By Ian Pollock
25 October 2011 Last updated at 13:46
The government has been accused of acting unlawfully by changing inflation proofing for public sector pensions.
Trade unions have started a judicial review of the decision to use the Consumer Prices Index instead of the faster-rising Retail Prices Index.
Michael Beloff QC told the High Court that the government had acted beyond its powers last year in adopting CPI.
The outcome of the hearing will affect the value of pension increases for millions of public sector pensioners.
Mr Beloff said the government had strayed into “forbidden territory”.
The hearing is expected to last for three days.
The court heard that the Social Security Administration Act obliged the government to measure the general level of price increases each year, according to Mr Beloff.
Any increase then had to be applied to state benefits and public sector pensions.
However, the formula for constructing CPI also attempted to measure the behaviour of people who might switch to cheaper goods as prices rose.
Mr Beloff said that such a consideration was outside the scope of the Act. It obliged the government to measure pure price changes only.
He also argued that the government’s publicly stated intention to use CPI to reduce the government’s spending deficit was a consideration not permitted by the law.
The government’s decision had been “contrary to the object and language of the act”, he told the court.
He said he was challenging a major government policy.
“It is either lawful or it is not,” he said.
The new policy came into effect in April this year, when RPI (as of September 2010, the benchmark month) was 4.6% but CPI was 3.1%.
Next April, public sector pensions will rise by this September’s CPI rate of 5.2%, compared with the RPI rate of 5.6%.
The new policy was announced in the 2010 Budget as an explicit measure to cut the government’s spending deficit.
Chancellor George Osborne described CPI as a “more appropriate” measure of inflation – for state benefits and tax credits as well as public sector pensions – which would save the government money by producing smaller increases each year.
“It excludes the majority of housing costs faced by homeowners and differences in calculation mean it may be considered a better representation of the way consumers change their consumption patterns in response to price changes,” the 2010 Budget document explained.
And, ahead of the case, a Treasury spokesman said: “Public service pensions will continue to provide protection against inflation and will remain among the very best available, providing a guaranteed pension level for all employees.
“CPI is already used by the Bank of England to set its inflation target and unlike RPI is designed to take account of the fact that consumers tend to shop around, switching to cheaper alternatives when prices for similar goods change.”
Lord Hutton’s independent report on public service pensions, whose final report was published earlier this year, calculated that the unfunded public pension schemes (a definition that included all but the local government scheme) would save £1.8bn a year in cash payments by 2015-16 by the move to CPI.
That saving would continue to grow indefinitely, as CPI increases will usually lag behind RPI ones.
In the past the gap between the two measures has averaged about 0.75 percentage points each year.
But the Office for Budget Responsibility (OBR) has forecast that from now on the gap will widen to 1.2 percentage points.
Lord Hutton calculated that if the 0.75 percentage point gap remained, then by 2060 the pensions being paid would have been cut by 20%.
The change to inflation proofing has also had a knock-on effect on some employees in the private sector, where schemes such as those for BA and BT incorporate whatever is the government’s preferred inflation measure into their own rules.
The law governing the issue in the public sector is the 1992 Social Security Administration Act.
It says that in order to compensate for inflation, public sector pensions and other state benefits should be revalued “in relation to the general level of prices obtaining in Great Britain estimated in such manner as the Secretary of State thinks fit”.
The unions argue that last year’s decision rode roughshod over previous pension agreements which were struck in the belief that RPI would always apply.
They also argue that the move to CPI means individuals who transferred previous pensions into their public sector schemes, or who bought added years of pension contributions, will no longer receive what they paid for.
The case is just one of several battle grounds between the government and unions over pensions.
Many public sector unions are currently balloting their members for a strike on 30 November against planned increases in pension contributions from next April.
And, following the recommendations of Lord Hutton, negotiations are under way over the wholesale introduction of new, less generous, career average pension schemes for all public sector employees – including current staff – from 2015-16.