Stump up now for a ripe old age

Last week the government announced its intention to raise income tax by up to two pence in the pound, a move that the opposition parties are also having to confront. It was an important moment in British politics. At long last a truth is becoming sayable - we have to pay for the benefits we want to enjoy.

Some readers will be saying they recall no such announcement and that this columnist has clearly taken leave of his senses. It is true that the collective intent of the three parties was well disguised, but when Alan Johnson, the new Secretary of State for Work and Pensions, announced in his speech to the TUC last week that he would not be lifting the retirement age for eligibility for the state pension, the issue was sealed.

The undeniable economic and political logic of his position is to imply an increase in income tax to pay for the consequent increase in the cost of the state pension, a logic that Adair Turner, the chairman of the government's pensions commission, will lay out in exquisite and forceful detail in the interim report on the issue he will present in mid-October.

Johnson will have already felt the full private wrath of the Treasury, now letting it be known that Mr Turner has exceeded his brief, trying pre-emptively to draw the sting from his report. Turner, the former director-general of the CBI and general policy factotum, is not deliberately trying to be awkward. His trouble is that he is honest. From what I know of the report, it will be pitiless in its thinking, a long overdue intervention after two decades of dissimulation.

He has been helped enormously by the parallel hard thinking of David Willetts, the Conservative's spokesman on work and pensions. He was among the first to recognise the unsustainability of Britain's current pension policy; that a country in which four-fifths of pensioners receive their pension conditional on their poverty is not only an affront but economically irrational, because there is no more effective deterrent to saving.

His answer is to re-establish the state pension as a basic universal entitlement, to upgrade it in line with the rise in earnings and to pay for it by a combination of consolidating means-tested pensions into the state pension and raising the retirement age, deferring for perhaps a few years the moment when we will have to pay more taxes.

To understand why tax rises are inevitable we have to return to Turner's report. It will begin by laying out what lower fertility and longer life expectancy are doing to the structure of our population. There will be progressively fewer workers producing the GDP out of which more and more pensioners will be drawing their pensions. At the moment there are nearly four workers supporting one pensioner; by 2050 there will be only two. Even if there is a remarkable increase in fertility and a surge in immigration so the population grows by a quarter to more than 80 million by 2050 - which it won't and can't - the numbers of workers supporting each pensioner would still drop to three.

Turner is uncompromising. There are only three ways out of this conundrum for the state pension. First, we have to raise the retirement age to keep the costs under control; second, the average pension has to fall to do the same thing; third, taxes have to rise to maintain the pension's purchasing power. Mr Johnson has now ruled out the first option; the second is increasingly difficult politically. Which leaves with us with the last option.

'Ha!' comes the retort from politicians. We can hold the line if we ask people to save more. But, as Turner says, the basic equation still doesn't change. We know the ratio of workers to pensioners is set to halve. When today's savers come to sell their bonds and shares in order to buy their pension annuities, the only buyers will be the next working generation, who will have halved in number in relation to pensioners.

As Turner patiently explains, unless the next generation increase their savings by much more than we have, share prices and bond prices must fall - and privately funded pensions will fall in value as well. Pensions in an ageing society with a dwindling workforce is a problem that we all face and which can only be solved collectively.

Turner will set another hare running by asking for a fair deal between the generations. What Alan Johnson is doing by declaring that today's generation can retire at 65 is to require today's workers to pay the consequent higher taxes. Those workers will almost certainly have to retire later themselves - a supreme policy of selfishness. And what's more, many of today's workers in the private sector are working to create profits to pay off the pension-fund deficits to support generous, guaranteed, so-called defined benefit pensions for yesterday's workforce.

Many of the delegates at last week's TUC conference seemed to think this was just dandy. They thought that today's employers and employees should put their own prosperity at risk by being compelled to top up pension-fund deficits that have resulted from yesterday's pension promises being ridiculously generous, given the collapse in both share prices and interest rates.

Pensions are paid from annuities that are invested in long-term bonds; if the returns from long-term bonds were to rise by 1 per cent from today's levels, most defined benefit pension funds would swing into surplus; if they fell by 1.5 per cent, about a third of our top companies would be technically bankrupt.

The way out of this trap is not to lock individual companies into the swings of the capital markets and, thus, potential receivership - the self-defeating policy of the unions and, apparently, Alan Johnson. The solution is to socialise the problem through the government issuing bonds that offer sufficiently high returns to keep pension funds solvent - the policy proposed, embarrassingly for the left, by David Willetts with his 'longevity bonds'. As we are all unexpectedly living longer with unexpectedly fewer workers in a world of unexpectedly lower investment returns, his proposition is that the government should issue high- interest bonds underwritten by everyone to bail out distressed pension funds.

All these proposals, though, involve a cost. There isn't a bag of swag in the private sector which can be raided, and there is no free lunch. There are only least bad ways out of the mess, and if we don't want to work longer or accept lower pensions, then we must pay higher taxes.

Some of us have been saying this for longer than we care to remember. Willetts and Turner, though, are finally opening the national debate up in ways that are unanswerable. Good for them. Let us hope that this time somebody is listening.