The Biggest Debt Of All

We were all the future once

This afternoon Tyler got a bit of a shock in the Wandsworth one-way system. There right in front of the motor, large as life, was none other than the legendary Ronnie Wood. Yes, crossing the road at the lights - dark glasses, fag in mouth, young lady on his arm, slightly weaving about, the works.

Which got Tyler thinking. Old Ronnie is getting on a bit these days. In fact he's just turned 63, and he'll soon be drawing his state pension*. He's become part of the problem.

Problem? Yes, the horrible fact that we've got far far too many people about to draw their state pensions. Here's the latest official forecast of the burden they will be placing on the national finances:

As we can see, on current policies, the burden increases from around 5.5% of GDP up to around 7% - and many experts think even that estimate is too low.

Now, we've blogged this many times, but since Tyler is currently working on some updated calculations of the real national debt, he thought it would be fun to work out what this burden comes to in terms of debt today.

To make the calculation easy we'll average the Treasury's forecast at 6% of GDP. So instead of having the burden grow as it does on the Treasury forecast, we'll assume it stays at 6% for ever - ie we'll deliberately err on the side of underestimating the debt.

Now, to translate all those annual figures into a single debt figure we have to convert each one into a present value, discounting by an appropriate interest rate. Since these pensions are a government liability, the appropriate interest rate is that on government debt. And since the liabilities are index-linked, it has to be an index-linked gilt yield (the government has now relinked them to earnings rather than the RPI, so perhaps we ought to use an earnings linked gilt, but since there isn't one, ordinary ILG will have to do).

As of now, long-term ILG yields are under 1%, but to keep it simple we'll assume 1% (again erring on the side of underestimating the debt).

What we have here is known as a perpetual annuity (or perp for short). And its present value can be easily calculated with this handy formula:

In our case, A = 6 (% of GDP), and r = 0.01 (which is simply our 1% discount rate expressed as a decimal, ie 1/100). Which comes to 600.

So, what we're saying is that the present value of our future state pension burden, measure as a percentage of GDP, is a cool 600%.

Which, given that GDP this year is estimated by the OBR at £1474bn, is equivalent to a debt in money terms of... gulp... can this be right... £8.8 trillion.

And that gives us a frightening perspective on HMG's contention that our National Debt is "only" £0.8 trillion - less than one tenth of our state pension debt.

Maybe as a public duty Tyler should have jumped the Wandsworth lights and at least made a start on the problem.

*Footnote Some unkind people reckon Ronnie must be far older than 63. They reckon he must be about 250. But what they forget is that Ronnie is a close associate of Keef, who is well known to be immortal. They may both look 250, but that's only because of all those life-extending substances they've ingested over the years. Celery and stuff.

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