Old and broke: the long term outlook for the UK’s public services

The UK faces a bleak future of rising taxes and rising deficits. Two forces will defeat the Government’s attempts to reduce the deficit: the ageing population and the Government’s own policies to increase spending on the basic state pension and the National Health Service. The dismal fiscal outlook means that the Government must hold firm on reform to public sector pensions, despite tomorrow’s strikes, and should resist ideas to spend more on long term care when the Dilnot Commission reports next week.

This report shows that population ageing is no longer a problem for the distant future. In fact, the fastest growth in the pensioner population in the whole of the 21st century will take place in this Parliament. Between 2011 and 2016, the number of people aged 65 and over will increase by 1,400,000 while the working age population below 50 will decrease. Population ageing will continue so that the number of workers for every person over 65 will fall from 3.9 in 2011, to 3.2 in 2021, and then to 2.5 in 2041.

The report estimates the cost of future public spending given the ageing population. It finds that annual spending on retirement pensions will rise by £32 billion, in today’s money, by 2041. Annual spending on the NHS will increase by nearly £40 billion by 2041. As a result, the deficit will begin to rise quickly in the next Parliament, despite steadily rising taxes. The resulting impact on the public finances will swamp the current plans for “consolidation”.

This outlook has a number of implications for Government policy. The Government is right to reform public sector pensions in order to reduce costs to the taxpayer and increase contributions from employees. When it reports next week, the Dilnot Commission must resist calls for new taxes and new spending to fund long term care. In fact, long term care can be funded by the users of the services, including the sales of homes. On recent estimates, people over 60 have more than 80 per cent of the nation’s wealth and over £1 trillion in unmortgaged equity.

But the real challenge is to change policy on the big spending items of pensions, pensioner benefits and the NHS. The Government must reverse the decision to increase the state pension in line with earnings rather than prices. It should drop plans for a single tier pension which has been estimated to cost an additional £11 billion per year by the Department of Work and Pensions. It should rethink its commitment to pay benefits such as the Winter Fuel Allowance to all pensioners, at an annual cost of nearly £3 billion, when almost 90 per cent of the payments are unnecessary. And it should look urgently at ways for citizens to pay privately towards the cost of the NHS. People in the UK make amongst the smallest private contributions to the costs of healthcare of any major country.

Other key points in the report include:

· The expensive and ineffective system of tax relief for pensions in the UK also needs reform. There is no evidence that this tax relief (which costs £39 billion a year) increases national savings, and too much of the relief goes to people who do not need support.

· Plans for near-compulsory pension saving will only realise their potential if private companies, rather than NEST, are the default providers.

· The poor public finance outlook is against a backdrop of a changing international environment where old and indebted countries like the UK struggle to remain competitive. Many of the fast growing and dynamic Asian economies, for example, will not face the drag of expensive welfare states and high taxes.

· Population growth will increase the importance of lifting the long term trend of economic growth, which will play an essential role in providing funds for repaying government debt, reducing tax burdens or increasing spending on public goods and services.

· Rather than addressing need, too much age related spending is designed to “buy” votes. The clearest example is the Winter Fuel Allowance. This programme costs around £2.7 billion a year. Yet evidence collected by a Parliamentary investigation showed that nearly 90 per cent of this spending goes to people who do not need it. Other research has shown that at least 70 per cent of this hand-out is spent on things other than fuel.