Public sector pension costs may reach £79bn a year

Pension payments to retired public servants could balloon by 200 per cent to £79bn a year in the next 50 years, according to a report by government spending watchdogs published today.

The independent study by the National Audit Office (NAO) will increase the pressure on politicians to rein in the generous final salary schemes for public sector workers as they seek to cut the deficit in the public finances after the general election.

The Tories and Liberal Democrats have already hinted that they would review public sector pensions, with David Cameron expressing concern about "pensions apartheid" since many companies have closed their final salary schemes.

Labour says it has already acted to limit the rise in the pensions bill and that the current schemes are affordable. But the NAO report will increase fears of a ticking timebomb. Edward Leigh, Tory chairman of the public accounts committee, said the £79bn forecast was "frightening." He said: "These figures must be used to inform an urgently-needed national debate about public sector pension schemes for new entrants."

The NAO studied the four largest public sector schemes currently paying pensions to more than two million retired teachers, civil servants, members of the armed forces and NHS staff. The current £19.3bn a year cost has risen by 38 per cent in the last 10 years. Some £14.9bn falls directly on taxpayers, with the rest coming from employees' contributions.

It discovered that the Government's own projections for all public sector schemes showed total payments reaching £79bn by 2059-60 – up from £25.4bn this year. These figures exclude employee contributions and so would not all fall on taxpayers.

The NAO said the figures were less stark when expressed as a proportion of gross domestic product (GDP) because this was expected to rise. The Treasury expects the economy to grow by about 2 per cent a year.

The forecasts take account of earnings growth, the number of public sector workers and longer life expectancy. They assume that men who retire aged 65 in 2055 will live to be 92 and women 94. However, the NAO challenged the Treasury's assumption that the size of the public sector workforce would not grow over the next 50 years. Amyas Morse, the head of the NAO, said: "The Treasury ... has not considered the potentially significant effects of changes in the size of the public sector workforce."

Unions argue that final salary pensions are justified because pay is lower in the public sector than in the private sector. Prospect, which represents 34,000 professional grades in the civil service, said the NAO report went a long way to debunk the "mistruths" often perpetuated about the affordability of public pensions.

Neil Walsh, the union's pensions officer, said: "The report makes it clear that public sector pensions are far from being the unsustainable burden on current or future generations of taxpayers they are often portrayed as. Rather, when viewed in terms of percentage of GDP and thereby an indication of the country's ability to pay, projected costs look set to rise from 1.7 per cent of GDP today to a peak of 1.9 per cent in 18-19 years' time and then back down to 1.7 per cent by 2059-60."

Steve Webb, the Liberal Democrats' work pensions spokesman, said: "This report shows ministers have failed to grasp the need to reform public sector pensions. The Government must be aware of the risks it is taking by not planning for changes in the size of the public sector."

A Treasury spokesman welcomed the report's contribution to the debate on the cost of public service pensions.

How to solve the problem

1. Tax them

The pension entitlement accrued by a professional in the public sector might be the same as a multi-million pound pension pot accumulated by a private sector counterpart from their – usually post-tax – income. The answer here is to find some way of taxing the public sector pension. This is now being done for top earners in final salary schemes, but it could be brought down the income scale.

2. Scrap them

A start has been made in trimming accrual rates, but more could be done with, say, a cap at £40,000pa. Alternatively, the growth of the public sector workforce could be restrained; and public sector staff could be migrated to money purchase schemes.

3. Learn to live with the burden

We could find ways to handle the colossal cost. This might include increasing immigration to boost the working population and tax take; reducing public spending in other areas; putting up with the higher taxes; or borrowing far into the future.

Sean O'Grady Economics Editor