On the basis of Theresa May’s answers at yesterday’s Prime Minister’s Questions, there has been significant speculation about whether the Conservative manifesto will pledge to maintain the ‘triple lock’ on the basic state pension (and the new single-tier pension) – guaranteeing that the annual rise will be the highest of inflation, average earnings growth and 2.5%. In this observation we discuss the problems with the triple lock, along with alternatives.
The most obvious problem with the triple lock is that 2.5% figure is totally arbitrary – it is entirely unclear why in a year where inflation and earnings growth are less than 2.5% the state pension should rise faster than both. But the biggest problem with the triple lock is the ‘ratchet effect’. Because the state pension grows in line with the highest of earnings, prices and 2.5% in the long run it will increase faster than all of them. This is the reason why the triple lock has such a significant effect on state pension spending in the Office for Budget Responsibility’s long-run projections. Relative to increasing in line with earnings each year the OBR estimates that the triple lock could increase pension spending by 0.8% of GDP in 2060–61, which is equivalent to £15 billion in today’s terms. The key thing to note is that getting rid of the 2.5% guarantee and moving to a so-called ‘double lock’ would not eliminate this issue. The state pension would still rise faster than both earnings and prices in the long run, and would still eventually become unaffordable.
The solution to the ‘ratchet effect’ is to go with an idea we discussed in our 2015 election analysis (page 15 here), which has since been recommended by the Work and Pensions Select Committee who describe it as a ‘smoothed earnings link’:
“The state pension would be uprated with earnings, but with temporary price-indexation when inflation exceeded wage growth. Price indexation would continue once earnings growth again exceeded inflation, but only for as long as the value of the state pension remained above [an] original fixed minimum proportion of average earnings. Indexation would then revert to earnings.”
As the Committee noted, this policy would ensure that the state pension rose in line with earnings over the long term (rather than rising faster than earnings), but also that pensioners were protected from real cuts to their income in occasional periods of falling real earnings.
Of course, you might have a different set of objectives when choosing how to uprate the state pension, and different objectives could lead to different choices. But whatever your objectives, neither the triple lock nor the double lock is the right answer.
IFS Election 2017 analysis is being produced with funding from the Nuffield Foundation as part of its work to ensure public debate in the run-up to the General Election is informed by independent and rigorous evidence. For more information go to www.nuffieldfoundation.org