Yesterday's ‘Tax reform of the day' referred to national insurance contributions, and for reasons that are not entirely clear it was massively trolled on the subject of pensions by those who rather aggressively dislike any public servant, tax and , possibly, me.
It was claimed (as is commonplace by those making such comments) that I was writing about something about which I know nothing. Of course, what they actually meant was that this did not like my analysis.
I have quite particular views on pensions. These are developed from a macro perspective, in contrast to the deeply micro perspective most were displaying yesterday. They were developed in my publication, now a few years old, called ‘Making Pensions Work‘. In this I argued that in any society there is what I called a fundamental pension contract:
This is that one generation, the older one, will through its own efforts create capital assets and infrastructure in both the state and private sectors which the following younger generation can use in the course of their work. In exchange for their subsequent use of these assets for their own benefit that succeeding younger generation will, in effect, meet the income needs of the older generation when they are in retirement. Unless this fundamental compact that underpins all pensions is honoured any pension system will fail.
As I then argued of private pensions:
This compact is ignored in the existing pension system that does not even recognise that it exists. Our state subsidised saving for pensions makes no link between that activity and the necessary investment in new capital goods, infrastructure, job creation and skills that we need as a country. As a result state subsidy is being given with no return to the state appearing to arise as a consequence, precisely because this is a subsidy for saving which does not generate any new wealth. This is the fundamental economic problem and malaise in our current pension arrangement.
I would argue that pay as you go pensions also do so, but at least they recognise one side of the equation correctly, whilst the private pension system fails to do so altogether. Public sector pay as you go pensions recognise that we divert income of those currently in work through the pension system to the old. By expressing the cost of pensions as an expense of those in work it gets half the equation right. What it does not do is recognise the capital value of the assets those in old age created whilst they were in work. That's what it gets wrong.
What we need to do to get the rest of the pension equation right is to recognise that current pension contributions must be used to create capital value within society to meet the needs of future generations — at the same time as the needs of current pensioners are met from the depletion of the capital stock they left to those currently in work.
This is really not a difficult issue to comprehend: it's a simple investment cycle. And yet we have got this fundamental wrong and for one very simple reason. We confuse saving with investment.
Saving is putting money in the bank. Or it's buying and speculating in second had shares issued by companies many years ago and now quoted on a stock exchange. Or its dealing in land and second hand building. And it's financing speculation which simply seeks a financial return. They're all saving. That's fine but for one thing: none of them earn a return. They do not directly, and many of them cannot indirectly, add value to society by creating gainful employment as a result of which they add to the sum lot of human capital or income. They merely reallocate that income and capital that already exists. And that's not the same thing at all.
So the last thing we need is saving for pensions. That's a complete mistake. Savings for pensions takes money out of the productive economy and deflates that economy as a consequence. Saving diverts resources from productive activity. It inflates the return to unproductive activity within the financial services sector. It reduces well being. And saving can, by misallocating resources, reduce income and so reduce our capacity to pay pensions. Those are all things we'd best avoid.
What we want is investment in pensions. Investment is very different from saving. Investment creates new assets, tangible or intangible. Some tangible assets we can see and touch, and use in the long term. They include private sector assets such as plant and machinery, offices and IT, transport and agricultural equipment, power plants and recycling equipment. Intangibles can include inventions, copyrights and music. They also include education, training, and social infrastructure. This is spending money for a purpose, to achieve a goal, to increase income and to increase well being and the support structures in society.
Investment and savings are terms often used interchangeably. That's wrong. Investment does not need saving to happen, it just needs cash. It's indifferent as to where that cash comes from: it can be from savings and it can be from borrowing and it can be from tax. There is no tie between investment and saving: it's just one can be used for the other, but need not be.
We can afford pensions for the old in this country, now and in the future. But we can't if we save for them. Saving removes our chance of meeting the needs of the old. In fact, as ‘Making Pensions Work' shows, that saving arrangement in the private sector has already failed. The tax subsidy the private sector pension now receives annually has already provided the private pension sector with more cash each year than it has paid out in payments to those in retirement. The result is that the situation has already arisen where every single penny of pension paid in this country is at cost to the state.
The reality is that we can only meet the needs of those already in retirement and those who will retire if we invest for the future, now. And we can only meet those needs if that investment is wisely managed for the benefit of all. And I mean all. That means the state has a duty to direct that investment.
Some of that investment must be in the resources the state sector needs — in dedicated funds showing how state infrastructure is paid for by current taxes the benefit of which is deferred to meet future pension obligations which will arise when the returns on the current investment are generated.
Some of that investment must be in the resources the private sector needs — but as I recommend in ‘Making Pensions Work' that has to be secured by attaching a condition to the tax releif on pension contributions — a condition that at least 25% of all money invested in pension funds must be used to generate new wealth creating and employment generating activity in the UK. It's a price of the tax subsidy. And it will ensure we get more than £20 billion of new investment in our economy each year — investment our economy needs to boost it now and get us out of recession.
There is a solution to the pensions crisis. We can afford to live in old age. But so far none of the solutions the government is looking at are heading in the right direction.
And that's what's really worrying.
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There are no lack of opportunities for investements (in the meaning of the word in the article) in the UK by pension funds. The problem is, it ain’t UK pension funds making the investments. Talking about one area that I know something about: both Vestas and Orsted have made great efforts to pull Danish pension funds into wind projects (modest to good stable returns over many years). There is growing interest & activity (ditto for energy renovation). I know this because I have spoken to both companies (and Danish pension funds). UK pension funds appear to be absent – even where a project is based in the UK project.
For myself, I confess I “do the stock market” but also fund early stage Uk companies (not quoted) – where the risk is high but so are the rewards (& I’m talking putting money directly into such companies said money used to buy “stuff” or employs people) . In mitigation with respect to the stock market one always needs a balanced risk profile in any portfolio.
Mechanisms need to be found to fund such companies – the UK has diddled around at the edges for more than 30 years in this area – with little to show. This is a great pity since, the UK (infrastructure) investment need is massive and as already noted there is no shortage of very good projects. I’m puzzled.
& a PS: in Denmark by law all off-shore wind projects have to offer to locals 20% of the equity in any given project. Good way of getting people to invest & a good way to make them feel as if they “own a piece of the action”.
Does it not benefit the state if I make my own provisions for my old age rather than being wholly dependent on the state when I retire? Does it not benefit the state when I retire five years earlier due to having a private pension, thus freeing up my job for someone who would otherwise be on jobseeker’s allowance and probably other benefits? I’ve always felt that the state should incentivise those of us who prefer to paddle our own canoe rather than be dependent on the state.
I am quite certain you will not be forsaking your state pension
Please don’t pretend sainthood when you are pursuing private gain
Your point Richard seems to be rely on the state for old age provision, but not how they would be financed? Don’t say clamping down on tax avoidance as you know (although you will not admit – its a chimera).
There is not necessarily a subsidy for private pensions (via a tax break) as private pensions are deferred income only i.e. to access the income it is taxed and the remaining funds are part of your estate for IHT purposes (unless you die before 75 and have not drawn any money from the fund).
In terms of the argument that saving withdraws funds from the economy – I’d agree that it does – but not all of the funds are invested in second hand shares or land – what about debt issued by corporates, infrastructure funds, private equity? – sure you do not like anything private – but you have to admit that the money that goes into private pensions are recycled into the economy either through direct investment in the ways I’ve outlined or eventually through payment of pensions.
I will address these issues in a blog, probably tomorrow
In this study of pensions, I think we should bear in mind that income paid after retirement is still taxed (above the tax-free threshold) and most pensioners will spend most of their monthly income, incurring VAT and will still be paying council tax. This in effect recirculates the money around the country and supports local shops, businesses, pubs, restaurants etc and their suppliers, while also returning tax to the Treasury.