Tuesday 19 September 2017

A Policy A Day: A Fiscal Apocalypse - Superannuation

In the lead-up to the election, we are examining a policy a day. We're exploring a variety of policy areas, explaining the background and analysing some of the policy options, with a mixture of technocracy and values-based approaches. Inevitably, some opinion will make its way in and we make no apology for that - after all, we're voters too. A list of all the articles is available hereEnjoy!

Today's post is written by Jason Armishaw

New Zealand Superannuation is a universal payment that every New Zealander is entitled to once they turn 65. This payment is given irrespective of the wealth, health status, or any other circumstances that might affect the individual. This payment is designed to give elderly people, particularly those without income, a payment so they don’t need to rely on their families or work in a way that is detrimental to their health. However, the ageing population is leading to a growing superannuation cost that has caused people to raise questions about its affordability in the long term.

While there has been some discussion this election on “fiscal holes”, superannuation is quickly becoming a fiscal apocalypse. Currently, we spend more on superannuation than we do on all other parts of social welfare combined. That means that every week, the government pays out more dollars to people over 65 than it pays out in dollars to anyone that receives any form of benefit payment. 17% of the Government budget is superannuation payments alone. To put some precise numbers on it we spend $13.7bn on Superannuation per year, while we spent $14bn on Education and $17.1bn on Health. Superannuation costs have been rising at approximately $1bn a year.

The New Zealand Treasury is required to project where the government books will be in 40 years in a “Long Term Fiscal Statement”. The most recent Long Term Fiscal Statement, released in 2016, outlined that if we don’t change superannuation it might swell to be as large as 50% of the government budget. At this level, the choice literally becomes “do we want public healthcare, public education, and social welfare, or do we want superannuation.” The ratio of kiwis over 65 to under 65 (who are able to pay taxes to support superannuation) is 1:5 right now, and this is expected to shrink to 1:2 by 2050. This means that half of the amount of tax our generation will pay will be given in cash to someone over 65.

There are a number of misconceptions about superannuation and it’s important to break all of them down.

Misconception 1 - This is a temporary problem caused by all the baby boomers
While baby boomers going through retirement is a contributing factor, the biggest driver of superannuation costs is the increase in life expectancy. When superannuation was first introduced in 1898, average life expectancy was only 54 for males. People that lived to 65 were quite old by that standard, and the government paid little in superannuation. Now, life expectancy is 83, meaning people spend (on average) 18 years, or a quarter of their lives, receiving superannuation.  That means that unless life expectancy drops, this problem is only going to get worse!

Misconception 2 – 2050? That’s ages away! We’ll fix it by then.
The reality is that we need to act now. You can’t just spring on a 64-year old that we are changing the age of eligibility to 70. People use superannuation to guide their retirement planning and savings decisions. This means that any decisions we make to superannuation need to be rolled out over a long period of time. There is realistically a 15-20 year lag to any changes in superannuation. If you add 6-9 years of relative inaction on the issues, 2050 starts to loom closely. Inaction by the Clark and Key governments means we need to make decisions quickly. Put simply, no politician can claim to represent young people or generational change if they do not support acting aggressively on this issue.

Misconception 3 – But don’t we have the Cullen Fund?
The New Zealand Superannuation Fund or “Cullen” Fund was created to be like a retirement savings account for the government; the government would contribute to the fund every year, that money would be invested, and we would then draw on it when baby boomers retired to cover their superannuation.

This idea would work if there was a temporary funding shortfall. but as we established earlier, this is an ongoing problem driven by people living longer. The Cullen fund might buy us time, but structural changes are still needed. Secondly, the cost of superannuation is projected to rise faster than the return rate of the fund, meaning the fund might not even operate effectively as a stopgap.

The final problem is that investing in the fund doesn’t make sense if the government is running deficit budgets (or increasing the amount of money that it borrows) such as when the country is in recession. Borrowing money to then save it is, by definition, not saving. Indeed, the current government paused its contributions to the Cullen Fund during the recession after the Global Financial Crisis. Some politicians have advocated for using the government’s low 3% borrowing rate to invest in the fund that returns 10% from their investments, but investing in the stock market is risky, and this is the equivalent of mortgaging your house to gamble in the stock market.

Party Policies
wants to raise the age of superannuation to 67 by 2040 (in small increments, six months a year from 2037). They also want to restart contributions to the Cullen fund when debt is less than 20% of GDP. This is minor tinkering on a long time frame. The biggest risk is that people then feel like this change “solves” the issue and are averse to more changes.

Labour and the Greens want to immediately restart contributions to the Cullen Fund, but have no policies in place to structurally change Superannuation. As stated above, the Cullen fund might buy us a bit of time, but more structural change is needed. Jacinda Ardern has stated that she would resign before she raised the age of superannuation.

New Zealand First wants to increase benefits to elderly. This is simply counterproductive. The Māori Party want a separate retirement age for Māori, as they have lower life expectancies and miss out on superannuation entirely. If Māori health outcomes improve, then this policy will worsen the superannuation crisis. If Māori health outcomes stagnate, then it would have no impact.

ACT want to start slowly raising the age of superannuation to 67 by 2032 (in small increments, two months a year from 2020). This policy is pretty aggressive, and people will struggle to change their retirement plans to meet this new rollout.

United Future’s policy is unchanged since the 2014 election, which we actually covered in A Policy A Day last time around. The Opportunities Party want to means-test superannuation, so that only poorer people who need state support receive it. This is one of the best practice potential solutions discussed below.

So what can work?
Means Testing
One of the big problems with superannuation is its universality; everyone gets it irrespective of how wealthy they are. People that earn millions a year and have large asset pools receive the same as someone who has relied on state support their whole life. Changing the universality of superannuation (along with other changes) so that only those who need it actually receive it would go a long way towards plugging the fiscal hole. However, changes to trust and companies law would be required to stop people being able to hide their wealth (though these are probably good changes anyway).

Tying the retirement age to life expectancy
As established, the biggest problem is that people are living longer, and thus receiving a larger number of superannuation payments over their lifetime. A strongly advocated idea is to tie the retirement age to life expectancy, meaning that on average everyone gets the same amount of superannuation. This would stop the massive cost increases in superannuation every year and keep cost fairly static.

Health Testing
Superannuation exists so that elderly people who are unable to work due to their age are provided for. This policy would remove superannuation and expand the health and disabilities benefits to compensate, treating elderly similar to any other kiwi that has a health condition. One counter-argument is that the health and disabilities processes are dehumanising, though this is perhaps actually an argument for humanising health and disabilities recipients.

Overall, if left unchecked, superannuation is going to destroy any possibility for investment in social services in New Zealand. Though we are not alone, most of the OECD have ageing populations and all of them need to think carefully about how they are going to fund their retirements in the future. Compared to the rest of the world, we are in an enviable fiscal position, but our leaders need to act boldly and quickly to ensure that remains the case.

Jason Armishaw is a graduate in Law and Economics from the University of Auckland, he has worked across the public and private sector at a number of institutions including the New Zealand Treasury and Deloitte. He currently works at a management consulting firm in Australia.

[1] Recent migrants have some requirements for living in New Zealand, and coming to New Zealand before a particular age.

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