The Return of Patrimonial Capitalism

The big change announced in the budget - the abolition of the need to buy an annuity with the bulk of your pension pot - has produced a slew of mostly pessimistic predictions. These have ranged from structural fears, such as the meltdown of the annuity industry, to behavioural prophecies, such as the moral hazard of sexegenarians spunking their wad on Lamborghinis. The behavioural dimension is always overplayed because the budget is deemed to be a moment when policy directly and immediately impacts on "ordinary people" (hilariously parodied this week by Grant "Bingo" Shapps). In recent decades this has been amplified by the popularity of behavioural economics and the sinister/sugary trope of "nudging". In practice, few us are able to say what the impact of a budget will be, because there are simply too many variables in the mix.

In the immediate postwar period, there were fewer fiscal levers that a government could pull and even fewer that affected the large majority of the electorate (and that despite the persistence of rationing). The secular change since then has been the growing extent and complexity of taxes and benefits, which has given government more to play with, and the parallel shift in tax composition away from real wealth (which few have and which has few sources) to consumption (which affects us all and is multifarious). This has accentuated the myth of predictability, encouraging the "ready reckoners" in the media to break down the population into the sort of consumption-oriented granularity beloved of marketing folk, with their pseudo-anthropological tribes ("gay couple, smokers, vegan, single income, 1 child, 2 dogs" etc).

The real message of a budget announcement is therefore a matter of ideology, rather than the pound in your pocket. George Osborne is trying to tell us something, though perhaps more subtly than the Conservative Party Chairman. I think the substance of that message is to be found not just in the pension proposal but in the announcement that inheritance tax will be waived for members of the emergency services who die on duty. The numbers affected by this will be trivial, and the quantum of money, relative to the economy, even more so. The symbolic value is the yoking of something that is ethically ambiguous, inheritance, with something that is unquestionably admirable, self-sacrifice.

The link to pensions is that an annuity is the liquidation of capital. The longstanding criticism (long before 2008 ushered in lower rates) is that once a pension pot is converted to an annuity, there is then no inheritance. Of course this is actually a feature, not a bug, as the capital is ultimately what allows annuities to pay at a higher rate (currently about 6%) than other savings vehicles. It is the surrendered capital of those who die early that pays the income of those that die late. It may well be that allowing pension pots to be reinvested any old how will boost buy-to-let, and equally predictable that some retirees will make disastrous choices and lose their savings, but this obscures the fundamental change. Whether invested in property or equities or bonds, the reform will allow capital to remain concentrated and be handed down within families.

But those families are not the sort that drink copious amounts of beer and play bingo every week. The average pension pot in the UK is £30,000, though the annuities bought are typically smaller as many retirees take the 25% allowed as a tax-free cash lump sum. The "trivial commutation" threshold, which allows you to take the entire pot as cash rather than buy an annuity, has now been raised from £18,000 to £30,000. In other words, the "liberation" entailed in the decision to make annuities optional (and the related reduction in tax rates on pension withdrawals) is primarily of value to those with above-average size pension pots. This is a policy targeted at the better-off, rather than a policy targeted at the elderly in general.

The timing of this policy change in quite deliberate, but it has nothing to do with continuing austerity or demographic trends, let alone a fear of UKIP success in the European elections. It comes after three decades during which executive remuneration has maximised the tax-breaks of pension contributions. Those who will benefit most are retirees with very large pension pots who can now recycle more of their funds into property and equities. In this light, it is worth looking back at the last major change to the pension rules, in 2011. The introduction of limits on tax-breaks for executive contributions apparently "sparked a surge in directors requesting cash payments in lieu of retirement contributions, to invest outside their pension plan in property and other assets". You can almost see someone joining up the dots. Interestingly, the Chancellor did not suggest that in tandem with pension "freedom" he would reconsider tax breaks on contributions, even though the tax incentive has always been seen as a quid pro quo for the restrictions of annuitisation.

The "face" of this reform is not a middle-earner hoping to get a better return by investing in a student flat in Manchester, but Fred Goodwin. While the former CEO of RBS won't directly benefit from the change, having already retired and crystallised his winnings, the other members of the multi-million pound executive pension class will. Another perspective on this is that those most likely to face poverty in old age are already free to spunk their pension pots. The poorest third of all retirees were able to do this under the previous rules, though most didn't (a result of inertia/fear rather than rational choice). The government's sanguine attitude towards the risk of moral hazard (i.e. pensioners frittering their pots away on world cruises and then falling back on benefits) looks like the consequence of the introduction of the single-tier, flat-rate pension, which means they can be confident the burden on the state will not increase.

The boost to inherited wealth that this policy delivers might appear a marginal issue (and it has certainly been marginalised by the fretting over buy-to-let property prices, Lamborghinis and Bingo) but the recent publication of Thomas Piketty’s Capital in the 21st Century should banish any doubts about its significance. Piketty's empirical finding is that returns to capital (by which he means broad financial wealth) have consistently been greater than growth (which distributes returns across society), outside of the exceptional mid-twentieth century, and that a lower growth rate is conducive to higher concentrations of wealth, which would go some way to explain the ongoing reluctance to invest in productive capital (as opposed to property) and the attractions of austerity. We have, over the last 35 years of modest growth and widening income inequality, been heading once more towards the "patrimonial capitalism" of the nineteenth century. George Osborne is now telling us that it's full steam ahead.