A New Generational Contract: The final report of the Intergenerational Commission

Executive summary

Just like our families, society rests on an intergenerational contract

Every day, 14 million parents in the UK bring up their children and 6.5 million of us care for an elderly, ill or disabled relative. Wisdom gets passed on and fresh eyes provide new perspectives, with family resources responding to the shifting needs of their members. This is the intergenerational contract – the principle that different generations provide support to each other across the different stages of their lives. Just as this contract underpins what we do as families, it is fundamental to society as a whole and to the role of government. From education for the young, to extra financial help for those bringing up children, to healthcare and a pension for the old, the intergenerational contract has long defined what the welfare state does.

The intergenerational contract works because everyone puts in and everyone takes out. We are happy to support older generations – indeed we feel obligated to do so – because we believe and expect that we will be treated the same when we are old. And we support children as they develop just as we were supported and nourished when we were young. Indeed, we expect that economic growth and continually expanding social opportunities will mean that our children have more than we did – and we welcome that progress.

We celebrate the good times and deal with the nation’s challenges together, across the generations. This feels natural, but that does not mean that we can take the intergenerational contract for granted. Increasingly, there is a sense that it is under threat.

 

That contract is under threat, with widespread concern that young adults may not achieve the progress their predecessors enjoyed

Commitment to Britain’s intergenerational contract remains strong. Large majorities of all age groups in Britain believe both that the success of a society is measured by how we provide for older generations and that each successive generation should have a better life than the one before.

And there are many areas in which we can celebrate significant progress against these goals. Adults in Britain are positive about young people’s access to information and entertainment, travel opportunities and the quality of their education. While there is still much to do, opportunities for women, ethnic minorities and lesbian, gay and transgender people are much better than for their predecessors.

But while there are strong grounds for optimism in some areas, pessimism dominates overall. Pessimists about young adults’ chances of improving on their parents’ lives outnumber optimists by two-to-one. That marks a dramatic, and very rapid, turnaround in outlook. As recently as 2003, optimists outnumbered pessimists by nearly four-to-one. The gloom that has settled across our society since then is common across advanced economies, though Britain is more pessimistic than most.

This pessimism is most marked in relation to the key economic aspects of living standards – housing, work and pensions – where pessimists outnumber optimists by at least five-to-one. It is these areas that have been at the core of the Intergenerational Commission’s work.

Our work has first centred on investigating whether the public’s pessimism is justified, by examining the experience of different generations. As far as possible we have compared these groups at the same age, allowing us to distinguish specific generational differences in outcomes from the usual differences that arise between age groups at different points in the life course. Intergenerational anxiety has come to the fore only in the period since the financial crisis, so we have also investigated the drivers of any shift in outcomes to see if they were caused by the crisis or have deeper routes.

Overall, we have developed a picture of Britain in the early 21st century as experienced by the generations born in the second half of the previous century. As well as some shared experiences, we find significant differences.

 

Post-crisis employment has been strong, but young adults have experienced incredibly poor pay outcomes

There has been good news for young people on employment. The unemployment rate for 16-29-year-olds rose less following the financial crisis than it did during the recessions of the early 1980s and early 1990s, and it has been quicker to recover. As a result, in their late 20s millennials (the generation born 1981-2000) have so far experienced unemployment rates that are around 25 per cent lower than those experienced by baby boomers (born 1946-65) at the same age.

There is good news on employment for women in particular. Employment rates for baby boomer women have been 5-7 percentage points higher at each age than for the pre-war silent generation (born 1926-45), and women in generation X (born 1966-80) and the millennial generation have experienced big gains on top of those, in the child-rearing years in particular.

While today’s young adults have been much more likely to work, however, they have been rewarded very poorly for doing so – with weak pay growth the dominant feature of their working lives so far. While in the past every successive cohort had higher real earnings at each age, the millennial cohorts born 1986-90 (at age 26) and 1981-85 (in their early 30s) had similar earnings to the cohorts born 15 years before them when they were that age.

The decade of poor pay growth since the financial crisis has played a big part in this outcome, and has held back cohort-on-cohort pay progress – albeit to a lesser extent – for older adults too. However, even before the financial crisis the oldest millennials recorded real pay at age 25 no higher than those born five years before them. The suggestion is that generational pay stagnation for today’s young adults has deeper roots.

One such root is the recent slowdown in the rate of human capital improvement. Millennials are the best-educated generation in history, but the very big cohort-oncohort gains experienced by generation X have not been replicated for them. The 37 per cent increase in degree attainment recorded between the 1969-71 and 1972-74 cohorts fell to just a 7 per cent improvement between those born in the early and late 1980s. Crucially, non-degree routes have not picked up the slack.

Another trend that preceded the crisis and has endured even as employment has reached record highs is a shift towards lower-paying and less secure jobs among young people. Increases in self-employment since the early 2000s have been driven by younger workers without degrees; millennials have been more likely to work part time than generation X at the same age; and the fastest-growing occupations for those in their late 20s have been the lowest-paying ones – elementary, caring and leisure roles.

Partly as a result of this increase in their exposure to risk, young adults today are taking fewer chances. A decline in job-to-job moves by young people that began in the early 2000s means millennials have so far been 20-25 per cent less likely to move jobs voluntarily than members of generation X at the same age. Moving jobs is the surest route to a big pay rise, particularly when young, so this drop off in job moves is likely to be one factor behind millennials’ low earnings growth.

 

Millennials have lower home ownership rates and higher housing costs than their predecessors

Declining home ownership is the most prominent worry about younger generations, and the changes are indeed large. So far millennial families are only half as likely to own their home by age 30 as baby boomers were by the same age.

An even bigger reduction in access to social housing means that four-in-ten millennial families at age 30 live in the private rented sector, four times the rate for baby boomers when they were the same age. This rise in private renting means that young adults face greater housing insecurity than previous generations did. They are compromising on quality and convenience too. Adults aged under 45 have slightly less space than they did two decades ago, whereas over 45s have more. And young adults are commuting longer distances: millennials are on track to spend 64 more hours commuting in the year they turn 40 than the baby boomers did at that age.

While home ownership falls take most of the headlines, an even greater problem threatening day-to-day living standards is the pressure that housing costs put on family finances. Millennials are spending an average of almost a quarter of their income on housing, up from an average of just 8 per cent among the silent generation at the same age.

These generational shifts are likely to persist. Even a repeat of the best economic conditions of recent decades would result in millennials only catching up with the home ownership rates of generation X by the age of 45, and still falling far short of baby boomer rates. Fast-growing inheritances that are set to double in the coming two decades will help some beyond this age. But they are much less likely to benefit the almost half of 20-35-year-old non-home owners whose parents do not own either.

 

Reforms underway are boosting pension saving, but working-age adults bear risks that their predecessors were protected from

Pensioner incomes have performed strongly in this century: median pensioner incomes are now higher than median working-age incomes after housing costs. There are headwinds to maintaining this performance for future retirees, however. That is because private sector membership of generous ‘defined benefit’ pensions, for those around age 35, halved for employees born in the early 1980s compared to those born around 1970. ‘Automatic enrolment’ of employees into less generous ‘defined contribution’ pensions does, however, mean that younger cohorts have higher overall pension scheme membership rates than predecessors did at each age.

If more favourable economic conditions returned (and under a simplified assumption of constant investment returns), auto-enrolment plus the move to a flat-rate State Pension mean future pensioners could achieve broadly similar outcomes to recent retirees on average. However, there are very big risks around these outcomes for younger generations that those currently retiring have not been exposed to.

Risks include the rate and timing of investment returns. A 1 percentage point decline in investment returns in each remaining year of working life would reduce retirement incomes for millennial men born 1984-86 by 8 per cent, well below the outcomes enjoyed by recent retirees. In the defined benefit system it was firms that bore this investment risk rather than individuals. The shift to defined contribution pensions plus new ‘pension freedoms’ mean people are increasingly having to individually plan for the wide variation in how long they might live. And unlike defined benefit pensions, defined contribution ones rarely provide protection from inflation during retirement, meaning future pensioners will be increasingly exposed to price shocks.

 

In contrast to older generations, young adults are making no income progress and accumulating much less wealth

Bringing together these trends, disposable incomes – the best measure of current living standards – are no higher for millennials who have reached age 30 than they were for generation X at that age. In contrast, older baby boomers have maintained significant income improvements on the silent generation, continuing the pattern of generational progress that was the norm across the age range in the second half of the 20th century.

Our pattern of large historical generation-on-generation gains followed by stagnation or actual income falls – and also declining home ownership rates – marks the UK out in comparison to other advanced economies. We have avoided the truly awful post-crisis outcomes for young adults in parts of Southern Europe, but the scale of our reversal relative to past experience of growth is more marked. Only Spain has experienced a comparable generational ‘boom and bust’ in both incomes and housing in living memory.

Popular narratives sometimes imply that measuring incomes misses some of what is really going on, with millennials losing out, in truth, because of their excessive spending. But the evidence on spending reinforces the wider findings: in 2001, 25-34-year-olds were consuming the same as 55-64-year-olds; they are now spending 15 per cent less.

While incomes faltered following the financial crisis, total household wealth has grown rapidly throughout the 21st century. Despite this, wealth is only higher for those born before the 1960s compared to predecessors at the same age. This is because unexpected house price and pension windfalls largely benefit older cohorts with existing wealth. These windfalls are unlikely to be repeated in future.

A look at income and wealth also highlights just how large differences within generations are. Intra-generational income inequalities have been higher for generation X and the millennials than for the preceding generations at each age, and absolute wealth gaps within cohorts are growing. Inheritances will get bigger in the coming decades, but with already-wealthy millennials set to inherit more than four times as much as those with no property wealth, they risk amplifying existing wealth gaps. Today’s intergenerational differences could create deeper intra-generational gaps in future.

It is not just young adults who are being affected by the challenges to a better Britain

The overwhelming conclusion from our analysis is that today’s young adults are having a tough time on key measures of living standards. But while millennials are clearly at the sharp end, there are areas of concern for older generations too. Rising housing costs have held back living standards improvements for all generations alive today – albeit in return for larger houses and the ability to accumulate property wealth in the case of the baby boomers. Older female pensioners have had poorer average pension outcomes than younger women, benefiting from auto-enrolment and a flat-rate State Pension, can look forward to. And insecurities in the labour market can affect older workers too – in some cases precipitating early exit from employment altogether.

The biggest risk for older people is the huge challenge in the coming decades of realising the welfare state’s promise to them as they age. The ageing of the large baby boomer generation means we will have more older people, even before factoring in increased life expectancy. Combined with other pressures on health costs, this ageing population means public spending on health, care and social security is set to rise by £24 billion by 2030 and by £63 billion by 2040.

The prospects for meeting this challenge weigh heavily on the public’s mind. Healthcare is the most pressing area of worry for British adults: 42 per cent place it in their top three concerns for the country, whereas internationally it ranks in fifth place. These concerns may be partly anchored in the increasingly parlous state of adult social care services, with the number of older people in England who do not get the care they need having doubled since 2010 to 1.2 million. The baby boomers feel they are at risk of not getting the health and care they need.

The difficulty is that meeting this spending challenge via borrowing or turning to the usual taxes on income and consumption would put disproportionate costs onto younger generations who have borne the brunt of recent living standards pressures. These approaches are both unsustainable in the long run – neither the national debt nor income tax rates can rise forever – and clearly unfair between the generations. We need to avoid breaching the intergenerational contract by either cutting essential support for older generations or putting unsustainable costs onto younger ones most affected by the financial crisis. That means we need new answers.

 

Families are responding to these challenges, but so far the state has failed to adapt

Families are already finding answers of their own – responding to the twin challenges of supporting older generations as their needs rise, while also looking out for younger ones as the pressure on their living standards and security has intensified. The ‘bank of mum and dad’ has grown significantly, helping up to half of first-time buyers to purchase a house in recent years. More young adults are living with their parents than a decade earlier. And the number of adults caring for elderly, ill or disabled relatives increased by 11 per cent in the decade to 2011.

Society as a whole faces similar challenges, but we have neither fully recognised nor responded to them. Perhaps this is not surprising because it is not an easy thing to do – requiring new thinking and tough choices. But our view is that it is possible, and indeed essential, if Britain’s intergenerational contract is to remain strong in the 21st century.

We can deliver the health and care older generations deserve, need and expect, and do so in a generationally fair way. We can prove to younger generations that Britain can work for them as it did for their predecessors. We can start by addressing the lasting effects of the crisis and overturning long-term policy failures that are holding them back – from housing to technical education. We can, and should, provide more security for young people, from the jobs they do to the homes they increasingly rent. And we can promote asset ownership for younger generations, so that owning their own home and access to a decent pension are a reality, not a distant prospect. The proposals we set out are both practical and deliverable. But our focus is long term, looking beyond what is achievable right now or aligned with the agenda of any particular political party.

 

Providing the health and care services that older generations deserve, need and expect in a generationally fair way

Giving older generations the health and care they need in the coming decades will not come cheap – but it is the right thing to do. However, asking younger working adults to pay that bill in its entirety risks undermining rather than strengthening the intergenerational contract. A better starting point is to recognise that Britain’s booming stock of wealth is increasingly concentrated in older generations and that it is also increasingly lightly taxed.

The most pressing challenge in making good on our welfare promise to older generations is to address the scandal of unmet social care need that is bearing down on families. This means sharing more risk collectively with additional public spending, at the same time as asking individuals able to do so to make a limited contribution towards their own care costs, but with proper protections.

We recommend a public funding increase of more than £2 billion for social care from a replacement to council tax, alongside an increase in property- based private contributions towards care costs. However, these charges should be limited by a strict asset floor and cost cap that mean no-one can be asked to contribute more than a quarter of their wealth for their own care. Such an approach would greatly increase the volume and quality of care provided while leaving over half of older people protected from care charges on the basis of their assets.

To maintain the NHS that the baby boomers were born into as they start to rely more heavily on it, we recommend a £2.3 billion ‘NHS levy’ via National Insurance on the earnings of those above State Pension age and limited National Insurance on occupational pension income. As well as raising funds for health services across the UK from better-off members of the group most likely to use them – four-fifths of revenues are drawn from the richest fifth of pensioners – this approach addresses inequities in the current tax treatment of pensions.

Changes to taxes are never easy and should never be made lightly, but properly funding the NHS and our social care system in the coming decades is essential if we want to deliver our welfare promise to older generations and reshape the intergenerational contract for the challenges of the 21st century.

 

Reducing labour market risks and restarting progression for young adults

The financial crisis has played a large part in millennial pay stagnation, but the problem started before and has endured since, even as employment has hit record highs. We should therefore be wary of assuming that the problem will quickly unwind as the crisis fades. Just as we responded to the new experience of high unemployment following the recessions of the 1980s and 1990s, the task now is to update our labour market policy for today’s challenges.

This means recognising that the current period of high employment is the right time to reduce the levels of insecurity people are bearing in today’s labour market. We recommend boosting employment security via the right to a regular contract for those doing regular hours on a zero-hours contract; extended statutory rights for the self-employed; and minimum notice periods for shifts. Alongside innovations to support collective bargaining among young workers, this is how we provide them with a stronger base for taking the kind of beneficial risks that drive career improvements.

Getting young people’s careers moving cannot be left to chance, especially when lower job moves and a slowdown in human capital improvements represent structural headwinds. We recommend a new £1 billion ‘Better Jobs Deal’ that offers practical support and funding for younger workers most affected by the financial crisis to take up opportunities to move jobs or train to progress; and £1.5 billion to tackle persistent under-funding of technical education routes. Both should be funded by cancelling 1p of the forthcoming corporation tax cut. These steps are designed to ensure businesses get the skilled and confident candidates they need.

 

Providing immediate housing security while turning around our housing crisis

The housing crisis that Britain faces – which is bearing down most heavily on younger cohorts but affects all of us – is so acute that no single solution will be enough. Action on three fronts is required.

In the short term, with the private rented sector now a tenure in which millions of children are raised and in which more people will spend retirements in future, it is essential to address its poor record for security. We recommend that indeterminate tenancies should be the sole form of private rental contract, with light-touch rent stabilisation limiting rent increases to inflation for three-year periods and disputes settled by a new housing tribunal.

In the medium term, we need to rebalance demand so young first-time buyers are in a better position compared to those buying second or subsequent homes. We recommend replacing council tax with a progressive property tax with surcharges on second and empty properties; halving stamp duty rates to encourage moving; and a time-limited capital gains tax cut to incentivise owners of additional properties to sell to first-time buyers.

In the long term we need to build more homes, year in, year out, in areas of strong housing demand, while increasing the number of affordable homes, to reduce housing costs. We recommend piloting community land auctions so local authorities can ensure more land is brought forward for house building, underpinned by stronger compulsory purchase powers; and a £1.7 billion building precept allowing local authorities to raise funds for house building in their area.

 

Reducing risks around younger generations’ pensions

Recent reforms to the pensions landscape have addressed the persistent decline in saving precipitated by the demise of defined benefit provision, and guaranteed a higher basic rate for the State Pension. But the crucial difference, compared to current retirees, is the sheer scale of risk that future pensioners are being asked to shoulder.

We need to build on these reforms by spreading the benefits to groups that are at risk of remaining outside private pensions saving – including the very lowest earners and the self-employed – and by increasing how much is saved without large numbers of people dropping out of the new system. We recommend requiring firms contracting self-employed labour to make pension contributions; lowering the earnings threshold above which employees get auto-enrolled; and providing greater incentives to save among low- and middle-earners by flattening rates of pensions tax relief and exempting employee contributions from National Insurance.

It is also essential that we reduce the risks that individuals are being asked to bear around investment returns, longevity and inflation – risks that those retiring in the past have been comparatively protected from. We recommend developing a legislative framework for ‘collective defined contribution’ pensions that better share investment risk; and reforming pension freedoms to include the default option of a guaranteed income product purchased at the age of 80.

 

Harnessing the power of assets to boost security and opportunity today and respond to tomorrow’s challenges

As well as addressing the issues young adults are facing in the jobs market, the housing market and in saving for retirement, a renewed intergenerational contract means recognising the significance of Britain’s growing stock of wealth and the inability of many young people to share in it. Assets are important because they provide individuals with security and a basis for taking chances in their careers.

Inheritances are set to play a bigger role in determining who holds assets, and therefore in what living standards look like for different members of younger generations. But many millennials will not inherit – and even those who will are likely to receive this support shortly before retirement rather than in the expensive family-raising years.

Nonetheless, the coming rise in intergenerational wealth transfers provides an opportunity to show that Britain has something to offer young people, no matter who their parents are. We recommend abolishing inheritance tax and replacing it with a lifetime receipts tax that is levied on recipients with fewer exemptions, a lower tax-free allowance and lower tax rates. The extra revenues should support a £10,000 ‘citizen’s inheritance’ – a restricted-use asset endowment to all young adults to support skills, entrepreneurship, housing and pension saving. In the medium term, citizen’s inheritances of £10,000 should be available from the age of 25 at a cost of £7 billion per year. During an initial transition phase, gradually rising inheritances should be offered at older ages, starting with those turning 35 in 2020.

The effects would be profound. A £10,000 boost today would at least double the wealth of more than six-in-ten adults in their late 20s. It would be enough for half the typical first-time buyer deposit in half the regions and nations of the UK; enough to fund a master’s degree or significant retraining; and would add an estimated £45,000 to retirement savings pots if immediately invested in a pension. And by bridging between rental deposits when people move for work, or adding to businesses start-up resources for those in recognised entrepreneurship schemes, it would support the kind of positive labour market risk-taking that is all too lacking for the young at present. Such an approach would represent a bold demonstration that the state’s role in delivering the intergenerational contract can evolve for the 21st century.

 

Renewing the intergenerational contract will not be easy, but it can be done

Families have adjusted to the 21st century’s intergenerational challenges, and now as a society we need to do so too. We do not underestimate the task at hand, especially for democratically elected politicians in an era of unstable politics. But people are increasingly concerned about the prospects of other generations within their families and communities, and electoral turnout gaps by age are narrowing. We have presented a policy agenda that addresses the concerns of both old and young, and in so doing rebuilds the intergenerational contract.

We have taken bold steps to strengthen the contract between the generations before. We responded to the needs of those increasingly living beyond working age by introducing the State Pension at the beginning of the 20th century. We built the homes for the children of the baby boom to be brought up in after World War II. And we maintained pay progress and kept our young workers globally competitive via huge increases in access to university education in the 1990s.

If we once again step up to the challenge of keeping the intergenerational contract strong, we will not only have a better Britain but a more united one.