You say CPI, I say RPI, let’s call the whole thing off: this was the gist of the letter from Sajid Javid to the chair of the UK Statistics Authority, Sir David Norgrove, yesterday morning. The UKSA had been in discussion with the government on moving to a single measure of inflation, following a seven-month inquiry by the Lords Economic Affairs Committee, but Javid responded that to do so “could be damaging to the economy”, and that the government would not be revisiting the subject until 2030.
Javid’s letter cast the issue as a technical matter of secondary importance. “I want to ensure that the Treasury… has the time and space to focus on delivering Brexit,” he wrote.
But this was a very serious decision. In ignoring the UKSA’s recommendations, Javid has allowed one of the fundamental problems of the UK’s economy to persist. In doing so, he quietly hands an unearned bonus to wealthy retirees while reducing the pay of younger workers and reinforcing inequalities between rich and poor, young and old, in the decades to come.
The UK has used the Retail Prices Index (RPI) since 1947, but in 1996 the Consumer Price Index (CPI) was introduced. Both indices give a rate of inflation based on the prices of goods and their importance to the average consumer, but they are calculated differently. Economists generally agree that CPI gives a more accurate picture of inflation, and in 2013 the Office of National Statistics removed RPI’s status as an official national statistic. Mark Carney told the Lords committee that RPI was “meritless”.
Paul Johnson, the director of the Institute for Fiscal Studies, agrees. ““The biggest problem with RPI is that it’s just plain wrong… it overstates inflation by 0.7, 0.8 per cent per year. Which is a lot, over time.”
This overstatement is most serious when it comes to pensions, says Johnson. “It’s one of the reasons that we’ve shut down occupational pension schemes, because loads of them are locked into increasing pension in line with the RPI, which is incredibly expensive, and is effectively paid for by current workers.”
RPI therefore drives a wedge between young and old, as today’s workers pay for overpriced occupational pensions of the kind that they themselves will never enjoy.
It also creates inequality for those already at retirement age, because the state pension rises with CPI, while private pensions rise with the higher RPI figure. “So if you start two people at retirement, one of whom has state benefits and one of whom has an occupational pension, the gap between the two will rise over time,” Johnson explains.
So why does the government keep using a measure that is both technically wrong and socially divisive? One answer is that the current dual system is useful to the Chancellor. Having two measures of inflation means he can use RPI where it allows the government to charge more for something (such as train fares) and CPI where it allows the government to pay less for something (such as disability benefits). This gaming of the difference between RPI and CPI has been described by the Royal Statistical Society as “inflation shopping”.
The biggest inflation-shopper so far has been George Osborne, who announced in 2010 that benefits, public sector pensions and tax credits – government expenditure – would be valued according to the lower CPI measure. Osborne claimed the change would save the government £6bn a year. Last year, John Glen extended the same trick to the interest on National Savings, trimming more than £120m a year off the government’s payments to the citizens who lend it their money.
But while Osborne argued back in 2010 that CPI “reflects everyday prices better”, neither he, Philip Hammond nor Sajid Javid have been motivated to use it to calculate alcohol duty, rail fares, student loan repayments or car tax – sources of income for the government, which are bumped up by RPI.
Not only is RPI a money-spinner for the government, but it would also be difficult to recalculate or remove. The government has already sold £450bn of RPI-linked government bonds, which pay £1bn a year more interest than they would if they were linked to CPI. To switch these to CPI would be highly controversial with institutional investors, and last year the Bank of England’s deputy governor, Ben Broadbent, warned that such a move “wouldn’t be without legal risk”.
Trade unions, too, would oppose a switch to CPI, precisely because it offers higher pensions payments and pay rises for their members. While Labour’s 2017 manifesto pledges to use CPI rather than RPI to cap rail fare increases and set business rates, the opposition, too, has yet to commit to a single measure of inflation.
Paul Johnson remains optmistic. “The ONS has now said that the right thing to do is to make this big change, so that’s a big step forward,” he says, “but we’re going to have a long time to wait.” In the meantime, a flawed piece of accounting from the 1940s will continue to quietly drive a wedge between the generations.
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