The future costs of the State Pension

David Eiser, David Bell and David Comerford

Nicola Sturgeon and James Naughtie had an interesting debate on funding pensions in an independent Scotland on GMS this morning (available here). The debate was a response to the latest UK Government paper on the economics of Scottish independence, this one from the DWP focussing on welfare spending and pensions.

Sturgeon claimed that pensions cost less to fund in Scotland in both absolute terms and as a percentage of tax revenues. Naughtie pointed out that the DWP paper argues that an independent Scotland would face an additional £1.4 billion in pension costs by 2032, amounting to around £400 per working age person in Scotland. So who is right? As ever, there is something to take from both sides.

Pension costs per pensioner

Nicola Sturgeon claimed that pensions cost 6-8% less to fund in Scotland than in the UK. Expressed as a cost per pensioner (and assuming the average value of a State Pension in Scotland is identical to one in the UK), this statement is correct, and is taken from our work published earlier this year in the NIER. It reflects the fact that pensioners in Scotland die earlier on average than those in the UK, so the government does not need to pay those individuals’ pensions over so many years.

Pension costs per working age population

A more relevant question from an affordability perspective is to consider spending on the State Pension relative to the working age population, given that the working age population pays the tax revenues which fund State Pension payments. This is what the DWP paper focusses on. Currently, the ratio of pensioners to working age individuals is fractionally higher in Scotland as in the UK. The average value of a state pension in Scotland is also marginally higher in Scotland. Putting these two together (a slightly higher ratio of pensioners to working age population, and a slightly higher average state pension), means that spending on the State Pension per working age individual is about 2% higher than in the UK, amounting to £32 per working age person per annum.

Old-age benefit costs per working age population

However, the DWP report considers not just spending on the State Pension, but also spending on other pensioner related benefits. On nearly all of these benefits, spending is higher in Scotland than in the UK per pensioner (and therefore also per working age individual). The difference is particularly marked in relation to ill-health benefits, such as Disability Living Allowance, but also for Pension Credit. Spending on all old-age benefits amounts to £2,391 per working age individual in Scotland compared to £2,309 in UK, a gap of some £80 per working age population.  Although Scots shorter life expectancy cuts the cost of an average pension, their higher levels of disability contributes to this higher overall benefit cost per pensioner.

Table 1: Old age benefit costs, Scotland and UK (2011/12) Source: DWP. Click to enlarge

Pensioner benefits

 

 

 

Population projections

That is now, but what about the future? Between now and 2032, Scotland’s population is projected to ‘age’ more quickly than that of the UK (strictly speaking, the working age population as a proportion of the old age population is expected to grow more slowly in Scotland than in the UK). As a result, the existing £80 gap alluded to above is expected to grow to around £200 by 2032, purely as a result of differential demographic change. It is important to note however that after 2032, the ONS population projections anticipate that the gap between Scottish and UK old-age dependency ratios will again narrow. Thus the DWP report shows Scotland’s pension funding gap to the UK falling after the 2030s, returning to around its current value (£80) by the 2050s.

Costing the White Paper proposals

As well as looking purely at demographics, the DWP paper then goes on to cost the pension proposals in the Scottish Government’s White Paper. The most significant of these in cost terms is the delay in the rise to the State Pension Age to 67 in Scotland (costing £0.8bn by 2032), the retention of Savings Credit (£0.2bn in 2032) and an increase to the Single-Tier Start Rate (£0.1bn in 2032). The cumulative impact of these proposals is to further increase the value of Scotland’s State Pension funding gap, expressed relative to the working age population, by a further £210. Again, there is an important time dimension here – the significant policy in cost terms is the delay in the rise of the State Pension, and this cost disappears post 2034. (It should also be noted that the White Paper did not actually commit to the delay in the SPA, but to consider this policy following a ‘yes’ vote at the referendum.)

The role of migration

In her interview on GMS, Nicola Sturgeon argued that the DWP’s analysis ignored some of the additional policy choices that an independent Scottish government might make, notably around efforts it might make to mitigate Scotland’s ageing population by encouraging in-migration of working age individuals. Using the DWP’s own analysis, we can calculate the potential impacts of different migration scenarios on Scotland’s State Pension ‘gap’. If Scotland’s population followed the ONS’ high migration population projection scenario, whilst the UK followed the principal projection scenario, then Scotland’s gap would fall to £272; if Scotland followed the high migration scenario while the UK followed the low migration scenario, then Scotland’s gap would fall to £230. In other words, the additional pensions costs associated with the White Paper proposals could be almost completely mitigated if Scotland followed a high-migration population scenario. However, it is worth pointing out that the high migration scenario implies net in-migration to Scotland of 24,000 per annum, a relatively high figure in historical terms – although perhaps not substantially higher than the recent historical trend, as pointed out discussed by David Comerford here.

The table below shows how Scotland’s funding gap (i.e. the difference in cost of old-age benefit spending expressed per working age population between Scotland and the UK as a whole) evolves between now and 2032. Demographic change causes the gap to rise from £80 to £200; the White Paper policy proposals increase these costs by £210; but a high migration scenario in Scotland combined with a low migration scenario in the UK could offset most of the White Paper policy costs.

In terms of the £1.4bn pension gap referred to in the introduction, this represents the gap between forecast spending on old-age benefits in Scotland given forecast demographic change and the White Paper proposals, compared to spending in Scotland if demographics and policies were the same as in the UK. Around half of this gap is accounted for by demographic differences, with the remainder associated with the policies in the White Paper, although higher migration could reduce the gap by £0.6bn.

Table 2: Scotland’s old-age benefit spending gap (difference in spending between Scotland and UK, expressed per working age population)

  2012/13 2032/33
All old-age benefits £80 £200
White Paper policy costings £210
Implications of high migration scenario for Scotland -£180
Total gap £80 £230

 

Old-age benefit costs as a proportion of tax revenues

Nicola Sturgeon also made the point that it is important to consider pension costs as a proportion of total tax revenues. Currently, the State Pension bill forms a slightly smaller fraction of total tax revenues in Scotland (11.9%) than in the UK as a whole (12.1%). However, spending on all old-age benefits as a proportion of revenues is identical in Scotland and UK as a whole (15.6%). Clearly, how these comparisons will evolve over time will depend on demographics, the trend in North Sea revenues, and productivity growth. These are clearly very significant unknowns, each of which would have a significant effect on the costs of pensioner benefits in an independent Scotland.

Conclusions

In summary, spending on all old-age benefits is slightly higher in Scotland than in UK, whether expressed per pensioner or per working age individual. Demographics mean that this gap will grow somewhat over the period to 2032, before declining again. The policy proposals in the White Paper will add to old-age benefit costs in Scotland, but these additional costs could be offset if Scotland achieved the ONS’ ‘high-migration’ population projection.

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