The Chancellor was advised that pensioners could lose up to a fifth of their income as a result of the changes to the tax system that he made weeks later, newly released Treasury documents show.

The paper, from the Savings and Investment Division of the Inland Revenue, predicted that someone on an average occupational pension income of £5,000 a year would lose £150 a year, but gave warning that “at the extreme, if share prices fell by a full 20 per cent and the fund was wholly invested in UK equities, a pension of £5,000 a year could fall by £1,000”. The officials added that “quite clearly any loss of pension could be difficult for someone with a small income to cope with”.

Estimates of the likely impact of the changes to company taxation were set out in four papers to the Chancellor and the Paymaster General after the election in May 1997 — two each from the Savings and Investment Division of the Inland Revenue and the Financial Institutions Division. The papers — each giving slightly different views — were combined in an 81-page analysis by the Economics Unit of the Treasury that was presented on June 27, just a week before Gordon Brown’s first budget.

The officials attempted to predict the consequences of a complex series of tax changes that involved the scrapping of tax credits on payments of dividends to pension funds and a simultaneous cut in corporation tax. The papers each outlined scenarios of what might happen and admitted that there was a large amount of uncertainty. They did not advise the Chancellor on which decision to take.

The papers each painted a gloomy scenario for the 11 million holders of occupational pensions and the 7 million holders of personal pensions, and warned about the inevitable clamour from the pensions industry. They stated that the losses would be mitigated by various factors, principally the buoyant state of the stock market, which meant that many pensions funds were enjoying surpluses in 1997, and that the package overall would promote economic growth.

The papers predicted that the value of pension funds would fall by up to £75 billion, with the values of the stock market falling between 6 per cent and 20 per cent. The head of the Treasury economics unit summarised the finding by saying: “For a central estimate, however, this would translate into a corresponding 17.6 per cent cut in actuarial value of equity assets . . . Taking the 17.6 per cent cut indicates that pension providers lose around £67 billion on the actuarial value of their existing assets.”

Employers would have to contribute between £3 billion and £10 billion a year more to make up the difference, while pensioners would find that their pensions would shrink, the papers predicted. The government actuary’s department expected that some pension schemes might be pushed into insolvency and cautioned that the Department of Trade and Industry was “likely to be ‘gravely concerned’ about the proposed changes from a solvency point of view”.

The assessment of the consequences was almost entirely negative, with no forecasts of immediate gains for pensioners. The best that could be said was that pension funds were enjoying surpluses of up to £60 billion, so they should have been cushioned from any blow.

The financial institution division claimed that “further work continues to suggest that the pensions industry should generally be able to cope”. The Inland Revenue said that “the consolation, to the extent that there is one, would be that stock market values have risen so far over the last six months or so that, despite any dip in the value resulting from the tax credit change, their pension fund is likely still to be worth more than might normally have been expected”.

Although the stock market was buoyant in 1997, it fell sharply after the collapse in the value of dot-com companies. Pension funds could not escape plunging into deficits, and what was once one of the best pension systems in the world has struggled to cope.

The advice

What the Chancellor was advised by his officials (May 15 — May 27, 1997)

— We agree that abolishing pension tax credits would make a big hole in pension scheme finances

— The loss of tax credits would cost pension providers about £4 billion a year, growing over time with future dividends

— The corporation tax changes are likely to reduce both income from, and value of, pension providers’ equity assets

— Those who are about to retire (or who have just retired) could be worst affected Quite clearly, any loss of pension could be difficult for someone with a small income to cope with

— Of course, the downside here is that benefits would be smaller and this would run counter to a policy of improving retirement income

— Employees (or their employers) would have to increase contributions if pensions were to be maintained

— The general message is that the big employer pension schemes will be able to cope at some cost to employers. But members of money purchase schemes would all be potential losers

— There is very big uncertainty over the extent to which pension schemes could absorb the effect of the loss of tax credits

— The change would therefore lead to a reduction in pension benefits for the lower paid

— Some schemes — which will be given a high profile by the pensions industry — will be pushed into acturial deficit by the loss of tax credits

— It is possible that some local authority pension schemes may need to be topped up. If so, this will lead to extra public expenditure

The official line

What ministers told the public

“Pensioners, in my view, will not lose out over this in the way that people are suggesting”
Gordon Brown, BBC News, July 3, 1997

“We are not raiding pensions — that is just ridiculous”
Gordon Brown, GMTV, July 3, 1997

“Nonsense.”
Gordon Brown, July 3, 1997, on claims that people would have to make higher pensions contributions

“There is no question that in the long term and the medium term it will be good for companies and it will be good for pensioners”
Alastair Darling, who was then Chief Secretary to the Treasury, July 3, 1997

“The decision will be good for pension funds because it will enable companies to grow”
Alastair Darling to Parliament, July 10, 1997

“The measure is good for pensions and pensioners, not bad for them . . . People should understand that our reforms will benefit pension funds”
Dawn Primarolo, Treasury Minister, to Parliament, July 3, 1997

“The measures on pensions in the Budget were entirely right and necessary. They were right, first of all, because they removed an unjustified bias in the tax system and they were right also in order to deal with the problems of public finances left by the previous administration”
Tony Blair to Parliament, July 9, 1997

“Pension funds should benefit substantially from the improvement in company performance as a result of this Budget”
Helen Liddell, who was then Economic Secretary to the Treasury, July 16, 1997

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