Savings policies can help address intergenerational inequality
Social justice is not just a class issue, but also an intergenerational issue one. Indeed, nowadays, poverty is more likely to be found among young people. It has been argued that the quality of life among young individuals may have deteriorated with respect to their parents (baby boomers) and new policies and conditions do not seem to be helping the situation improve (increasing house prices, the increase in tuition fees, recent benefit cuts for under-25).
Social justice is not just a class issue, but also an intergenerational issue one. Indeed, nowadays, poverty is more likely to be found among young people. It has been argued that the quality of life among young individuals may have deteriorated with respect to their parents (baby boomers) and new policies and conditions do not seem to be helping the situation improve (increasing house prices, the increase in tuition fees, recent benefit cuts for under-25). The risk of not addressing the issue of intergenerational fairness is that inequality, both within and between generations, will return to the levels of 40 years ago, where inherited wealth and privilege were the primary determinant of life chances.
As pointed out by Portes (2014), pensioners have done much better than non-pensioners (their average income has increased faster since 1977) and older people have been more protected from the latest spending cuts, while lower income working-age families with children have been the greatest losers (Horton and Reed, 2011). However, intra- (as opposed to inter-) generational inequality and redistribution still remain an important issue. As an example, the rise in house prices is not just, or even mainly, an intergenerational problem; it redistributes wealth in regressive way within generations as well. The increase in house prices does not necessarily raise the consumption of older people, but with over two thirds of property wealth belonging to the top 30% of the population (Portes, 2013) it certainly redistributes to the better off.
Having said that, reshaping the welfare state so that less is given to the better off among older generations should still be seen as one possible way to redistribute wealth. In particular, reforming the pension system can potentially redistribute both across and within generations.
So what is the problem with pensions?
First, population aging is likely to be the main cause of the increase in the public sector net debt. Moreover, household savings are decreasing. If we take the example of Japan whose population is far ahead us in terms of aging, the household saving ratio is estimated to become negative next year. The whole culture of savings needs to be restored in order to face the high cost and the sustainability of the system.
Yet, it is not only a question of the aging population. Government tax subsidies for retirement saving are expensive, ineffective and regressive. Out of the 54 billion the government invests in tax relief, through income tax on employee and employer contributions, 58% goes to the top 10% of wealthier taxpayers (Johnson, 2012). And the evidence suggests that there is little need for such subsidies for wealthy people. A recent paper showed that, in Denmark, top earner individuals who started to received a smaller tax subsidy for savings did start saving less in retirement accounts but simply because they shifted their savings outside the system. At the same time, other research suggests that implementing policies like automatic employer contributions has a greater impact on the rise of savings, being most of the individuals passive savers who do not care much about the amount of contributions paid by the employers.
Finally, the existing system of incentives is ineffective for young generations who have an increasing distrust in financial services; are financially myopic, because of uncertainty about the future of the system, and do not know what they are paying for.
The upside of this analysis – that the current system is regressive and inefficient from both a macroeconomic and microeconomic perspective – is that the opportunity for welfare-enhancing reforms is large. Some possible options include:
- Abolish higher rate tax relief. Because income tax is progressive, tax relief is regressive. By limiting tax relief to 20%, the government would save around £7 billion each year. Moreover, as said before, high income individuals would save anyway.
- Replace all income tax relief with a single flat rate of (say) 25%-30%, so that costs can be controlled by imposing a limit on contributions. Costs could be adjusted by setting the flat rate at a higher level than the maximum income tax pensioners can face.
- BOGOF (buy one get one free option). This option would help deal with the mistrust of future generations in the system, by creating a matching saving scheme. This scheme would require the government to match with a fixed amount each pound saved by the individuals (up to a limit). This would disconnect saving from income tax, making it more progressive. In addition early access to personal accounts would incentivize young generations to invest in savings.
This blog is NIESR’s write-up of a seminar that took place on 21st January as part of an ongoing series on the subject of “Money and Poverty”. The series is part of the Joseph Rowntree Foundation’s ongoing programme devoted to the creation of strategies to eliminate poverty in the UK over the next 20 years. The idea of the programme is to find alternative solutions which could be a combination of different approaches in order to raise the capabilities and opportunities for people in poor conditions to access the resources they need for subsistence. This seminar was opened by Angus Hanton from Intergenerational Foundation, followed by a presentation by Michael Johnson from Centre for Policy Studies based on report “Costly and Ineffective: Why Pension Tax Reliefs should be Reformed“ and was attended by a number of experts in the field. The views above are entirely the responsibility of NIESR, not of the speakers, JRF, or the seminar participants.