David Willetts

In this speech to the Institute for Public Policy Research, David Willetts set out an agenda for dealing with some of the fundamental social changes we have experienced over the last few decades.

“I welcome this opportunity to speak to you at the IPPR. You believe in modernising the welfare state and that’s what I want to talk about today. I will start with the pensions debate which is getting livelier as every week passes. But it needs to be part of a wider debate about what a modern welfare state should be like. Above all we need to connect the pensions debate to evidence about how society is changing and how families lead their lives today.

In the past two months we have had three notable contributions to the pensions debate. Adair Turner produced his excellent Interim Report. The Governor of the Bank of England gave a masterful lecture at the British Academy, including an endorsement of the idea of longevity bonds which I had floated earlier in the year. And last week the Pensions Policy Institute and the National Association of Pension Funds produced their carefully worked out ideas for a Citizens Pension. So there is a lot going on. Three contributions of such high quality all in the space of eight weeks show that we in this country are still capable of intelligent and well informed policy debate. We can take some pride in that. To have such a debate six months before an election makes it even more extraordinary, though of course none of the authors are politicians! Today I want to show how my Party’s thinking is moving forward in the light of these reports.

A Progressive Consensus

Everybody talks about the need for consensus when it comes to pensions. I believe that a strong consensus is emerging. In fact I am tempted to call it a ‘progressive consensus.’ You played your part with your path-breaking report ‘A New Contract for Retirement’, in March 2002. We in the Conservative Party have also played a role by radically changing our approach to the basic pension. The central principle, accepted by just about everyone who wants to reform pensions, is that we have got to increase the value of the basic state pension. If you hold down the basic state pension for a generation we can now see that two consequences follow. First, contributory social security is submerged beneath mass means-tested welfare. Secondly, the state over-regulates company pensions to achieve social policy objectives that go way beyond the logic of the employment contract. That is why my Party is committed to increasing the value of the basic state pension so as to reverse the spread of means-testing and to disengage the state from over-regulation of company pensions.

I said that just about everybody shares in what has now become the mainstream view. The one exception is of course the Government. But even here we seem to be making progress. That important constitutional treaty, the Granita Pact, which, like imperial powers dividing up Africa, made the Department of Work and Pensions a colony of the Treasury, is now being challenged by Alan Johnson. He has abandoned ritual defences of the current system. For example, when it comes to means-testing, he has admitted that “it would be crazy to say it didn’t act as a disincentive to some people.” I welcome such frankness though it is rather curious to have a Secretary of State who has given up defending a central plank of Government policy.

The only defence of Pension Credit which you do still hear is that it was necessary as a short-term measure to tackle pensioner poverty now. In the words of Malcolm Wicks, it is a ” short to medium term policy only.” Just before this argument enters the mythology I should point out that even this case for the Pension Credit does not stack up. In March 2002, Frank Field, Steve Webb and I came together to urge the Government to spend the money which was to go into the Pension Credit instead on a higher pension for older pensioners, who tend to be poorer. We argued that this would tackle a significant amount of pensioner poverty without the problems created by mass means-testing. I still believe that that would have been a better route to go down than the Pension Credit.

Gordon Brown has increased public expenditure on pensions by billions of pounds. With that amount of money he could have created a far better pensions system. Instead he has made the system more complicated than when he started. In every single one of his last seven Budgets he has tinkered with the system adding new layers of complexity. Sometimes he does not even pretend they are part of a long-term plan; he just announces special payments to pensioners that are only to be made for one year. This is a bizarre way to run a pensions policy. What we have ended up with is special payments for people triggered when they reach the ages of 60, 65, 70, 75 and 80. Each has special conditions which are mutually inconsistent: some are for households, others for individuals; some have contribution conditions, others do not.

The Chancellor’s pension structure, to use an architectural analogy, with its ascending steps and special features is an ancient ziggurat with gothic detail and rococo features. No wonder that just about everyone who cares about decent pensions in Britain has a deep yearning for exactly the opposite of what Gordon Brown has been doing – a solid, straightforward comprehensible structure above which for every pound you save you are a pound better off – a classical temple if you like.

You at the IPPR and we in the Conservative Party have tried to identify ways in which we could achieve this objective. The approach I previously favoured of a higher pension for older pensioners doesn’t work so well once you have the Pension Credit going to pensioners of all ages. Increasing the basic state pension steadily by more than prices is an effective way of getting people off means-tested benefits without abolishing the Pension Credit. That is why my Party is committed to increasing the basic state pension by earnings not prices. We calculate that that alone will take one million pensioners off means-tested benefits in our first four years. We have set out very clearly how we can finance it by a combination of the abolition of the New Deal and the off-setting savings on means-tested benefits. Provided that we carry on identifying other savings, and I am confident that we can, we can keep on going and increase the value of the basic state pension in our second term as well.

A Citizens Pension?

You at the IPPR came up with something rather more radical. It was your report in March 2002 which first proposed the idea of a big step change in the value of the basic state pension, to be financed by abolishing contracted out rebates. It was an interesting idea which deserved serious consideration. I remember how shocked you were – and I was too - when Alistair Darling, the then Secretary of State, rubbished the idea even before the report was out, calling it “simplistic and misguided” What a change this time round. Last week the NAPF and the PPI produced a report also proposing a much higher basic pension, though without an contribution conditions – a true Citizen’s Pension. This time round, Alan Johnson said, two days before it was out, “It’s an idea I’m interested in, so I have to talk to Government colleagues and it has to become a view of the Government” The extraordinary contrast in those two approaches is evidence of how far the pensions debate has moved on. We in our Party will not stand in the way of a Citizens Pension if it is clear that it commands an overwhelming consensus in the pensions world. However, to be confident it has achieved a consensus we need to think about a Citizens Pension rather more rigorously. For a start, different people mean different things by a Citizens Pension.

The Secretary of State says he is “veering towards being very positive” about the Citizen’s Pension. But what, precisely, is it that he’s “veering towards being very positive” about? At its most basic, a Citizen’s Pension simply means breaking the link between the National Insurance Contribuitions people have paid and the state pension that they receive – a move that may appeal to women pensioners with incomplete contribution records. Making the system fairer to women is a laudable aim in itself, but true advocates of the Citizen’s Pension want to go further and set it at a higher level than today’s basic state pension in order to reverse the spread of means-testing – say at £105 per week for a single pensioner. This is where I fear they take their leave from the Secretary of State, who always explains his nods towards the Citizen’s Pension by describing the problems faced by women pensioners, and never talks about setting it at a level high enough to get everyone off means-tested benefits.

Looking carefully at what Alan Johnson has said, my best guess is that he wants to pay a full basic state pension to everyone of pensionable age, but to keep its value far below that of the means-tested payment. This is a reform to which the Chancellor is less likely to object, as it does not challenge his fundamental commitment to extending means-testing amongst pensioners. You have a long tradition of announcing Labour Party policy initiatives at IPPR events. I see no reason to break with that just because I am a Conservative. So let me announce today that the next Labour manifesto will contain a pledge to move towards a full basic state pension to everyone regardless of their contributions. If this is what apears in Labour’s manifesto, you heard it here first.

The Citizen’s Pension has enormous appeal as a solution to one of the biggest problems in today’s welfare state – mass means-testing. The true model – much more ambitious than anything the Government is likely to propose – involves, with one glorious bound, putting everyone, regardless of their National Insurance contribution record, on a pension as high as the basic minimum under means-tested benefits. It is very much the flavour of the month. But it does have two significant drawbacks which do need to be properly faced.

The first problem is that the Citizens Pension involves the end of the contributory principle. The contributory principle has a real moral and cultural significance to many people. It is odd how Ministers don’t appear to get its significance as it would be well suited to a Blairite language of rights and responsibilities. In fact one of the most powerful claims pensioners make on us is when they say, “I have paid my contributions so I am entitled to …”. Saying, “I am a British citizen so I am entitled to …” is not quite the same thing.

Most advanced western countries have some sort of contributory principle at the heart of their welfare state. One of the few exceptions is New Zealand which does not have a contributory principle but a Citizens Pension instead. When it comes to social policy, New Zealand is a far away country of which we know an awful lot. The historical parallels here are fascinating. New Zealand introduced non-contributory old-age pensions in 1898. It did not have a contributory principle. In Britain, the Liberal Government introduced their non-contributory but means-tested pension in 1908 partly influenced by the New Zealand model. Instead of contribution conditions, it had a residency test – twenty years of continuous residence.

Lloyd George only visited Germany to see how the contributory principle might work after the Liberals had already proposed a non-contributory system. He was won over to the idea of National Insurance on Bismarckian lines and in 1911 introduced it to finance healthcare, not pensions. It was a Conservative Government which applied the contributory principle to pensions in 1928 and introduced what we now recognise as a contributory state pension. The aim was – you guessed it - to get pensioners off means-tested welfare. If we ended up with the contributory principle for healthcare and a non-contributory state pension we would indeed be back to re-creating Lloyd George’s welfare state. If the reformers are really bold and radial, they might be able to get us back to 1908 by 2008.

This would be the end of any serious model of National Insurance paying for social security. No longer would any contribution conditions attach to receiving healthcare or a pension. So the contributory principle would be an empty gesture not something that really protected anyone’s individual entitlement. If I may carry on with the architectural image I used earlier, the new structure would be like one of those strange post-modernist buildings with great big robust columns detached from a super-structure which they no longer supported. In most western countries, apart from New Zealand, the form which pension reform is taking is to revise and modernise the contributory principle rather than abolish it entirely. I still believe this is the better approach.

There is a second problem with a full-blown Citizens Pension high enough to get people off means-tested benefits. To increase the value of the basic pension up to the level of means-tested benefit, or approximately £105 a week would cost £15bn, and that is net of savings on means-tested benefits. The NAPF proposal saves money by netting off from the Citizen’s Pension the incomes people get from the State Second Pension or from funded pensions financed through contracted-out rebates. It might even be seen as a means-test. It does, however, bring the cost down to some £7bn. Even that is quite expensive. It is one of the reasons why I have a cautious approach for increasing the value of the basic state pension, with clearly identified savings to finance it. The Liberal Democrat proposal is for a higher pension for everyone aged over 75. They say this will cost £3bn a year but so far the only thing they have said about how they would finance it is that it comes from abolishing the DTI. This is not serious. So the only political party that has called for a Citizens Pension has avoided explaining how they would finance it.

There is one pot of gold at the bottom of the garden which the advocates of a Citizens Pension look at more and more hungrily. This is contracted out rebates. These rebates are a reduction in the National Insurance contributions paid by employees and employers if they have a funded pension and so are not going to be requiring the state second pension on top of the basic state pension. It is supposed to cover the cost of providing a pension equivalent to the state second pension. In reality it no longer reflects that cost fairly. Moreover, the formula is so complicated and the sheer administrative hassle so great that the Institute of Directors now regard contracted out rebates as a red tape burden on business.

The sums involved are very large. Officially the Government says that £11bn is going out in contracted out rebates in respect of about 12 million pensions. I have severe doubts about some of these figures. Every time a company closes its traditional final salary pension scheme to new members and sets up instead a new DC scheme it time contracts back in to the state system at the same time. So the Government gets higher revenue today in return for a bigger liability to pay pensions in the future. This effect is not shown up in the Government’s figures which claims to have a pattern of contracted out rebates that is steadily growing. There may well be something wrong about these figures. I therefore urge Adair Turner’s Commission to investigate whether the data are accurate.

It is obviously very tempting to abolish these rebates and instead use the money to pay for higher benefits. We have in the past suggested that contracted-out rebates could be used to finance new incentives to save and could be a kind of contingency reserve to help finance further increases in the basic state pension. For the past two years I have been regularly asking the industry whether anyone out there wants to keep contracted out rebates. If they do, they should speak out now. So far there has been a deafening silence, at least until the ABI spoke out a fortnight ago. If industry is happy to lose contracted rebates to pay for higher benefits I would not wish to stand in their way.

Contracted out rebates certainly have their faults. We have perhaps £10bn of money going into pensions as a reward for saving, yet hardly anyone appreciates or values it. This is one of the many missed opportunities of British pensions policy. I can say today that my preferred approach is to modernise contracted out rebates so they are a direct vivid and comprehensible reward for funded savings. They could be a direct matching contribution from government for a company or individual that set up a pension scheme of a minimum standard.

The only good thing to be said for contracted out rebates is that at least this is money which is being set aside in funded pension savings for the future. Everyone agrees that we need to encourage funded savings for the future. But instead the Citizens Pension involves taking money that is currently going into funded pensions for the future and instead spending it on higher benefits today. You do get a higher state pension and less means-testing as a result but it is financed by spending today money that was going into pension savings for tomorrow.

Pension Reform to Help Women

I recognise that it is no good simply raising these criticisms of the more ambitious ideas put forward by some reformers. At the same time we have to show that we have better ways of tackling the grievances they have identified. By far the most powerful criticism of the contributory pension system as it exists today is that it is structurally biased against women. It was designed for the days when men earned their pensions by work and women by marriage. It is much less well suited to a world in which women work and marriages break down. It is this deep unhappiness amongst millions of women about the way in which they are treated by the current rules for contributory pensions which is the biggest single factor driving support for a Citizens Pension. If we are to keep the contributory principle, we need to modernise it so that it offers a fairer deal for women.

Today I want to set out my Party’s policy for modernising the contributory system. We do not need to go to a full blown Citizens Pension in order to tackle this grievance. There are instead four key rules about the way in which National Insurance contributions work which have the combined effect of seriously disadvantaging women. If we tackle these we can keep the contributory principle but modernise it so that women get a far better deal. The origins of many of these rules are lost in the mists of time but they cannot be justified now. The Fawcett Society, the TUC, the Equal Opportunities Commission and others have done excellent work showing how they can be changed, and today I can announce that my Party is committed to doing that. We are going to make the rules for contributory pensions family-friendly for the first time.

First, we will abolish the rule which says that you have to make ten years of National Insurance contributions before they earn you anything. It means that someone with eleven years of contributions gets around £20 a week while someone with nine years of contributions gets nothing. Scrapping this rule would entitle around 100,000 pensioners, most of them women, to claim some basic state pension. And people paying National Insurance Contributions today would know that they are earning a pension with their contributions regardless of what they do in the future.

Secondly, we are going to offer better pensions to those who take time out of the labour markets to bring up their children or care for sick relatives and who contribute just as much as those who go out to work. Home Responsibilities Protection, introduced in 1978, was an attempt to recognise the contributions that these people make. But the system is crying out for reform. To benefit from HRP, you must be eligible for it for a whole tax year. So if a woman stops work in May and gives birth in July, she is most unlikely to accrue any pension rights that year. You can’t earn a year’s worth of contributions by working for a few months then spending a few months looking after a child or relative. The system doesn’t match how people live their lives, and it needs to change. We propose to replace Home Responsibilities Protection with a much more flexible weekly credit which gives people positive pension entitlements.

Thirdly, we should make it easier for people to “buy back” the years in which they failed to pay National Insurance Contributions. As things stand, people have just six years in which to make a retrospective payment. Relaxing this restriction would give people more opportunity to participate in the contributory system. There are practical difficulties, but if this could be done on terms that were fair to everyone, it is something I would like to take forward. The new rules on tax relief for private pension saving give people much more flexibility about when they make their pension contributions. We shouldn’t have a state contributory system that is so much less flexible than the new rules for tax relief.

Fourthly, people in low paid jobs face enough difficulties without being denied a state pension. You start earning the right to a state pension once your pay reaches £79 a week – and that is before the level where you start paying National Insurance Contributions. There are around three-quarters of a million people earning between £60 and £79 a week, most of them women. So lowering the bar for state pension rights could give substantial numbers of low paid people access to state pensions, without their having to pay National Insurance Contributions. Of course, this would have a cost. It would need to be considered alongside all the other demands on the public purse, and might have to be phased in gradually. But it’s something that deserves to be looked at.

So we will pay pensions to everyone who has paid into the National Insurance system. We will introduce a more flexible way for parents and carers to build up an entitlement to state pensions. We will look at how we could we could make it easier for people to make up for years when they didn’t manage to make contributions. And we want to give low paid workers state pension rights. That way, we could bring the contributory principle up to date and offer women a better deal by properly recognising the contributions they make at work and at home.

These changes sound technical. But what they add up to is an agenda for making the national insurance system fairer to women. At last we would have a system of contributory benefits which would be family friendly. In many ways it achieves the same benefits for women as a Citizens Pension. One way to help women is by modernising the contributory principle and another way is to abolish it altogether and start all over again with a Citizens Pension. Maybe it’s just because I’m a Conservative that I’m inclined towards reforming the contributory principle rather than abolishing it.

The critics will say that there is no need to bother with these reforms as we can just sweep the whole structure away. But, on close inspection, I don’t believe we would reach the utopia they promised. For a start, we would still need to collect National Insurance contributions so we will still have this elaborate system even though it would no longer serve any useful purpose. Moreover, they are going to have to start operating some sort of residency test. This is not as easy as it sounds. It needs a computer system to record how long we have all been living in the country. And is there a sudden cut-off point so that if you have been here for eleven years you get the Citizens Pension but not if you were here for nine years or is there a taper? Before we know where we are we will end up with a set of conditions for receiving the Citizens Pension which don’t look so different from the old contributory system. So the two models converge. I prefer to come at it by modernising contributions. A Citizens Pension with a residency test reaches the same objectives but via a rather long detour. What is crucial is the shared ground of wanting to ensure a fairer deal for women.

Funded Savings and the Lifecycle

So far I have talked about state benefits. We won’t be able to give a fair deal to our pensioners and offer better incentives to save unless we reverse the spread of means-testing. But it is only half the story. The other half is to rebuild confidence in savings. One of my Party’s long-standing commitments has been to the idea of a property owning democracy. But progress has sadly stalled. It is particularly depressing that now, as one of the world’s most prosperous societies, we have 50% of the population with very few financial assets or savings. Figures published by the Office for National Statistics last week show that the proportion of the nation’s wealth held by the richest 1% of the population increased from 20% in 1996 to 23% in 2002. You at the IPPR were one of the first organisations to pick up on the US debate on the need to spread ownership of assets. Sir Samuel Brittain has been an eloquent advocate of this for many years. All too often all we ever offer poor people is long-term dependency on state benefits. Building up some personal financial ownership is equally important. Conservatives have always recognised that the psychological dimension of poverty is just as important as its physical symptoms. When we allowed people to buy their council houses, we found that many neighbourhoods improved as people with a newly acquired stake in their community suddenly had a stronger reason to take pride in their surroundings. By spreading asset ownership, we can give more people a sense of control over their own destinies.

Moreover, if we politicians are to be serious about security, it is not just David Blunkett’s seven Bills, it’s also about savings in the bank. But encouraging saving and spreading ownership is one of the disaster areas of British public policy. There are three big obstacles standing in the way of progress; we can remove each one of them.

First, the opinion research shows a depressing loss of trust in many savings products. There are extraordinary similarities between the problem that the savings industry has in regaining trust in its products and the problem that we in politics have in getting people to believe anything we say. I guess as a politician interested in savings I must have a double disadvantage! It is partly the hangover from the pension mis-selling scandal but the problem goes deeper than that. As society becomes less deferential so people just won’t trust the sort of smoothing between good years and bad years which with profits policies deliver. And in a way a company pension scheme is a kind of with profits policy. The whole direction of accounting standards as well has been to move away from a smoothing formula towards market accounting. We can’t fight against such a social change, instead we have to accept that as trust has declined the only alternative is transparency. People want to know exactly how much they have got in a personal account at any given moment. So we need wherever possible to give people a clear sense of what they own, including in state schemes, to encourage funded saving. The old black box has to be replaced by a transparent, Perspex one.

Secondly, too often when we preach about the virtues of saving all we talk about is a pension for your retirement. Every time I go to a pensions conference an earnest financial expert says that if only we got people at the age of 25 to start saving money for their pension then they would have a decent nest egg when they were 65. But asking people that young to make a discretionary decision to put money aside for 40 years is, in today’s world, pretty heroic. What young people are really worried about is saving enough money to buy a first house or perhaps to pay for an extra training course to get a qualification. Just as we need to reform the state system so it fits with how people live their lives, we must also look at how the structures we have in place for funded saving can go with the grain of the lifecycle.

If anything, the changes we’ve seen in recent years have put back the time at which saving for retirement can reasonably be expected to become a priority. With house prices having more or less doubled over the last five years, people starting work today and aspiring to get on the housing ladder will have to save harder and for longer than their older brothers and sisters. Only last week, a survey by National Savings and Investments showed that on average first time buyers would need to save for more than four years to build up a 5% deposit to buy a home – 21 months longer than a decade ago.

The arrival of the new structure of tax relief for pensions is another crucial change here. It abandons many of the limits on annual contributions; it would be very sensible for people to put their money aside in short-term savings vehicles, then, perhaps in their 50’s, start converting this, or any other assets they might have, into a pension fund. The need to set the money aside early in order to take advantage of any tax relief is much reduced.

Meanwhile, changes to student finance mean that young people coming out of university will spend years paying off their debts before they can afford to think about saving for retirement.

Together, these three changes – high house prices, the new tax regime for pension saving, and graduate debt - are going to have a massive impact on patterns of savings across the lifecycle. I’m not sure that politicians or the savings industry yet realise how big this could be. It means we need fresh thinking on the design of savings products.

One of the reasons why Britain and America have low savings ratios compared with most other western countries is that too much of our reward for saving has focused on saving for retirement. In France, for example, they have very large amounts of savings but because it doesn’t have an age rule for accessing, for example, mutual funds or insurance policies they don’t appear in the international statistics for pension saving. But in reality a French pensioner gets almost as high a proportion of his or her income from funded saving as a British pensioner. The difference is that theirs comes from more flexible forms of savings which are not officially defined as pensions.

We have not done enough to encourage precautionary saving, saving for a rainy day. What begins as precautionary saving can subsequently become the saving that is used to finance retirement. This is the thought which lies behind our Lifetime Savings Account. If people can access their money they may be willing to pay more in the first place. It is precisely because the car has got brakes that we are able to drive it faster.

Thirdly, there are too many different fragmented savings initiatives. The IPPR takes great pride in having first proposed what you called the “baby bond” and what is now known as the Child Trust Fund. I’m not sure whether the Chancellor was persuaded by the intellectual case for asset-based welfare or whether he was more taken with the idea of sending large cheques to thousands of families just weeks before a general election. Either way, the Child Trust Fund has become one of many Government initiatives designed to encourage saving or allocate a pot of money to individuals.

If the pension system Gordon Brown has created looks like the un-thematic work of an over-excited architecture student, the same could be said of his initiatives on savings and assets. We have the Child Trust Fund, where the Government provides a lump sum which parents can top-up if they like. We have the Savings Gateway, where the saving is done by low-income individuals and the topping up by the Government. Then we have Individual Savings Accounts, which use a more traditional tax exemption, and which the Chancellor threatens with the axe in the days preceding each Budget, only to reprieve them at the last minute so he can posture as the saviour of the middle-classes. For a while, we also had Individual Learning Accounts, out of which people could pay for training courses. What these disparate initiatives desperately need is a single lifecycle account to pull them all together.

It should not be beyond the wit of man to tie some of these different initiatives together into a single account that can meet people’s saving needs at different stages of the lifecycle – from cradle to youth, from adulthood to retirement, and from retirement to grave. Our Lifetime Savings Account uses the matching principle of the Savings Gateway. I have suggested that the assets in a Child Trust Fund could, on maturity, be transferred straight into one of these accounts, and that precautionary savings can go on to become savings for retirement. I wonder whether we couldn’t also find a way to incorporate some other aspects of the welfare state, such as the money that the Government is prepared to pay for people’s educational development. That really would be a personalised welfare state – and one with real funded savings behind it.

With the age of deference long-gone and people’s expectations higher than ever before, I don’t think the traditional model can hold. Pensioners who have worked hard all their lives don’t want to go cap in hand to the Government for an income when they retire. Today, I’ve set out a range of reforms – better pensions for women and a more flexible approach to saving across the lifecycle. This surely fits with the direction in which our society is heading. After all, the task of those of us who care about good social policy is to is to develop policies that go with the grain of the deep social changes we see taking place all around us. “