Patrick Nolan: The pension system needs reform, but "raiding" funds is not the way to build a culture of savings

Dr Patrick Nolan is the Chief Economist of the independent think tank Reform. Its new research report Entitlement Reform is released today.

On the Andrew Marr show on 7 October David Cameron quite rightly put welfare reform at the centre of the Government’s plans to rescue the public finances. The government spends more on welfare than on anything else and it is simply not possible to fix the public finances without getting the welfare budget under control. Yet there is a major blind spot in the Government’s plans. The Prime Minister has continued to rule out saving money in the largest part of the welfare budget – that relating to pensioner benefits. As a Reform report released today shows, this is not only the wrong thing to do but is a political mistake.

Reform’s research looked at the welfare states in Australia, New Zealand and the United Kingdom. These countries provide an interesting comparison given their similar social policy traditions. They also provide important lessons – on what to do and on what not to do – for each other.

Australia has done the most to encourage a nation of savers and private contributions to services like healthcare. In the United Kingdom and New Zealand pensioners rely to a greater degree on the government for their incomes. A similar bias is present in their health systems, with both countries having relatively low levels of private health funding.

The Australian approach of encouraging people to make provision for themselves and their families provides real benefits. Private funding creates the space that makes public programmes affordable in the long run and lowers the risk of deficits returning and debts increasing. Emphasising the role of saving and products like insurance and equity release can also highlight the options that families have. They do not just have to rely on what the State provides but can make arrangements that reflect their circumstances.

Patrick Nolan: Making the case for cuts in the regions

Patrick Nolan is Chief Economist at Reform

The effect of fiscal consolidation in the regions was the subject of BBC research released yesterday. This survey of 76 per cent of councils in England showed that the funding of social care is a major area where changes in spending will be felt, although there is a North-South divide to this with spending falling by about 4.7 per cent in the North in 2011-12 and rising by 2.7 per cent in the South. Yesterday I spent a few hours being interviewed by nine regional radio stations to discuss this research and the Coalition’s overall approach to fiscal consolidation. Some of the key points that came up in these interviews are discussed below.

Overall these interviews highlighted a number of challenges in communicating the case for consolidation. There is a perception that the cuts are happening faster than is actually the case. Even this morning this mistake was repeated in coverage of IMF research that claims cuts are being ‘front loaded,’ when in reality most of the consolidation is still to take place. Many people still do not grasp the scale of the changes that are yet to come if the Coalition is to achieve its Budget targets.

These interviews also highlighted how inconsistencies can undermine support for change. By protecting some areas of poor value for money spending, such as the Winter Fuel Allowance, principles such as cutting where value for money is lowest have not been consistently applied. This leads to the question of whether specific parts of the population are being picked on while others escape change. This inconsistency undermines the case for consolidation and makes it more, not less, difficult to generate support.

The first question, asked by Phil Gayle on BBC Radio Oxford, was why the cuts were necessary. I noted that the Government needs to get on top of the deficit to help the economy grow faster. Failing to do so would mean that the UK would be seen to be a more risky place to lend to, which would mean that it would be harder for businesses to borrow and they would not be able to expand and create new jobs.

There is also a question, raised by Andy Harper of Radio Cambridgeshire, of whether the timing of the consolidation is right. The Coalition is right to move quickly and it should be borne in mind that, as the Budget documents (table 1.1) show, most of the cuts will come into effect in the later years of this Parliament when the economy will be stronger. Consolidation also needs to be put into its public finance context with the Coalition plans differing little from those of Alistair Darling before the election and government spending only returning to 2007 levels.

Jonathan Cowap on BBC Radio York asked about the causes of the crisis. There is a widely held view that the crisis was solely caused by ‘bad banking’ and that other areas are now having to pay to clear up their mess. Yet that this view is widely held does not make it any less wrong. The reality is much more complex. While the Global Financial Crisis (GFC) clearly played a part in the deficit, the larger factor was the increase in government spending (much of which was low value for money) since 1997. The reality is that the UK went into the GFC in a particularly vulnerable position with the Government running deficits even when times were good.

As well as the problems caused by spending getting out of control, on BBC Wiltshire Mark O’Donnell and I discussed the role of private providers in the provision of public services. Properly regulated, private sector provision of services can play an important part in improving value of money and outcomes. A major reason for this is that private sector providers tend to be more focussed on doing what is in the interests of their users, rather than satisfying the desires of distant politicians based in London.

On BBC Coventry and Warwickshire Annie Othen asked about the effect of spending cuts on the ‘North-South Divide.’ Councils in the North of England face particular challenges from cuts as they are more reliant on government spending to begin with. But, I argued, this is not a reason for not cutting. The key is to ensure that the right spending is cut in the right way and that thought is given to how these areas can make the transition to economies less reliant on government funding. The best future for these regions will be one that does not involve such a heavy dependence on government spending.

Changes in council spending on adult social care show the implications of ring fencing for non-protected areas of spending. As Neil Green and I discussed on BBC Tees adult social care is the largest area of non- ring fenced council spending and so it is not surprising that councils have turned to it as a major area for savings. This is, however, only one part of the equation. As I noted in my interview with Tony Fischer on BBC Hereford and Worcester these changes need to be seen in the broader context of the need to change the overall approach to funding social care. As well as the levels of state funding, expanding the funding base through greater use of co-payments and user charges must be given consideration.

Expanding the funding base for public services is important because, as Martin Bailie and I discussed on BBC Cornwall, the challenge is to not just eliminate the deficit but to also address the costs of an ageing population. Population ageing means that programmes that are already unaffordable will simply become more so and alternatives to government funding for services must be developed.

On BBC WM Ed Doolan asked whether fiscal consolidation can be popular. There is no doubt that fiscal consolidation is a hard sell. But, I noted, surveys have shown that there is support for changes such as asking people to make a greater contribution to their own costs of care. Support for consolidation can be built if the right cuts are made in the right way, if people understand why the changes are taking place and if people understand what the logic behind the approaches is. Political support for ideas is never fixed and leadership requires creating support not just reflecting it.

Patrick Nolan: How to stop spending too much in the good times

Patrick Nolan is Chief Economist at Reform.

At a time when the IMF is talking of ‘rewriting the macroeconomists’ playbook’ there is value in looking to see how different countries are redesigning their fiscal and monetary policy institutions. In the latest of its series of Reformer lunches yesterday Reform held a lunch with Anne-Marie Brook of the New Zealand Treasury to discuss whether and how to make fiscal policy a more stabilising influence. The idea is that the government would change its spending or tax plans to help cool or heat up the economy and help make the job of the monetary authority easier. This event was held under the Chatham House rule.

Different countries are coming into the debates on the interaction of monetary and fiscal policy from different starting points. New Zealand is a small open economy with its own currency and relatively low levels of public debt. Eurozone countries are looking at fiscal policy to compensate for their lack of independent macro-policy tools. Countries like the UK, the USA and Japan are looking at fiscal policy as they are approaching the limits of what monetary policy can do (as they are facing the zero interest rate bound).

Patrick Nolan: The Coalition's policies on income tax thresholds and benefits for the elderly fail fairness tests

Patrick Nolan, Chief Economist, Reform.

Fairness is at the heart of this Parliament’s policy debate. In his speech to the Liberal Democrat Spring Conference yesterday Nick Clegg made no less than 23 references to fairness. The Labour Party leader, Ed Miliband, has spoken of a “fairness divide” between “the richest at the top who have been doing well” and the “majority – lower and middle-income.” The Spending Review was based on fairness, reform and growth. Yet, as a Reform report released today highlights, these claims of fairness are being used to justify major policy mistakes.

Policies such as punitive taxes on high income earners have the potential to make us all poorer. Both Nick Clegg (yesterday) and Ed Miliband have singled out the very rich in recent remarks. To illustrate the damage of this approach Reform modelled what would happen if a cap on income was introduced for very high income earners (on £1 million a year or more) so that income inequality (as measured by the Gini coefficient) would fall back to the levels of the 1980s. This showed that while inequality would fall, tax revenues (based on a static analysis) would also fall by £7 billion or by around 2p on the basic rate of tax. At a stroke tax burdens on low and middle income earners would rise and eliminating the deficit would become more difficult.

The report also highlights that the Coalition is wrong to propose increasing the personal tax allowance to £10,000. While the goal of reducing tax burdens is right, this is the wrong approach. Of the £14.2 billion reduction in tax from this policy, £13.2 billion would go to people with incomes above £10,000. The policy would encourage tax avoidance and reduce incentives to work for most earners. Reform has also released an online tax calculator (here) that allows people to see how a change in a personal tax allowance would affect them.

The report also shows that three-quarters of the £40 billion tax gap is due to VAT, Income Tax, National Insurance and Capital Gains Tax, i.e., the taxes paid by individuals and small companies. It is not right to say that reducing tax avoidance from large companies would mean public spending does not need to be cut. Reducing tax avoidance not only requires a focus on the big end of town but on the activities of small to medium enterprises and many families. The entire tax system needs to be simpler and less open to abuse.

Patrick Nolan: Time to bite the bullet on paying for long term care

Dr Patrick Nolan is the Chief Economist of Reform

Long term care needs reform. The major parties all agree that the current system is outdated and unsustainable. They all recognise that an ageing population and changes in morbidity mean the cost of care will continue to rise. Yet efforts to adopt solutions are stuck in the slow lane.

Earlier this week Reform held a summit on paying for long term care. This summit generated front-page coverage in the Telegraph, as well as articles in the Guardian, Daily Mail and Associated Press, with coverage focussing on comments by Lord Warner, a member of the government’s Commission on Funding Care and Support, ruling out “100 per cent universal state provision” and highlighting the need for a look at the money that is locked up in people’s houses.

Yet as well as discussing where the money will come from Lord Warner also highlighted three other priorities for reform. The private sector needs to develop better products to allow people to protect themselves, there needs to be an improved understanding of how the care support system works and there needs to be better information on how long term care interacts with other support, such as the NHS and welfare.

The importance of improving understanding of how the care system works was also highlighted by Penny Mordaunt MP and Richard Humphries from the King’s Fund. As Richard Humphries said, if there was an international award for a poorly designed system then England’s would be the favourite to take it out. It is the “King’s Speech of poor systems,” being stingy, confusing, fragmented and poorly understood.

One poorly understood feature of the system is the role that housing assets already play in covering the cost of care. The financial journalist Paul Lewis noted no one is obliged to sell their home to pay for care. The real problem is an unwillingness to contribute to the costs of care out of inheritance, although there are £1 trillion of housing assets held by the elderly generation, who have enjoyed windfall gains from a long period of house price inflation higher than wage and price inflation.

Patrick Nolan: Project Merlin – Have we forgotten what got us into this mess?

Patrick Nolan, Chief Economist, Reform.

The government has announced an agreement (Project Merlin) with the largest UK banks on lending, bonuses and transparency. This agreement includes bank lending of around £190 billion to businesses. Of this £76 billion will go to small firms. The performance targets used to determine the bonuses of bank chief executives will include whether they are providing these loans to businesses. The Federation of Small Businesses has expressed concern that, in spite of this, the cost of borrowing will remain too high.

Yet, as Gillian Tett wrote in 2009, there is no such thing as a free financial lunch. It is not possible to have less tightly rationed mortgages or bank lending and simultaneously a less risky banking sector. As she wrote:

"The only way to make the system more stable is to slap on a new level of regulation, curb innovation and to force the banks to hold dramatically larger capital cushions than before. The net effect of that will inevitably be to make capital more expensive. Tighter controls, in other words, means that mortgages and business loans will be more rationed – either through price, or supply, or both."

Recent history should make us cautious when politicians argue that controls over bank lending should be relaxed. As Nicholas Boys Smith showed in 2009 government policy under Jimmy Carter, Bill Clinton and George W Bush played a central role in creating the subprime mortgage market:

"Minority home ownership increased by 3.1 million between 2002 and 2007. And subprime loans funded this. For instance, 55 percent of black and Latino home purchasers in Boston in 2005 were classed as subprime. And more than three quarters of black and Latino borrowers from Washington Mutual were given subprime mortgages. Subprime was a phenomenon that the US government desperately wanted to exist. Neither it, nor the phenomenon of securitisation would have existed in anything like the scale they did had the not the state so actively supported them."

This collapse in this subprime mortgage market was a major trigger of the global financial crisis and is one reason we are in the mess we are in. While there may be a case for improving UK bank’s lending processes, politically driven targets for bank lending should be resisted. Project Merlin risks repeating past mistakes.

Patrick Nolan: A fairer system of parental leave requires new thinking

Patrick Nolan, Chief Economist, Reform.

Earlier today the Deputy Prime Minister, Rt Hon Nick Clegg MP, argued that Britain needs a better system of parental leave for families with a new child. He is right. As Reform showed in a 2009 report, Productive parents, Britain’s support for families with new children, especially maternity pay and leave, is unfair, anti-dad and bad for business. Fathers are treated as an irrelevance and government maternity pay is more generous for rich mothers than poor.

Yet, as I noted when this issue was raised early last year, the proposal to allow couples to share leave has, understandably, caused concern among business groups. One reason for this concern is the cost to businesses of administering this proposal – as it will require employers to monitor the leave use and entitlement of the spouse that does not work for them. With the difficult trading environment facing many businesses, and the uncertain state of the labour market, this is not the time to be increasing the regulatory burden facing businesses.

Given this there is a need to develop a system where parents are provided with the support to organise their lives flexibly, while fiscal costs are reduced and bureaucratic meddling eliminated. As Reform has shown this could be done through moving to a system where parents are provided with a flat rate ‘parental payment’ and making leave unpaid. As the payment would be no longer tied to taking time off employers could be exempted from costly and bureaucratic meddling (the Reform proposals are discussed in greater detail here).

Although well-intentioned, government policy on parental leave is stuck in a rut. Rather than an expensive and complex extension of existing arrangements a new approach is required. Given the state of the public finances and outlook for the labour market this is more important than ever. As the Nobel Prize winning physicist Lord Earnest Rutherford once said: “we don’t have the money, so we’ll have to think.”

Dr Patrick Nolan: Reducing family breakdown requires fairer incentives within families

Dr Patrick Nolan is Chief Economist of Reform.

Earlier this week Reform issued a new report, Productive parents, on Britain’s support for families with new children. The report concluded that these arrangements, especially maternity pay and leave, are unfair, anti-dad and bad for business. The study showed that fathers are treated as an irrelevance and that government maternity pay is more generous for rich mothers than poor.

This means that current arrangements for parental leave are short-changing the families who need it most.  While professionals and managers can rely on generous employer help and afford time off, those in casual and low skilled jobs receive the least pay and take the least maternity leave.

Mothers earning £50,000 and taking six months leave receive nearly £8,000 from the taxpayer.  Mothers earning the minimum wage (£12,000 per year) receive only £4,500. Two thirds of professional/managerial mothers also receive employer based support, while around 10 per cent of mothers in lower skilled occupations receive no maternity pay at all.

British fathers are ‘invisible men’ in the current system, with fathers having few rights to parental leave.  Politicians and commentators have raised a chorus of concern about the absence of the father in the modern home. Policy has largely been limited to campaigns to raise awareness of the value of fatherhood, without tackling the financial disincentives for fathers to take greater responsibility in the home. This is in spite of evidence that families are stronger and fathers more likely to read to their children if they take paternity leave.

The British system also forces mothers to make an “either / or” decision about working or staying at home.  Mothers who want to stay in touch with the workplace without returning full-time are likely to forfeit their maternity pay.  These arrangements are out of touch with modern employment and reflect an outdated idea that what counts is hours spent at work rather than work achieved – that presenteeism matters more than productivity.