Social Security Benefits Up-rating Order 2011

Monday 14th March 2011 Lords Chamber

Motion to Approve

19:27

Moved By

[Lord Freud]

That the draft order laid before the House on 3 February be approved.

Relevant documents: 16th Report from the Joint Committee on Statutory Instruments.

[The Parliamentary Under-Secretary of State, Department for Work and Pensions (Lord Freud)]

My Lords, I also speak to the draft Guaranteed Minimum Pensions Increase Order 2011. I am satisfied that the orders are compatible with the European Convention on Human Rights.

The Guaranteed Minimum Pensions Increase Order provides for contracted-out defined benefit schemes to increase their members’ guaranteed minimum pensions that accrued between 1988 and 1997 by 3 per cent. Such increases are in line with the growth in prices or 3 per cent, whichever is the lower.

The uprating order embodies two notable changes this year. This is the first uprating after the restoration of the earnings link for the basic state pension, and the order introduces a clear and consistent approach to price measurement with the move to the consumer prices index, thereby putting the annual uprating of social security benefits on a sustainable footing for the future.

I know that noble Lords will welcome the coalition Government’s immediate fulfilment of the promise to restore the earnings link for the basic state pension. Not only that, but we have also given a triple guarantee which means that the basic state pension will be increased by the highest of earnings, prices or 2.5 per cent. As a result of those actions, it is estimated that the average person retiring on a full basic state pension in 2011 will receive £15,000 more in basic state pension income over their retirement than they would have done under the old prices link. Through these policies for the basic state pension, we will provide a solid financial foundation for people’s retirement income.

The basic state pension goes to more than 11 million pensioners in this country, and is the most efficient and equitable vehicle for distributing resources to pensioners. From this April, the standard rate for the basic state pension will increase by 4.6 per cent. That means an increase of £4.50 a week, taking the weekly rate from £97.65 to £102.15. This is in line with a promise made at the Budget to increase the basic state pension in line with the retail prices index in 2011. In subsequent years the triple guarantee, with the consumer prices index used to measure prices, will apply.

In the other place, there was an accusation that we have had to override the triple guarantee this year because the relevant CPI figure—3.1 per cent—would have resulted in too low an increase. This is not the case. We made a promise to increase the basic state pension in line with the RPI in April 2011 if it showed the highest growth. It did, so that is what we are doing. There is no override here; we are simply fulfilling a promise. We have also ensured that our poorer pensioners see the benefit of the increase in the basic state pension by ensuring that the standard minimum guarantee in pension credit rises by at least the cash increase for the basic state pension this year. Therefore, from April 2011 single people on pension credit will receive an above-earnings increase to their standard minimum guarantee of £4.75, which will take their weekly income to £137.35. For couples, the increase will be £7.30, taking their new total to £209.70 a week.

I will now turn to the second notable change I mentioned; namely, the switch to the consumer prices index as the measurement of prices for benefit and pension uprating. This is not the first occasion on which we have discussed the CPI and it will not be the last. Indeed, we will be returning to it tomorrow in our deliberations in Grand Committee on the Pensions Bill. Nonetheless, I hope noble Lords will permit me to take this opportunity to outline our thinking on the matter again. It has been said before but bears repeating that the purpose of the annual uprating exercise is to ensure that the purchasing power of social security benefits is protected against inflation. It is not to give the highest increase possible.

We believe that the CPI is the most appropriate measure of inflation and one that is fair to the taxpayer. As the Chancellor announced at the Budget, the move will save almost £6 billion a year by 2014-15. We do not claim that it is a perfect measure of inflation, but it is the most appropriate and is the measure used by the Bank of England to measure the general level of price inflation. The key difference between the RPI and the CPI is the so-called formula effect. Put simply, the CPI is calculated in a way that takes account of the choice available to consumers who can trade down to, or, in the jargon, substitute cheaper goods when prices rise. RPI is not and arguably overstates inflation as a result.

A basic principle of economics is the law of demand, which states that, all other factors being equal, a rise in the price of a good will cause consumption to fall and vice versa. A key driver of this is substitution: as prices rise, consumers will substitute away from higher-priced goods, choosing less costly alternatives. Substitution can occur in different forms. There can be substitution among brands or types of products, such as brands or types of ice cream; across different store outlets and across time. This is known as elementary or lower-level substitution. There can also be substitution among items in different product categories—such as between ice cream and cupcakes, or bus rides and train rides—referred to as substitution at higher levels of aggregation.

The geometric mean in the CPI is used only at the elementary aggregation, or lower level. There is no higher-level substitution assumed. A good way to think about substitution is to employ the concept of elasticity. Price elasticity is a measure of how responsive demand is to changes in price. Higher-price elasticity means that small changes in price lead to a large shifts in demand and vice versa. Where a good is described as having unit elasticity, a 1 per cent rise in price will lead to a 1 per cent fall in consumption and vice versa. This is a common way to represent demand behaviour in economic literature, in the form of the Cobb-Douglas utility function. For a given basket of goods, the Cobb-Douglas function assumes a unit elasticity of demand for all goods in the basket.

How does this relate to the geometric mean? Economists have shown that the geometric mean is an exact reflection of the cost of living if the elasticity of substitution is equal to one; that is to say, if a 1 per cent change in price leads to a 1 per cent change in consumption. The arithmetic mean is appropriate if the elasticity of substitution is equal to zero; in other words, if price change has no effect on consumption. Clearly, there are some goods for which price change will have little or no effect on consumption, because there is no recourse to a substitute good which has increased less in price. One example would be petrol. That is why the arithmetic mean is used in the CPI to combine petrol prices. In fact, the arithmetic mean is used in 30 per cent of the CPI’s basket of goods for precisely that reason. Other goods it covers include electricity, newspapers, transport and postal services.

What about the remainder of the index, the 70 per cent where substitution is implied by the use of the geometric mean? Do people really substitute away from goods which have risen sharply in price to those which have not? Is the geometric mean appropriate? Noble Lords will not be surprised to find that there is a body of empirical evidence that people do substitute and that the geometric mean is an appropriate reflection of that. In Australia in 2009 a study by Ivancic, Diewert and Fox found that, in the overwhelming majority of cases, elasticity of substitution was much closer to one than to zero and therefore that the geometric mean was a more appropriate reflection of consumer behaviour. One of their key findings was that consumers are very responsive to price changes at the elementary aggregate level, the level on which the geometric mean operates. However, the study went further, finding that even the geometric mean might not fully capture substitution, with some elasticities exceeding one. There is separate evidence, for example, that brand-level elasticity is often more in the one and a half to two range.

Closer to home, also in 2009, the Scottish Government published an overview of evidence on food prices. Within this, the use of TNS Worldpanel market data showed that consumers do respond to higher food prices by substituting within a general category of food. I hope that this reassures noble Lords that consumers do substitute when prices rise; not necessarily that they substitute all the time, for the geometric mean does not demand that; simply that some people will substitute when an item has risen sharply in price and there is a good substitute.

The CPI deals only with substitution on the elementary aggregate level, the lower level. In the United States a widespread view developed that their consumer prices index was overstating inflation by not taking account of substitution behaviour. The US Advisory Commission to Study the Consumer Prices Index, also known as the Boskin commission, was concerned about substitution bias—concerned that their CPI was overstating inflation by not taking into account consumer substitution. However, the commission’s report made the point that higher-level as well as lower-level substitution was an important part of consumer behaviour.

Suffice to say that the theory and evidence for consumer substitution is compelling, that the geometric mean is an appropriate method of capturing that behaviour and therefore that the CPI’s method of aggregation is superior. That is why the geometric mean is used in the consumer prices index of the United States, Canada, Australia, Denmark, Finland, Ireland, Italy, Luxembourg—I could go on; I will go on—France, Portugal, Spain, Sweden and Austria. You get the picture.

Once we accept that the use of the geometric mean, where appropriate, is superior, then we have accounted for most of the gap between the CPI and the RPI. In fact, it has accounted for an average 0.53 percentage points of the average 0.88 percentage point gap since 1997, or 60 per cent of the gap. Already it seems that the CPI is the more suitable index. People tend to gloss over the fact that most of the gap is contributed by methodology, which experts agree is superior, and concentrate on the basket of goods instead, so it is to that factor that I will now turn.

The CPI excludes mortgage interest payments, which are not relevant to the majority of pensioners and benefit recipients. Only 7 per cent of pensioners have a mortgage, and many working age benefit recipients can get help with their housing costs. As noble Lords will know, it was mortgage interest that caused the RPI to fall in 2009 and, consequently, many pensions to be frozen. Without mortgage interest, the RPI would have grown 1.3 per cent rather than fallen 1.4 per cent in the relevant period. The CPI grew by 1.1 per cent in that same period. This illustrates the significant effect that mortgage interest can have on RPI inflation, and it is not a cost relevant to most benefit and pension recipients. There are other housing costs, of course—rent, for example—but, since the CPI already includes rent, we need not concern ourselves with that.

What about owner-occupiers though? The ONS is working on incorporating owner-occupier housing costs in the CPI. It is not something that can simply be dropped in, and the work is currently at an early stage. We will monitor this work closely and look seriously at the new index when it is close to production.

In correspondence with the UK Statistics Authority, the Royal Statistical Society has made some suggestions with regard to the CPI. Naturally, we welcome the ONS’s continuing statistical development programme. However, let us not lose sight of the fact that the Royal Statistical Society has issues with the RPI, to which I shall return in a moment.

Increases in line with the growth in the CPI maintain benefit and pension value as well as putting the system on a more sustainable footing, allowing the Government to focus help where it is needed most. In short, it is fair to recipients and to the taxpayer. I mentioned the Royal Statistical Society. You will often see reports of its concerns with the CPI in correspondence to the UK Statistics Authority. Have any of those reports mentioned its repeated calls for the RPI’s methodology to be improved, given that it arguably overstates inflation? I suspect not. The Institute for Fiscal Studies’ report on the Budget said that the CPI’s methodology was,

“a sound rationale for the switch”.

For a final word on the CPI, let us look no further than that longstanding Chancellor, Mr Brown, who said:

“It is more reliable ... It is more precise”.—[Official Report, Commons, 10/12/03; col. 1063.]

That is the consumer prices index—not a perfect index, but more reliable, more precise and more appropriate. I commend these orders to the House. I beg to move.

[Lord McKenzie of Luton]

My Lords, I thank the Minister for introducing these orders and for that journey through geometric means, elasticity of demand and Cobb-Douglas. I am certainly reassured to know that the geometric mean works only at the elementary aggregate level. He has certainly given us plenty to read this evening in time for tomorrow’s further debate on this issue when we get to pensions.

The Guaranteed Minimum Pensions Increase Order presents no problem to us. Although the general level of price increase has been based on the CPI, not the RPI, the limiting factor is the 3 per cent cap, and we can support this order. However, the more substantive benefits uprating order is an altogether different proposition. Of course, we are not supposed to vote against it as it is includes matters that we support, such as the uprating of the basic state pension by the RPI, but we will not vote for it since, as we have heard, it is the start and signals the continuance of the switch to uprating by reference to the CPI. When it comes to debating these things, the Minister is right that there is no perfect index; an index measures what it measures.

The Minister made great play of the triple lock and the re-linking of the basic state pension with earnings. This is something that we support, and why not? After all, we locked it in as a requirement into primary legislation. We should remember that it was a Conservative Government who broke that link at a stroke. It was a consequence of this that when we came to government in 1997, our priority was to target maximum resources on the poorest pensioners. This was helped through measures such as pension credit, which meant that by 2007-08 there were 900,000 fewer pensioners in relative poverty than in 1998-99, as measured by the 60 per cent contemporary median income. On average, pensioner households were £1,500 a year better off in 2009-10 as a result of the tax and benefit changes than if the 1997 policies had simply been rolled forward. The poorest one-third of pensioner households were over £2,000 a year better off.

19:45

I should say that we recognise that the order before us relates to the basic state pension and the S2P. Issues concerning occupational pensions and the revaluation of preserved pension rights were dealt with by an earlier order in December last year, when the Secretary of State again used the CPI as the basis for revaluation, and they presage the order for public sector pensions, which will similarly be laid before us before 18 March. Those issues might spill over into the debate that we have today.

On the basis of the GAD report that accompanies the order, assuming that uprating continues to be done on preceding-year increases, it will be 2013-14 before the earnings increase at 2.6 per cent will determine the basic state pension increase. For the period covered by the report to 2015-16, the 2.5 per cent underpin would never determine the uprating, and for two years—2012-13 and 2013-14—where the CPI and earnings respectively would under the Government’s proposals, the RPI on the old basis would produce a better result. Despite the triple lock, then, uprating by the RPI for 2012-13 and 2013-14 would have produced a better result.

The Minister has placed much reliance on the switch to the CPI as being the most appropriate measure of inflation for uprating pensions and benefits. It is somewhat surprising, notwithstanding the Minister’s comments, that the Government have abandoned the policy at the first opportunity and held on to uprating the basic state pension by the RPI and the minimum-guarantee element of pension credit by a mixed rate of 3.6 per cent that is designed to preserve the full basic state pension increase.

The Government announced last year the use of the CPI as a basis for determining the percentage increase in the general level of prices for a range of matters. It is widely acknowledged that the CPI as a measure of inflation will generally be below the RPI; I think that the Minister acknowledged that. That is reflected in the GAD report, which shows it to be below the RPI by 0.4 per cent to 1.6 per cent for the period to 2015-16. It is also reflected in the June 2010 Budget Red Book, which by 2014-15 expects the Exchequer to save some £6 billion a year because of the switch. The saving will come at the expense of those on benefits, tax credits and public sector pensions.

As we have heard, the Government’s arguments in favour of the CPI are that it is a headline measure of price inflation, that it uses a standard international classification system—we heard about the other countries that use it—that a single index across all upratings is best, and that the CPI is most suitable for use as a single index. For pensioners, it is argued that the CPI is preferable because it uses a methodology that implies that consumers will switch to cheaper goods when prices rise. On coverage, the challenge is that the RPI includes mortgage interest payments, which are not relevant to the majority of pensioners, although there is the recognition that the CPI, while excluding mortgage interest, also excludes certain other indirect housing costs. How does that argument run for benefit recipients as well as for pensioners? How does switching to cheaper goods operate for poorer households? If households are living at the margin, at the cheapest level that they can, at the moment because of their circumstances, what does switching in that index actually mean for them?

We have to look at other comments on the CPI/RPI indices. The Minister quoted the IFS research. The IFS notes that the CPI tends to give a lower rate of inflation for two reasons:

“Because of both the formula effect and the fact that items excluded from it tend to rise in price more quickly than average prices, the CPI tends to give a lower rate of inflation than either Rossi or the RPI … This means the decision to link benefits to the CPI is likely to save the government money”—

We know that. It continues:

“These savings will cumulate over time: in any given year, the differences between different measures of inflation may be small, but over many years the difference in the value of benefit payments will be substantial”.

The IFS analysed the government rationale for the switch. Part of its conclusions was as follows:

“Overall, then, we find that the move to CPI-uprating is not clearly justified by the coverage of the CPI being more appropriate for all benefit recipients, particularly for those of working age. Nor do our results suggest that the switch from RPI to CPI as part of the triple lock guarantee for the basic state pension was obviously justified on coverage grounds: whilst we find the majority of pensioners in receipt of other benefits are insulated from the costs excluded from the CPI, if we include state pension recipients as well, the proportion insulated falls to between 31.5% and 32.2% of pensioner households, similar to the proportions insulated for working age households”.

The Minister referred to the Royal Statistical Society and the UK Statistics Authority. A letter from the Royal Statistical Society said:

“As we all know, the CPI was originally the Harmonised Index for Consumer Prices … constructed in order to compare price movements between EU countries; its methodology and coverage are on agreed EU definitions. Lack of agreement over the treatment of owner occupier housing costs, of particular importance for the UK, means that these are still excluded; it is debatable whether its exclusions of items such as council, vehicle excise duty, trade union subscriptions and television licences, and its inclusion of spending in the UK by foreign residents, are appropriate for all purposes. Its methodology, specifically the comprehensive use of the geometric mean at the lowest level of aggregation, has many supporters. It is approved by some other international bodies as well as the EU. However, some would argue that it is not the best approach for products where consumers are typically slow to substitute newly cheaper outlets, brands or varieties for existing more expensive ones”.

In October 2010, the UK Statistics Authority replied, saying that the CPI should become the primary measure of consumer price inflation once the inclusion in the index of owner-occupiers’ housing costs had been achieved. It said:

“We continue to regard both the Consumer Prices Index … and the Retail Prices Index … as important measures of consumer price inflation. We believe that the CPI should become the primary measure of consumer price inflation but only when the inclusion in the index of owner occupiers’ housing costs has been achieved”.

We consider that there is a persuasive case for making a change to CPI uprating for a period of time, provided that recipients of benefits did not lose out in growth and earnings. If that were the case, we could have a discussion on that as part of the deficit reduction plan, but the switch goes way beyond the period when the deficit should have been dealt with, which is why we are unable to support that long-term switch. A temporary expedient deal to help with deficit reduction is not on offer. It would be wrong to sign up for the long term, given the profound consequences that it would have for pension rights and for benefits.

We have had an interesting debate about the construct of indices, but we should not lose sight of what our deliberations mean for pensioners and for those on benefits. Most people struggling on income support or on the basic state pension with pension credit would be somewhat bemused by the abstract debate that we are having about what a proper measure of inflation is.

This order covers a multitude of changes to benefit upratings, and I would like to ask the noble Lord a couple of questions. I have ploughed through this but I cannot profess to have read every line. Does the order contain any changes to the capital limits—the savings limits—in calculating benefits? I think not. There are some changes to the non-dependant deductions in the calculation of benefit; these were presaged in earlier debates and government announcements. What assessment has been made of the impact of those changes, which are basically ramping up the loss for non-dependants in a household, on housing demand and the related impact on housing benefit?

Are there any fundamental changes in the order to income disregards? Is the full income disregard for child maintenance payments now fully in place?

I conclude with one further question on indexation and uprating. Before the last election, the CSPA—the Civil Service Pensioners’ Alliance—wrote to all three parties, particularly about the impact of index-linking on the future of pensions. All three parties responded. In a letter dated 27 April 2010, Philip Hammond, then shadow Chief Secretary to the Treasury, said:

“Indexation of pensions in payment is an established part of pensions legislation. The Conservative Party has no plans to change the current index-linking of public sector pensions in payment. We agree with the view that the right to indexation of pensions already accrued is part of the accrued pensions rights, and those rights will be protected”.

Does the noble Lord contend that what he has now proposed for index-linking is consistent with that assertion?

Similarly the Liberal Democrat shadow Pensions Minister at the time, now Pensions Minister, Steve Webb, said in a letter dated 12 April:

“We are very clear that all accrued rights should be honoured: a pension promise made should be a pension promise kept. Therefore we would not make any changes to pensions rights that have already been built up. I have confirmed that I regard accrued index-linked rights as protected”.

Does the noble Lord think that that commitment is to be honoured?

Tonight’s debate has focused mostly on the two issues of the basic state pension and of CPI/RPI or any other form of index-linking. Contained within this order is a raft of changes to benefit levels that will have a significant effect on the lives of many. We are not able to support the order in its totality because of the long-term commitment that it presages to the switch to the CPI. On that, we must remain apart.

[Baroness Lister of Burtersett]

My Lords, I wish to speak particularly on the shift from the RPI to the CPI. The Minister in the other place acknowledged that no single index is perfect, and the noble Lord, Lord Freud, said something similar this evening. Given that, I argue that the criterion that we should use is which index best protects the living standards of some of the poorest members of our society. That is not the CPI. Typically, the CPI rises more slowly than the RPI—15 times in the past 20 years, according to the Minister in the other place—and, of course, that is why it represents a spending cut. We should not underestimate the significance of this shift, which is easy to do when we get caught up in technical jargon about geometric means and so forth. A 2008 Joseph Rowntree Foundation study concluded that uprating policies have big effects over time. This change will have a very damaging effect over time on the living standards of some of the poorest members of our society. As my noble friend Lord McKenzie has said, these are people for whom substitution is rather difficult because they have already substituted a lot in adapting to living on such low incomes.

20:00

I do not want to get involved in debates about geometric means and so forth with the Minister; I want to stand back a step. Over the years, I have read many uprating debates. That is a rather sad occupation and I can see that not many people share my interest. I might be wrong but I cannot remember one debate in which people have stepped back and asked what for me is a fundamental question: are the benefits that we are uprating adequate in the first place? Therefore, I would like noble Lords to reflect on the question of benefit adequacy when we are considering the uprating of benefits. I want to focus on the adult jobseeker’s allowance and income support rate, because that is the rate that has been most neglected and because the failure to improve it in real terms has blunted the impact of the very welcome improvement in children’s rates under the previous Government. I will spare the Minister the trouble of pointing out that my own party’s Government contributed to the neglect of this rate because I am on record as having been critical of that neglect despite achievements in children’s benefit rates.

A recent Joseph Rowntree Foundation paper said that a single person who is able to work and who has no dependent children will be living on £65.45 a week on current benefit rates. This money will have to cover all items of expenditure apart from housing costs, including food, clothing, water, heating, lighting and travel. The foundation says that it is therefore reasonable to ask how adequate this is as a basis on which to live. To help answer that question the foundation developed a minimum income standard—what ordinary people believe is needed not just to ensure food, warmth and shelter but sufficient resources to participate in society and to maintain human dignity, consuming the goods and services that are regarded as essential in Britain today.

According to my colleagues in the Centre for Research in Social Policy at Loughborough University, the single adult income support/JSA rate is only 41 per cent of the minimum income standard. The Joseph Rowntree Foundation comments that while there is no suggestion here that benefits ought to be at the level of the minimum income standard, the sheer scale of the shortfall is indicative of the fundamental inadequacy of current levels. My colleague Donald Hirsch of the CRSP has calculated that this shortfall will increase significantly as a result of the switch to the CPI. He projects that the minimum cost of living index, which he constructed to uprate the minimum income standard, could rise by 9 to 18 per cent more than the CPI over the next decade.

Another indicator is provided by the Marmot strategic review of health inequalities, to which I made a very minor contribution. This showed that the benefit rate of a single person is only 50 per cent of the poverty line and only 46 per cent for a childless couple. Marmot drew particular attention to the vulnerability of pregnant women living on benefit, and particularly of younger women under 25 who receive only £51.85 a week. The Marmot review called for a minimum income for healthy living to enable people to live a physically and mentally healthy life and as crucial to reducing health inequalities.

Yet another indicator that illustrates the impact that uprating policies have is how benefits relate to average earnings. I was sent a graph by Professor Jonathan Bradshaw of York University that shows that the ratio of JSA for a single person to average earnings was in 2009 roughly half the equivalent of 40 years ago. I cannot help but reflect on the comparison between what we expect an adult on benefit to live on and what we in this House can claim. We expect a single adult to live for a week on not much more than a fifth of what we can claim for a day. I could not live on £65.45 a week and I wonder whether the Minister could.

I draw attention to a benefit—child benefit—that will not be uprated in April because of the three-year freeze. I remind noble Lords that when child benefit was introduced in the late 1970s, it replaced child tax allowances as well as family allowances. At that time there was cross-party consensus that child benefit should be treated as akin to personal tax allowances in recognition of the impact of children on taxable capacity. That seems to have been forgotten by policy-makers. I cannot help but draw attention to it when the Government laud the fact that they are increasing personal tax allowances by more than the rate of inflation. Of course, that is no help to those who are too poor to pay tax, whereas increasing child benefit would help this group—families with children.

I express my regret at the switch to the CPI because it will mean a further deterioration in the living standards that are achievable on benefits that are already inadequate for healthy living and for ensuring human dignity.

[Lord Beecham]

My Lords, it is a pleasure to follow my noble friend Lady Lister, who has for many years been a leading advocate of improving living conditions for many people and who has made a distinguished contribution to national debate.

Like perhaps only a few noble Lords present, but like perhaps many more who are not present, I ought to declare an interest in the Guaranteed Minimum Pensions Increase Order, as I am entitled to claim a state pension although I have not yet done so; it is temporarily deferred. Having said that, I enjoyed the speech, or economics lecture, given by the Minister. I would have enjoyed it more if I had understood it more, but I suspect that, even so, I am slightly ahead of many of those who will be subjected to the effects of these orders. The Minister and the Government have claimed enormous credit for advancing the date by which earnings related payments will be made, but they have done so at a time when average earnings are not increasing. They have made a fairly safe bet because, had they relied on the earnings index, I suspect that there would have been no increase at all. They are therefore making the provision a little earlier, but its effect will be felt at probably about the time it would have been under the previous Government. We should remember that when the RPI fell, the previous Government ensured that a 2.5 per cent increase applied.

Mention has been made of a number of distinguished bodies that have commented on the RPI. We can all choose arguments from what they have said and written that advance our own side in the debate. I hope your Lordships will bear with me if I cite selectively, just as the Minister did. The Royal Statistical Society has said that the CPI fails to reflect the spending patterns of pensioners and the rising costs that they face. The Institute for Fiscal Studies has shown that most pensioner households are not shielded from many of the costs excluded from the CPI. The UK Statistics Authority has said that it does not believe that the CPI should become the primary measure of price inflation until housing costs are included. Other costs are not included, for example changes to council tax.

The Minister will no doubt point out that council tax is frozen and indeed it is—for three years in most cases. That freezing has been affected by top-slicing the grant to local government in the first place, but I leave that aside. There will be a temporary benefit in terms of council tax increases not bearing on the incomes of families, although the elasticity of their demand is extremely limited in any event, as both my noble friends have pointed out. However, while that is the case for the time being for council tax, it should be borne in mind that council tax benefit will be cut by 10 per cent in two years’ time. The Government, in an Answer by the Minister to my Written Question of some time ago, made it clear that they had no intention of promoting the take-up of council tax benefit, despite the fact that £1.8 billion of council tax benefit is unclaimed, largely, although not exclusively, by the very pensioners to whom this measure applies and by other low-income families. In fact, under the new index, the changes and reductions to council tax benefit, the failure to promote take-up, and the apparent reinvention of the 19th century Poor Law—because council tax will eventually be determined not on a national basis but by individual local authorities—it seems that pensioners and others in low-income groups face an onslaught on their living standards.

As both my noble friends have pointed out, the geometric mean will not signify very much to people living on very limited incomes. They feel that they will fall behind many in their communities, and that will certainly be the case nationally. It is particularly disturbing, as my noble friend Lord McKenzie pointed out, that this is not just a temporary measure designed to help tackle the deficit but a permanent change at the expense of many of the poorest in this country that will also affect those on modest fixed incomes in their later years.

I very much regret that the Government have seen fit to bring forward these proposals. As my noble friend said, we shall not oppose them tonight, but their impact will be serious and will certainly reduce the quality of life of far too many people in this country.

20:15

[Lord German]

My Lords, perhaps I may follow that speech by the noble Lord, Lord Beecham, by also declaring an interest. I am in receipt of my basic state pension and I suppose that I should be thanking the Minister for his announcement that I will be earning, on average, £15,000 or more during my lifetime. However, I am particularly grateful that the measure increasing pensions restores the link with earnings. For many of us here who have campaigned on platforms at election time, the issue of re-linking pensions to earnings has been asked for on virtually every occasion when there has been an audience of prospective and actual pensioners who were concerned that the link had been broken and wanted it to be restored. I am therefore deeply grateful that the triple lock will replace the double lock.

I shall come to the issue of RPI and CPI in a moment, but I should first say that the orders demonstrate that we need a less complex system. Noble Lords on the other side have said on several occasions that this is a weighty document containing many changes. That reflects the complexity of the arrangements in our benefits structure and the calculations that flow from it. I welcome the simplification that will occur when the Welfare Reform Bill is enacted.

However, I agree that my noble friend will have to respond to the question of whether these measures will satisfactorily protect the worst-off in our society. That is the test we must put before him. Some measures that are not in the orders will support particularly the long-term employed—the Work Programme, more apprenticeships, and the more rigorous, enlarged and targeted work experience programme that will produce dynamic changes and have an impact upon the take-up of benefits overall.

I turn to the CPI/RPI debate. It is clearly difficult to produce a set of proposals that will be understood by people who are not in this Chamber and who want to hear a simple explanation. Geometric and arithmetic means are not words that roll off the tongue as you sit talking after watching the evening news on television. It is difficult to understand the complexity unless you can understand what lies behind it. What I take from this is what I call the old Tesco/Waitrose test regarding upper and lower shelves, whereby when you make a substitution, you might move shop or shelf when choosing products, in order to make savings in your weekly bill. There is something in that, given that the former Prime Minister, when he was Chancellor, said that CPI is a better measure of substitution. That is a matter which the mathematicians are beginning to grapple with.

However, it is clear that when compared with the UK no country in the western world has such a statistical difference between the two indices. The majority of other countries use the CPI index, but why is there such a difference here between the two indices? We need to understand why, and that was what the Royal Statistical Society was attempting to do. It is not just about whether there is something wrong with using the CPI, but about why there is a gap between the two indices that does not occur elsewhere. That again relates to the way that the formula is constructed. As we know, the formula includes a difference of between 0.5 per cent and 0.8 per cent, and we need to understand that better in future.

Therefore, it is not a question of which is the better index, but of which is the right index. It is not that one is a good index and one is a bad index; we are looking for the right index which measures inflation and how prices are rising. It may well be that we have not got that right in the past and that we are now looking for a change. However, I note that the opposition party in the shape of its leader, and reinforced here tonight by the noble Lord, Lord McKenzie, is prepared to accept CPI as an interim but not a permanent measure. That means that there is a sense that they generally agree with the former Prime Minister that there is a role for this index, although they may disagree about its long-term purpose.

What we do know, as international comparisons tell us, is that CPI is a much more stable measure. I was interested to hear the remarks of the noble Lord, Lord Beecham, concerning the pension. One effect of the methodology used by the previous Government was that the pension rose by 75 pence a week. Of course, it is not reasonable for people to be told that prices have not risen appropriately in that period. We need a stable measure which reflects people’s understanding of how prices have risen during the year.

As we heard from the Minister, housing is reflected in CPI in terms of rent but not mortgages. Work is now being done to improve the involvement of house prices and housing measures within CPI, although we know that only 7 per cent of pensioners have a mortgage. It is important to reflect on the value of the basic state pension, to note that in future the triple lock will work to the benefit of pensioners, and, if I read the newspapers correctly, that the basic state pension will be uplifted even further, which will give people a basic entitlement in tier 1. I hope that that will occur.

[Lord McKenzie of Luton]

I hope that the noble Lord will forgive me for interrupting. I accept what he says about the triple lock on the basic state pension, but does he acknowledge that applying CPI to S2P on a long-term basis would reduce what would otherwise be payable?

[Lord German]

The basic pension is bigger than the additional pension. In the long run, the earnings link is worth 2 per cent more than prices, and CPI is 0.8 per cent less than RPI. Therefore, the increase in the basic state pension can be set against the change which will occur with CPI for S2P. It is very important to see the connection between the two. Of course, as the noble Lord, Lord McKenzie, will know, there is much talk in the ether about an improved single-tier pension, and I think that that will be the test. Not only would it benefit people through the measure that I have just described but in the future it might improve matters even more.

[Lord McKenzie of Luton]

I am sorry to interrupt the noble Lord again, but how would he factor into his assessment occupational pensions which, in terms of future indexation, could be subject to CPI rather than RPI?

[Lord German]

I was very grateful that the Government did not put the override in place, because of course it should be up to occupational pension schemes to make up their own minds according to their rules. Clearly, if RPI were written into the contract that already existed, that would apply and the schemes would be able to stay with that. Most pension schemes will be able to make that choice, and I hope that there will be a debate among pension fund members about the way in which that might be put into place. It is also very important that pensioners with accrued benefits under RPI should have those benefits maintained and that, if the choice is made to change, CPI should occur only after the CPI regulation hits the deck.

Going slightly beyond this issue, I want look at the packages in the round and I also want to ask the Minister some questions. I am pleased that there was no override, and I wonder whether the Minister can confirm what I have just said regarding accruals for occupational pension schemes. Will the switch to CPI see the pressure on occupational pension funds reduced? I know that some figures have been produced regarding the reduction in pressure on some occupational pension funds. I should be grateful if the Minister could update us on the current thinking on that matter and on the current analysis of who is going to move and in which direction.

My final question relates to the much bigger world of the reforms proposed by the noble Lord, Lord Hutton. What are the Government’s thoughts about the direction of travel of the matters that we are discussing today, and how will that impact on the public sector pension funds? Will the Government be responding to the noble Lord, Lord Hutton, and in what timescale? People will want to understand the Government’s direction of travel, both on the basic pension and on public service pensions, which I imagine are a cause of concern to many people at present.

[Lord Kirkwood of Kirkhope]

My Lords, I should like to make a few comments at the end of what is always a very important annual occasion. There have been occasions in the past when colleagues in the House have not considered it appropriate to look at social security benefit uprating orders, but these orders are extremely important for the people whom they affect and it is right that we should spend time looking carefully at the provisions. I am not surprised that more colleagues do not participate in these debates, as they are extremely complicated, particularly this year when we are contemplating wholesale changes in the benefit system. It is particularly difficult to foresee the impact that some of these announced changes will bring in future.

It would be helpful to receive some reassurance from my noble friend on the Front Bench on a couple of points. I agree with the comments that have been made about the pension provision. That is one area where substantial progress has been made, for which I am very grateful.

I want to pick up an important point made by the noble Baroness, Lady Lister, who is probably the only person in this Chamber who has been doing uprating orders for longer than I have—she advised me about them when I was elected to the other place in 1983, which was not yesterday. She has a huge amount of experience and knowledge and she will be a great asset to this House in considering these issues in the future. She raised the point about freezing child benefit until 2014. Of course, that is against the background of deficit reduction. I defer to no one on the necessity to attack the important financial circumstances that we all face, but how will that affect the child poverty strategy? In the legislation that we passed in the dying days of the previous Parliament, the Child Poverty Act 2010, we set out the requirement for a child poverty strategy. I anticipate that that will be unleashed on us quite soon. These changes will have a dramatic impact on the staging posts of 2015 and 2020 in the child poverty strategy.

Deficit reduction notwithstanding, I hope that the Government do not make these changes in a way that makes it impossible to get to a more comfortable place on child poverty by 2020. If that were the case, I would be very concerned. I think that redistribution is still necessary. The noble Baroness was absolutely right to say that this benefit was a tax allowance in the days before it was converted. It is extremely important that we keep the pressure up. People like me are uncomfortable about freezing child benefit. If the Government continue to freeze it, I shall be more than uncomfortable; I shall be very upset. A word of comfort about the fact that there is a child poverty strategy in gestation and about to be unleashed on us would send me home a happier bunny this evening.

We shall return to the CPI/RPI debate, and at great length. For me, there is some conflicting evidence. My noble friend dealt with the substitution effect. I think that he is right about substitution and I concede that he is right about geometry and not arithmetic. However, I do not necessarily concede that, therefore, CPI is an appropriate measure. I think that the IFS is on his side when it comes to substitution but, on whether this is an inflation experience that is adequate and appropriate for the client group, it is on a different side of the argument. The press release that I have in front of me, dated August 2010, suggests that it believes that,

“only 23 per cent of benefit claimants are unaffected by increases in mortgage interest payments and council tax”.

Therefore, the rest will be caught by the reduction. We cannot ignore that. I want to think about that more carefully and I shall study, with care, what my noble friend says about it, if not tonight then at another stage. I think that the jury is out. I think that he has won the argument about substitution but I do not think that that necessarily means that it is a safe measure in perpetuity. You only have to ask the Library not just about the short-term effects but also about the long-term effects to see that reductions in domestic household incomes are stark. Over a 20-year and a 30-year period, they are unconscionable. I hope that we in the coalition Government are not lashed to the mast on some of these things. If the CPI in the middle-to-longer term—five to 10 years—starts to pinch in a way that I think it may, I hope that we will be big enough to look again at whether it is an appropriate measure.

20:30

My third point was picked up by the noble Baroness, Lady Lister. The important work that the Joseph Rowntree Foundation has done on minimum income standards demonstrates what people require to live a modest but adequate lifestyle. Some of the benefits to which she referred, and there are others, have been losing out consistently year in, year out. For example, some of the capital thresholds have been in place for a long while and are beginning to pinch in a serious way. That deserves attention. No one is suggesting that any Government are going to offer benefits at these levels immediately, but the work that has been done on minimum income standards is a measure of how far benefit rates are slipping behind year after year. It is not fair to ignore that at a time when financial distress is being faced by a lot of people. For example—and I could go on at great length about the differential impact of inflation on low-income groups—the Joseph Rowntree Foundation recently produced some work that reminded us that bus fares were nearly 60 per cent higher in 2009 than they were in 2000. Low-income families depend on buses. Little things like that are an important part of looking at the totality of what we are agreeing. We ought to bear in mind in these debates how they affect, in particular, the two lowest deciles of the income distribution.

I shall make two other quick points. The first I have made every year for 23 years. The Government Actuary’s Department has certified the National Insurance Fund to be proof of the changes in these regulations. I remind colleagues that in 2010-11 the balance in the National Insurance Fund was £56 billion. We know that, in order to keep it safe from the requirement of a Treasury grant, the fund is required in law to have one-sixth of the expected spend safe in hand to look after emergencies, which is £13.8 billion. So we have £56.3 billion in the National Insurance Fund at a time of austerity when a lot of our families are suffering real, serious and continuing hardship. If you look at the GAD’s forecasts for the next five years, you see that by the time we get to 2015 there will still be £56.6 billion in the National Insurance Fund. I am not suggesting for a moment that we should be profligate and start raiding the National Insurance Fund, but there are occasions when we should be prepared to say that circumstances are so hard and there are households that are suffering such financial adversity that it may be time to look at making use of some of those funds to help some of those families through the difficult months and years ahead.

Finally—and I agree that this is a bit of a cheap shot—the Public Accounts Committee report of 10 March points out yet again that the DWP’s annual accounts have been qualified for 22 years because of the amount of error and fraud. Of course, the Government have a strategy, which I welcome. It was set out in October 2010 and has put some money—£400 million or so between now and 2015—into reducing the cost of overpayments. Although that is important work, so is the £1.3 billion underpayment identified by the Public Accounts Committee year after year. Of course, this is a measure of complexity. If we get the benefit that we hope for from the universal credit moves proposed in the Welfare Reform Bill, that will perhaps lead to simplicity, which, as my noble friend said, would be welcome. However, surely we must do something about the recognised £1.3 billion underpayment. I know that my noble friend is on the case and is deeply, personally concerned about fraud, but will he give us an assurance that he will use his best offices to get that underpayment down just as fast as he wants to get the overpayments down between now and 2015? If he does that, certainly I for one would rest happy in my bed at night.

[Lord Lea of Crondall]

Perhaps I may say how interesting I find the noble Lord’s analysis of the difference between the RPI and the CPI. Some 30 years ago, I was a member of the RPI advisory committee when it had a great row with the Treasury about mortgage interest payments. The philosophical argument was that you cannot have the cost of money as a factor in the national income. I respect that that was always the Treasury position. It might be slightly provocative to say this, but perhaps an organisation such as the Office for National Statistics or the new Office for Budget Responsibility could objectively set out the pros and cons for the different purposes. Whether one is dealing with national accounts or the cost of bus fares, one has to disaggregate the RPI. This issue arises all the time. Therefore, it would be useful if the Cabinet Office or somewhere else could produce a paper on the strengths and weaknesses for different purposes of the RPI and the CPI, including European standardised statistics and all the rest of it.

[Lord Kirkwood of Kirkhope]

I certainly think that that is a good idea and I would support it.

[Lord Freud]

My Lords, this has been an interesting debate, as one would hope and expect. I thank noble Lords for their valued contributions. I should probably declare an interest in that I am due a winter fuel payment this year, although I did not get it. The DWP says that it paid everyone and I find that I am the only person who did not get their winter fuel payment.

The uprating order and the GMP increase order both legislate for increases to benefits and pensions to be paid from April, thus protecting their value at a difficult time. My overview of what the noble Lord, Lord McKenzie, said is that the party opposite was perfectly happy with the CPI in the short term and would agree with the UK Office for National Statistics on the issue if the CPI was to include housing costs in the slightly longer term. On that basis, I suspect that there is rather less between us than might appear at first instance. We are very interested in the changes that will potentially be made to the CPI if housing costs are incorporated, which is being looked at. However, as the noble Lord, Lord Lea, hinted, it is likely that that would be done not by including the changes in mortgage interest rates but by the actual changes in house values.

A lot of points were raised in the debate and I will do my best to answer as many as I can. An important point about substitution was raised by the noble Lord, Lord McKenzie, the noble Baroness, Lady Lister, and my noble friend Lord German, who pointed out that people will buy everything at the bottom, which is what one expects them to do—that was the sentiment. However, that is not what happens with this index, which it is important to emphasise. If in a given range of the cheapest items—or best value goods, whatever they are called—and one of them goes up but the rest stay the same, people will substitute the one that has increased in price with the ones that remained stable. The relative movement in those goods, rather than their absolute value at any one time, is what counts. It is really important to understand that when looking at how the substitution effect actually works.

We could probably all bore each other by quoting lots of different experts—and I think we have, so I will not bother doing so—but the noble Lord, Lord McKenzie, made the point that we abandoned the policy of the CPI when it came to it. I repeat what I said in my opening remarks: we announced the RPI for the basic state pension for the year at the same time as we announced the move to the CPI, so there has been no reversal or change. That was what the policy was.

On the point raised by the noble Lord, Lord McKenzie, on the triple guarantee, in the current environment the earnings factor does not make much immediate difference, but over time it will make a substantial difference and pensioners will benefit from it. As I said in my opening remarks, the 1.5 per cent increase from the previous year was not reversed. Picking up on some of the noble Lord’s other points, I think that he knows almost better than I do that, when it comes to mortgage interest for people of working age, benefit recipients and working people on low incomes can also get support for mortgage interest payments.

The noble Lord asked what assessment had been made of the changes that we have introduced to non-dependent deductions. The equality impact assessment on those changes has been published on the DWP website. A question was also asked about indexation rights for public service pensions. Those have been index-linked on the same RPI basis up to this point, and in future the indexation will be made on the new basis, which is CPI.

The noble Lord, Lord McKenzie, and the noble Baroness, Lady Lister, also homed in on the effect on poorer households, which is the big question here. We now have 5.8 million adults of working age living in relative poverty. As I have argued, the idea is that using the CPI will ensure that typical changes remain in line with real experience. Where we need to go in this area—a much more important point—is in the structure of the benefits system so that we strike the right balance between the welfare system as a safety net and one that sends out a clear message that work is valuable and that, if you can work, you should work.

We are modelling the big impact that will be made by introducing the universal credit. We estimate that 350,000 fewer children and 600,000 fewer adults will be expected to live in poverty—on the normal definition of 60 per cent of median household income. Some two-thirds of that effect will be because of better take-up. My noble friend Lord Kirkwood asked whether we would chase underpayments as hard as overpayments, but that is exactly how that effect will happen in practice. A lot of the effect will come from take-up by people who simply do not take up what they are entitled to.

20:45

I think that comparing the minimum income standard with one particular benefit rate is dangerous; one has to take the whole package of benefits that people have in practice. However, I acknowledge, with the noble Baroness, Lady Lister, that there is a shortfall compared to the minimum income standard. There is then a fall against median earnings—60 per cent of median earnings is what we are targeting for poverty—and then there is a fall further to benefits. However, the least fall is for pensioners.

The noble Baroness, Lady Lister, made some points about child benefit. Some of the savings from withdrawing child benefit from families with a higher rate taxpayer will be used to fund above-indexation increases in child tax credit. That was designed to shift support to low-income families with children. In terms of the amounts recycled, £1.2 billion of welfare savings will go back into child tax credits in 2011-12 and £1.8 billion in the following year.

The noble Lord, Lord Beecham, asked about the exclusion of council tax changes from the CPI. Within the CPI, council tax is looked at as a tax, which is the fundamental reason that it is excluded from that basket. The main difference between CPI and RPI—60 per cent of the difference—is the formula effect. Staying with council tax benefits, I note that the cost of administering the system is just short of £1 billion—it was estimated to be £986 million in 2010. The changes that we are making include an element of discretionary housing payment, which is meant to give money to the people who need it most.

The noble Lord, Lord German, asked about the RPI. It is impossible to be ruder about the RPI than I have been in explaining why the difference between the RPI and the CPI is less here than elsewhere. The reason one could potentially be rude is that the RPI incorporates something called the “average of relatives” as its way of calculating the arithmetic mean—to the extent of 38 per cent of the total. That creates a bounce effect and that is why that particular index has been banned for international comparison. If you wanted to have a posse against the RPI, that is where the suspicions are likely to lie.

[Lord Lea of Crondall]

Can I just point out that that is by no means the whole argument about the merits of the RPI?

[Lord Freud]

It is an attempt to find an explanation for why our RPI is so different from the CPI compared with other countries. I was just looking for a clue to answer the rather potent question asked by my noble friend. It was not a complete answer, but I tried to give a more complete answer earlier.

My noble friend Lord Kirkwood asked about the child poverty strategy, which we are aiming to publish shortly. The strategy will set out our plan to transform the lives of children in poverty now and in the future. It will be a step change from previous approaches, which focused solely on income poverty, to a more sustainable and effective approach that addresses the root causes of poverty rather than the symptoms.

On the National Insurance Fund, I am sure that my noble friend Lord Kirkwood, has had this answer back many times and I almost do not want to say it again. The formal answer is that there is no fund in the sense normally meant; there is no pot of money to hand out. But I shall not go into that.

There may be one or two other items that I have not covered, but if there are I shall write and clear up all other points—otherwise I shall be here all night.

I shall try to wrap this up. We are taking an approach that seeks to balance the interests of benefit and pension recipients and the interests of the taxpayer. The CPI is an appropriate measure of inflation and one that helps to put the welfare system on a sustainable footing. The CPI is a legitimate measure for price inflation; it increases in line with real world prices and protects purchasing power. As such, there are good reasons for concluding that it is more appropriate than the RPI for our purposes. Despite the fact the nation’s finances remain under severe pressure, this Government will spend an extra £4.3 billion in 2011-12 to ensure that people are protected against the cost of living increases. Through the restoration of the earnings link and the triple guarantee for the basic state pension, the increase to pension credit and the continued protection of benefit and pension value, we are fulfilling our commitment to ensure that no one is left behind. I commend the orders to the House.

Motion agreed.