Is the State Pension triple lock doomed to fail?

The state pension triple lock is one of those government policies that was designed with good intentions (and to win votes), but that has been shown to have some severe shortcomings in the real world. 

The triple lock was introduced by the coalition government in 2010 to ensure pensioners' incomes are protected. 

Under the guarantee, the state pension rises each year in line with whichever is higher, 2.5%, average wage growth between May and July compared to the prior year period, or inflation. 

It means pensioners can rest safe in the knowledge that their income will continue to grow every year, keeping pace with rising prices. 

The logic behind the state pension triple lock 

In theory, this sounds like a good idea. In stable economic conditions, where inflation sits at or close to the Bank of England’s (BoE) target of 2%, and wages grow in line with inflation, the government will have a fairly good idea of what it’ll be on the hook for year after year. 

And that’s just what happened between April 2010 and April 2020. In this period of low inflation and low wage growth, the Basic State Pension, payable to individuals who reached state pension age before 6 April 2016, rose from £97.65 a week to £134.25, a compound annual growth rate of 3.2%. 

However, as any student of economic history will tell you, economies generally go through cycles of growth, stability, and decline. Inflation rises and falls, wages go up and down and the government will have other spending priorities. 

We’re seeing the downfalls of this well-intentioned but short-sighted policy play out right now. 

In 2020, the government locked down the economy, leading to huge disruption. Millions lost their jobs and millions of workers saw their incomes collapse, but, under the terms of the triple lock, pensioners received a 2.5% income boost. 

When the economy reopened, wages bounced back, rising 8.8% between April and June 2021, according to the Office for National Statistics (ONS). 

Under the rules of the state pension triple lock, this should have meant pensioners received an 8% increase in their income, costing the government £3bn. 

However, the government stepped in to cap the rise at 3.1%, arguing that the pandemic disruption caused an artificial boost in wages. 

This logic didn’t persist in 2022. In September the government confirmed that it would be increasing the state pension by 10.1% from April 2023, in line with CPI inflation. 

The state pension obligation gets bigger

While there’s a good argument to be made that pensions should receive an inflation-linked uplift every year, it’s difficult to argue that they deserve a bigger slice of the pie (and the government’s limited resources) every year. 

The Basic State Pension will hit £156 a week next April. That’s a compound annual growth rate of 5% since 2019, a very acceptable rate of growth. 

However, according to the ONS, over the same period, gross median wages have only grown 3.6% a year. 

The Basic State Pension is paid out of general taxation, and, therefore, the funds available to fulfil this promise are limited by the tax take. This in turn depends heavily on wage growth. 

Pay As You Earn (PAYE) taxes and VAT, which account for around half of UK government revenues, are both heavily dependent on wage growth. If these income streams aren’t growing as fast as spending, then you have a problem. Unlike the state pension, which can only rise due to the triple lock, wages (and tax collected on wages) can fall. 

For example, in the tax year ending April 2020, the UK government collected £633bn in tax overall. When the pandemic struck, tax revenues slumped. In the year to the end of April 2021, revenues were just £584bn. The tax collected dropped but pension spending still increased. 

The rising cost of the triple lock 

The Department for Work and Pensions (DWP) pegged the total cost of the state pension at £69.8bn in 2010. In this tax year, according to the Institute for Fiscal Studies (IFS), that cost will be £111bn, with a further hike of £5bn coming in the tax year commencing April 2023. 

As a percentage of total government spending, the state pension accounted for 7.7% in 2010 but based on current trends it’ll be nearly 11.5% next year. 

In other words, as the state pension triple lock keeps pensioners' incomes rising year after year, while the rest of the economy is subject to the general peaks and troughs of the market cycle, spending on pensions is consuming more and more of the government's resources. 

Now, this doesn’t mean the triple lock will be scrapped anytime soon, but it does mean that, with an ageing population and limited financial resources, the government will have to make some hard choices. 

Nothing can go up and up forever. If I launched an investment firm promising only positive returns, I’d be hauled in front of regulators for misleading investors. 

Either taxes rise to fill the gap or spending commitments are reconsidered. Borrowing to fill the gap is an option, although as we saw at the end of last year, the UK government’s creditors are no longer willing to swallow large, unfunded spending commitments from policymakers.