Buttonwood
Sauce for a Brussels goose
Billions depend on the choice of a discount rate
DIVORCES are rarely easy. In the 16 months since Britain voted to leave the EU in a referendum, the negotiations have made little progress. One of the trickiest aspects is the amount that Britain should pay to meet its existing spending commitments for EU programmes.
This is not analogous to dividing up the bill in a restaurant, and deciding who had the lobster and who stuck to the mixed green salad. Take the cost of EU officials’ pensions. The tricky bit in calculating it is that pensions are long-term commitments; a bureaucrat who starts work in Brussels today might still be collecting a pension 70 years from now. Working out the cost is fiendishly complicated, requiring estimates of how much wages will rise (if the pension is linked to salary) and how long employees will live. Then the sum of future benefits has to be discounted at some rate to work out the current cost; the higher the discount rate, the lower the presumed expense.
The EU doesn’t pre-fund pensions for its officials; it pays them as they fall due. So the calculations don’t need to involve any assumptions about investment returns. But the cost estimate needed for Britain to pay its “fair share” will depend on what discount rate gets used.
And that could be the subject of a big dispute.
In its annual accounts, the EU calculates a pension liability of €67.2bn ($79.3bn). This is based on a discount rate of 1.7% in nominal terms and 0.3% in real terms (after inflation). This cost has jumped from around €35bn in 2011 because the discount rate has fallen sharply. This rate has not been plucked out of thin air; it is based on the interest rates paid on EU government debt. An agreement to pay a pension is, after all, a debt like any other. So it may seem that there is little to argue about; Britain should simply cough up its share of €67.2bn.
However, when it comes to calculating the contributions of employees, the EU uses a completely different approach. As a Eurostat document shows*, the discount rate in these numbers is a 22-year average of real government-bond yields. This includes the period from 1995 to 2000, when real rates were often 4% or higher. The result is a nominal discount rate of 4.8% and a real rate of 3.1%.
Up until 2012, the EU used a 12-year average of bond yields. But it is steadily moving to a 30-year average by 2021, which means that those high real yields from the late 1990s will stay in the numbers for longer. The remarkable result is that while the discount rate in the balance-sheet calculations has been falling, the discount rate used for the contribution of officials rose in 2016. The good news for employees is that they were required to contribute 0.5% less of their salaries than would otherwise have been the case.
Had the EU used the discount rate it applied to its balance-sheet to calculate the size of contributions, its officials would have had to stump up a lot more—resulting in significant cuts in take-home pay. So it is understandable that it has softened the blow. But Britain is surely at liberty to argue that what is sauce for EU bureaucrats ought to be sauce for British taxpayers as well. Bruegel, a think-tank in Brussels, concluded that, if this more generous discount rate were used, the British pensions bill would fall by between a third and more than half. In cash, that could be €2.5bn-4bn.
All Britain has to do, then, is argue this case. But EU negotiators might ask how Britain calculates the pension liability for its own public servants. Unfortunately, the accounts of the England and Wales teachers’ pension scheme show a real discount rate of just 0.24%. That would undermine the logic of the British argument.
Another approach might be for Britain simply to pay its share of the pensions bill every year; after all, that is what the EU does at the moment. Then Britain would not be “punished” by the use of a historically low discount rate. But the snag would be that Britain could still be paying out for some bureaucrats in the 2070s, creating the kind of festering sore that the country’s tabloids will complain about for decades (and demand that some future government repudiates).
Perhaps some cunning British civil servant has found a way of escaping this dilemma. When Buttonwood contacted the Department for Exiting the EU (DEXEU), he was told it was a matter for the Treasury; the Treasury said it was a matter for DEXEU. There was no news on whether either department planned to hold its Christmas party in a brewery.
* “Pension Scheme of EU Officials (PSEO): Actuarial assumptions used in the 2017 assessment”. June 2017.
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