Monday, 25 August 2014

A Policy A Day: Variable Superannuation

In the lead-up to the election, we are going to examine one policy per (working) day. We've selected policies to be as balanced as possible across a range of policy areas and across the political parties. The idea is to explain the background, analyse the policy to investigate the pros and cons, and give a verdict on the policy at the end. Inevitably, some opinion will make its way in and we make no apology for that - after all, we're voters too. Also, I say 'we' because this series will feature some guest posts from other young people, to share their thoughts and ideas as well. A list of all the articles is available hereEnjoy!

Today's post is written by Jason Armishaw.

The policy for today is from the United Future Party. Flexi Super was announced by leader Peter Dunne around this time last year. This policy would allow those qualifying for superannuation in New Zealand to choose at what age they would start their superannuation payments, between the ages of 60-70. Superannuitants starting their payments earlier would receive reduced rate for their lifetime. Conversely, those starting later would receive an increased rate.

What’s wrong with the status quo?
Superannuation is the single largest part of the welfare state, making up nearly half of all Social Welfare payments in New Zealand. In turn, Social Welfare makes up roughly 25% of the government budget. The costs of superannuation are not static and are projected to massively increase over the coming years. This is caused mainly by the demographic change occurring in New Zealand, with the baby boomers reaching retirement, and life expectancy increasing. These pressures mean that Superannuation costs are going to increase. In addition, decreasing fertility rates means that the proportion of tax paying workers is decreasing in comparison to the amount of superannuitants. The combination of the two will mean that Superannuation will end up taking a larger segment of government expenditure, leaving less to spend in other areas. This creates problems with intergenerational equity, where there are large transfers of wealth from the current generation to the previous one. Additionally, Superannuation is currently universal for all of those above the age of 65, regardless of if they are still working, or their general level of affluence. While this may be good or bad, depending on your perceptions of the role of state welfare, the universality of Superannuation creates significant costs to government.

Analysis of Flexi-Super
One of the arguments put forward by United Future in favour of their policy is greater choice for the elderly, because individuals will be able to take control over when they retire, understanding that the decision has financial implications. While this is ostensibly true, the argument operates under the assumption that everyone is in a roughly similar position, and can all make rational choices. In reality this assumption does not hold. Generally speaking, those in more labour intensive work (who will be unable to work after 65), or lower socio economic individuals are more likely to take state support sooner. Conversely those who are wealthier with larger savings will have the option to take Superannuation later in their life. This is effectively the state increasing inequality amongst the elderly. While it may seem on the face of it that the policy offers greater flexibility, this is only true for those wealthy enough to hold off on receiving payments until later. Additionally, people are generally unable to make rational decisions because they do not have perfect information because they can't accurately predict the future; when you are age 60, it is difficult for you to say with certainty what your situation will be in 5 or 10 years time, so you cannot make a well-informed, rational decision on whether you should retire now or later.

While I have not been able to find figures for how much United Future would give at each age level, I have done some rough calculations of my own to figure out the degree of difference between taking the payment at a lower level and deferring the payment. I used a discount rate of 6% and discounted back the current superannuation payments. I then projected the 6% rate forward, and worked out that the someone opting into the scheme at 60 would receive roughly 75% of the current payment, while those taking it at 70, would receive 134% of the current payment. A single individual living alone would ordinarily receive $421.76 a week at 65, however if taken at 60 that individual would receive $315.16 a week, while if taken at 70, $564.41 would be received. I understand that this analysis is shaky, but with no figures to go on it illustrates the point that the scheme may generate inequality between those who are forced to take the payment earlier with those who are fortunate enough to defer the payment. (A spreadsheet with the calculations used for this post is available here.)

The second main argument in favour of the policy is that those with lower life expectancies have the ability to take the payment earlier. The line of reasoning is that it is unfair that those who die earlier don’t receive as much state support. With a Flexi Superannuation scheme, individuals will be able to increase their overall superannuation in their lifetime in comparison to the status quo by taking superannuation earlier if they know that their life expectancy is lower than the average. However, individuals aren’t able to effectively guess their life expectancy; in addition the level of financial literacy in New Zealand is not particularly high. It does not seem reasonable for individuals to be able to guess their life expectancy and plan financially for it.

As mentioned above, there has been no costing provided by United Future in their policy documents about how the scheme would look. Just that it would be done in a way that is “fiscally neutral”. Assuming that this is true, this policy would not change New Zealand’s short term financial position. However this policy does not do anything to affect the underlying demographic changes occurring in New Zealand. As touched upon earlier, the biggest drivers in the growth of superannuation payments is increasing life expectancy, meaning people spend longer on state support, and baby boomers reaching retirement age. The problem of the increasing costs of superannuation is not going away. This policy does nothing to address the fact that life expectancy of a Pakeha Male when the Universal Superannuation scheme was implemented by Muldoon in 1977 was 69 years, and would be on Superannuation for 9 years. In 2012, average life expectancy for a male was 80.2 years, and would be on Superannuation for 15 years. Flexi Super does not in anyway fix the underlying issues with the long term affordability of Superannuation. To say that this policy is kicking the can down the road would be too grandiose.

A more minor issue is the increased complexity that arises from introducing variability into these sorts of schemes. The current universal scheme is fairly straightforward to administer; just find everyone over the age of 65, work out their living situation (living alone, married, etc), and pay them their respective rate. Introducing variable Superannuation would increase the amount of administrative work that would need to be done significantly. Additionally, a married couple's superannuation is currently calculated together; how would this policy work where both spouses did not start taking their superannuation at the same time? The figures decided on would need to be constantly checked to make sure that there is no potential for welfare arbitrage (such as going on the Unemployment Benefit and deferring Superannuation). Finally, how does the scheme reconcile with those receiving pensions to/from overseas? This system is complicated already and having to adjust all of these figures depending on the year that the superannuation was taken would significantly increase it.

Verdict: While the policy seems like a sensible idea initially, it does not hold up to a reasonable degree of scrutiny. It does provide greater flexibility to the elderly, but this may not be worth the increased administrative costs and the potential increase in inequality among the elderly and infirm. The policy does not address the long term cost pressures of superannuation. I think that this policy is not a particularly good one, but more discussion needs to be had about how the state can continue to afford rapid growth to Superannuation.

Jason Armishaw is a third year Law and Commerce Student majoring in Economics at the University of Auckland. He was a writer of the Youth Long Term Fiscal Statement which was developed out of the Treasury sponsored Affording Our Future conference. He has a strong interest in public policy and fiscal management. 

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