraging savings. By failing to lay out clear principles and commit to open policy development, the government risks scoring a costly own goal.
Dr Patrick Nolan is the chief economist of the independent think tank Reform. Its research report Entitlement Reform is published today
