Bill English - New Zealand SuperFund Conference
Opposition Finance Spokesperson
New Zealand SuperFund Conference
Wednesday, 19 July
Not for the first time in 25 years, superannuation is yet again become a political football.
I have come today as Opposition Finance spokesman because we have concluded, as others will, that current proposals to prefund superannuation could have a significant economic impact on capital markets, economic growth, tax and spending policy and income distribution for two generations.
Superannuation needs to be discussed in the context of the whole economy.
The proposal to prefund New Zealand superannuation has been described in very general terms and the Government has refused to answer questions about it so it has been difficult to debate.
The months since the election have seen very substantial changes in the proposal. The Labour party pre-election manifesto described a superannuation tax set so that at a constant level it will be sufficient to fund New Zealand superannuation over a 60-year time frame. It is then claimed that “the problem of sustainability disappears”. The manifesto also says a referendum will be held.
Earlier this year it became a proposal to prefund superannuation by channeling fiscal surpluses into a fund which will build up to 80-100 billion dollars and last for 60 years.
As recently as Monday the media ran a different description again. Now the basis for contribution is to be a percentage of GDP, rising from 0.5% of GDP ultimately to 6% of GDP.
The purpose of the fund has also changed dramatically. Up to now the proposal has always been pure pre-funding, with assets built up to be released when the aging bulge arrives. Now two-thirds of the fund is to be used to fund existing pensions and one-third for pre-funding.
Not everyone has been able to keep up with these changes.
This is no basis for the kind of widespread support such a major measure needs. One reason there has been little debate on the issue is because hardly anyone thinks it will happen. Recent Government statements should put that complacency to bed. The Government is going to move in the next few months to a radical change in our superannuation arrangements intended to last at least two generations.
Another reason is that even informed observers have little idea what is actually being proposed. Fund managers and financial advisers don’t yet know just what the proposal is. What chance is there for the taxpayer to understand the proposal and decide whether to support it? It is the taxpayer after all who will foot the bill.
National wants to protect the elderly from insecurity and unjustified change. Voters accepted the change in the age of entitlement, but they rejected means testing and any further reduction in the relativity between national superannuation and the average wage.
National is strongly critical of the process the Government is using for a such a large public policy change. Its other large changes such as the Employment Relations Bill have caused confusion and anxiety and backdowns as will its sweeping changes to matrimonial and defacto property law. The superannuation proposal is going down the same path. The Government underestimates the need for people to understand what it is that will swallow up billions of dollars of hard earned taxes.
Today Labour is a major party in a coalition Government. This Government will need the support of either the Greens or NZ First to get their scheme through the House. The scheme cannot be entrenched without the support of the National Party, and we will not entrench a scheme that no-one except Dr Cullen understands.
National’s position is this: Most New Zealanders want certainty for their retirement income. We moved unilaterally to peg the level of national superannuation at 60% of the average wage in 1998, and it was a significant factor in our defeat at the last general election. The public understand that political certainty underpins financial certainty. National is prepared to put its own positions on the table in order to achieve political certainty. That requires the Government to do the same, and both major parties need to be willing to participate in a wider public debate.
In February, Mrs Shipley wrote to the Government offering to participate in the policy making but the offer was not taken up. We cannot be expected to sign up to a policy we have not yet seen let alone considered.
One might take a more cynical view of the talk about pre-funding as a way of establishing the Government’s low tax credentials and protecting the surpluses from a cabinet inclined to big spending.
What then are the terms on which we will engage in a debate? Here are some criteria any major superannuation proposal should meet. Much work has already been done on these issues by taskforces and review groups throughout the 90s:
The policy should provide long-term certainty for New Zealanders
The policy should enjoy multi-party support based on widespread public consultation and approval
It should be comparable with other successful options around the world.
It should be sufficiently flexible so future Governments can respond effectively to economic circumstances in the interests of New Zealand
It should have clear economic benefits over and above other options such as debt retirement, or the status quo.
It should enhance economic growth
It should fair between generations and avoid placing too much burden on any particular generation
I want now to comment on some general arguments around pre-funding. I will take a skeptical point of view, because in the last 15 years New Zealand has looked hard at and voted on most variations of a public superannuation scheme.
National does not reject outright this or any other proposal, but any new solution should be thoroughly scrutinized.
I ask all who are interested not to succumb to the temptation to sign up “because something must be done.” There is increasing international interest in the simple clean New Zealand model and any proposal must at least be measured against the status quo. We may already have “done something”
The concept of pre-funding has been presented as the only solution to the problem of an aging population which will certainly solve the problem.
The problem is often confused. Are we more worried about the wider economic effects of an ageing population, or the Government’s books?
So far Dr Cullen has faithfully reflected the Treasury view that the fiscal effects matter most. It’s quite possible, indeed likely, that the proposal could be good for the Government but bad for the economy.
First, can pre-funding spread the economic cost? Economists are ambivalent. The fallacy of composition is now well known to anyone who has studied superannuation issues. At the very least, it’s not near as simple as the Government’s assertion that a dollar saved now reduces future cost by a dollar plus compound interest. If we aren’t sure about the impact on costs to the Government, then we ought to be sure about the impact on the wider economy. Any financing arrangement needs to enhance economic growth so that in the future a larger economy can support higher absolute standards of living.
Any financing scheme represents a way of establishing how the cake is cut at the time the liabilities arise. If retirees build up disproportionate claims through a huge saving effort, it represents the same sort of burden on the future economy as economic claims achieved through taxation and voting power. So pre-funding doesn’t reduce the claim older people will make in the future, it just accumulates those claims in a different way.
One difference is that pre-funding is likely to be heavily invested offshore, so the retirees of the future will be making claims on other economies. But so will everyone else at the same time. Every country will be looking to cash up at the same time, and a surplus of assets for sale will drive down the value of the savings. Countries can’t all run balance of payments surpluses at the same time.
Secondly, if the cost can be spread, is pre-funding the only way to do it? There are alternatives. For instance, the cost can be post-funded. We should be debt free within the next 7 or 8 years. When the costs of superannuation exceed the capacity of existing tax levels, the Government can borrow to make up the difference - this spreads the cost onto people who live beyond the hump, rather than people who live before it. There is no economic reason to distinguish between the two.
What about the long run relationship between debt and tax levels? This is complex and I want to talk about only a few effects. As I will discuss later, this fund is financed by higher taxes. Right now New Zealand has low Government debt but we have high private debt levels, over 100% of GDP. That stock of debt is growing.
Retained earnings in businesses and discretionary earnings in households are major drivers of investment and increasing net worth. In the long-term, higher taxes reduce the capacity of the household and the business sector to meet their own capital needs and reduce their debt levels.
The pre-funding scheme growing to $70-100 billion will shift that much equity off the balance sheets of businesses and households and onto the Government’s balance sheet. We need to be quite sure that we want to see a large shift of equity from household and business balance sheets to the Government balance sheet.
We have a developing structural issue with the amount of debt New Zealand needs to service. Higher debt levels represent higher risk levels, and therefore a higher cost of capital. New Zealand is already facing a hurdles for inbound investment capital through a lower exchange rate. Pre-funding will exacerbate this problem when we know it is already significant.
It might be good for the Government’s books, but bad for the economy.
Pre-funding is the same as compulsory saving – both presume people will not build up their own balance sheets with savings, so the Government has to do it for them. If the Government investment earns a lower return it may not yield a larger capital amount than a smaller amount of private investment earning higher returns. The Government’s view that the economy is one dollar (plus accumulated interest) bigger for every dollar into the fund is unrealistic.
In any case, building up financial assets on the Government balance sheet only makes sense if the rate of return on the assets invested exceeds the cost of borrowed funds. International experience suggests that a rate of return above the cost of debt is not likely for public funds.
Let’s be clear about the transaction. We still have Government debt of $20 billion. When the Government starts a fund it becomes a geared investor, effectively borrowing money to buy shares. This is possible, but New Zealand needs to know that’s the choice it is making with a big chunk of public resource. New Zealanders also need to know that’s what the Government means by security in retirement.
They also need to know that most of the capital collected through higher taxes will be exported overseas. It is only prudent to invest substantially off shore. Labour, and Jim Anderton in particular, should contemplate whether their own supporters knew that is what the pledge card meant. The Government stumbled this year over small FDI issues because of their political potency in the coalition. Now Dr Cullen is proposing to invest billions of dollars overseas. New Zealand has a bad record on investing overseas but the Government seems confident it can do a lot better than the historical record.
What effect does pre-funding have on savings incentives? It will reduce the incentive to save. Right now New Zealand is beginning to change its savings habits. As long-term low inflation sets in, New Zealanders have become much more aware of the risk return trade-off. They have become more aware they need to chase better returns. At the same time most younger people believe there will be no provisions for them in their retirement. Now is the time to ram home the savings message.
The incentive to save will only continue to exist to the extent that people believe the fund won’t work in securing their retirement income. The whole point of Dr Cullen’s pre-funding proposal is to reassure people that the State will provide them with a retirement income set at 65% of the average wage at the time they retire.
Incentives will be further reduced if Dr Cullen can persuade the public with his best political line, that pre-funding costs no one anything because the Government pays. The message to young people has suddenly changed - now they can have a good retirement income without any change in savings or investment behaviour. The Government will painlessly do the saving for you.
So the incentives to save will disappear.
What about economic efficiency ?
This is a tax financed investment scheme. The $50-70 billion it will accumulate represent taxes paid over and above that required for the Government’s current spending needs and debt repayment programme.
The theory supporting compulsory schemes hinges on the payer seeing their contribution as savings rather than as tax. A compulsory scheme can look more like savings if people have individual accounts, where their contribution and likely benefit are known.
This proposal is unique because it is a tax funded savings scheme. It locks in higher tax rates at least through the life of the fund. Dr Cullen’s has already raised taxes and pre-funding provides no guarantees that he won’t have to raise them later as well. Any calculation I have seen shows the fund falling short,
Dr Cullen has accused us of threatening to raise taxes in 40 years time. Will he guarantee there will be no tax increases with the pre-funding scheme. Even if he did, what would the guarantee be worth?
I invite him to put forward legislation that will entrench a Government spending ceiling to match the life of the fund. Such a measure is what’s required to secure current tax rates.
If the fund is built up opportunistically from surpluses, there is no way the Government can know what will be in the fund to be paid out. Certainly, no 35-year-old can be sure what the Government will be paying out, and none would be inclined to rely on a promise form the current Government that they won’t spend it all. What we do know is that if the fund does not pay out what is considered adequate, older voters will have the numbers to enforce higher taxes.
Taxes have an effect on incentives to save and work. The disincentives of higher taxes through the fund build up period will reduce potential growth. This further reduces the net benefit of pre-funding to the economy.
That brings us to the issue of fairness. Who pays for this scheme? The political answer is no-one. So where then does the $50 billion come from? It comes from people who will pay more tax than they otherwise would over the period of fund build-up. Today’s 30 year olds will be 70 when the demographic pressure peaks, so it is they who will pay the most.
Like any contributory scheme, someone pays twice through the start-up phase - they pay for the current generation of retirees and for their own retirement. We could argue current taxpayers who have paid off tens of billions of debt are paying for the previous generation as well – a triple whammy.
As I have already explained, other financing methods would spread the costs differently and therefore affect different generations. These options need to be carefully considered, because a system that comes to be seen as unfair will lose political support. This type of scheme hides massive redistribution of income, hidden only because it occurs over a longer period of time. Dr Cullen is set against vesting funds in the name of individuals, so it’s even more important that the direction and size of redistribution are understood.
You may recall that these issues were widely discussed during the debate on Winston Peters’ compulsory scheme. Its odd that a Government which professes to be concerned about income distribution is unwilling to discuss this aspect of its scheme. It likely that analysis will show middle-income tax payers will pay a lot in and not get much out. Private superannuation products will look terrific by comparison, even at punitive tax rates.
At a general level the sandwich generation need assurances that they will get the benefit of their contribution. This is a live issue right now. The Government is moving towards changing the TTE regime perhaps to TET. This involves taxing withdrawals from the funds. I was junior treasury official when TTE was introduced. I can still hear ringing in my ears the warnings that a future Government would eventually succumb to the temptation to tax a flow that looked a lot like income - and so it may well happen
The Government cannot in fact offer such assurances that the rules won’t change. At best there should be rules now which stipulate when a Government can start to make withdrawals from the fund and the rate at which those withdrawals can be disbursed. The temptation to dip into the fund as a safety valve for other fiscal pressures will be great. The current proposal to take 6% of GDP and split it between current retirement incomes and future needs looks tailor made for accounting and fiscal compromise by politicians.
Apart from vague murmurings about a TET regime, the Government’s view on pre-funding is curiously bereft of a view about how it integrates with private provision. In every other country where retirement income is an issue, discussion centres around how to better integrate public and private provision so the cost of public provision can be reduced. If the Government has big ideas about a concessionary savings regime then it should be discussed alongside its pre-funding proposals. That in itself is a good reason not to hurry large changes in public provision.
Then there are is the issue of governance. The Government already owns $16 billion of companies where the governance has become more politicised and confused by the day. This pre-funding proposal puts Government in charge of another significant proportion of New Zealand’s capital stock.
What reassurance is there that this and future left wing Governments will water down the fund managers mandate with laudable if confusing social objectives. For instance they may be prevented from investing in countries or companies with inadequate environmental or labour laws or companies involved in genetic science, which is currently under moratorium in New Zealand. Can the fund invest in companies who operate in Fiji, or in countries like China with a history of debate on its human rights record. New Zealand’s moral foreign policy stance could make more difference to returns than anything else.
Finally, we need to consider the constitutional realities this proposal faces. We have no effective means of locking in such a scheme. Dr Cullen cannot bind future Governments to this scheme. He has demonstrated himself with respect to ACC that politicians can reverse sensible changes just because something was said about them before an election.
Any proposal for long-term major change can be secured only by wide and strong moral support. This is a minority coalition Government that continues to overestimate its mandate, and looks likely on this issue do it again. There is no constitutional means of creating legal security in the absence of widespread support.
It can’t be assumed that anyone in the Government other than Dr Cullen understands or is committed to this proposal. I expect the Prime Minister will be waiting to see how the debate develops, and as in other matters she will have no hesitation in removing her support from the minister if there is significant opposition.
Lets look at the deal this proposal offers to the sandwich generation.
Our 35-year-old is expected to believe the following:
Suddenly Government has
decided it can afford to support her in retirement,
after years of saying it can’t.
The income she can expect in retirement will be 65% of the average wage
She can be sure of this because money is being put aside now, and no-one had thought of it before.
But the Government will build the fund from the surpluses left over after its finished spending on the needs of the day. If there is no surplus nothing will be paid into the fund
No-one knows how much money will be in the fund at any given time, but the payouts are guaranteed and there will be no tax increases.
National is keen to engage in this debate and does so with goodwill. Let me make some final points on our approach.
First, we have learned the lesson of history. National is looking at how the entitlement of current superannuitants and those close to the age of entitlement can be locked in. Under fiscal pressure we moved to alter the existing entitlement in a way that was regarded as unfair. Older people were angry and we paid the price at the ballot box. The entitlement of people close to retirement age was significantly altered by the increase in the age threshold over the last decade, and further change would undermine the security they seek in old age. We have not decided the age to which this security should extend.
Secondly, if the scheme proposed is unsatisfactory, our preference as an incoming Government would be to use the fund to pay down debt. We could then look at redeploying the funding flow to lower taxes. In our view New Zealand’s future economic prosperity is best served by a flexible low tax economy. The process so far used by this Government gives us no sense of obligation to support a move the public does not understand.
Thirdly, we want to deal with this issue in the context of a positive ageing policy. My own party has been as guilty as this Government of seeing ageing as a uniformly negative aspect of our future. I don’t believe an ageing population is a huge burden or totally negative. We will be an unhappy country if a big part of the community is regarded as a fiscal nuisance.
New Zealanders are in fact adjusting to large and small demographic changes all the time. The baby boomers have been with us for half a century, and their echo generations continue to dominate demographic change. Our Maori, Pacific Island and Asian populations have changed significantly in recent years as their growth picks up momentum. Our net migration patterns remain highly volatile, changing job and housing markets in just a few years. Our capacity to adapt to events 20 years away will be greater than we assume.
Fourthly, National will be looking again at the arguments around tax incentives for savings and compulsory superannuation. We are skeptical that either hold the answer, but it’s possible that even if they don’t work, we would be no worse off.
I look forward to a vigorous debate reflecting the stake every New Zealander has in getting retirement income policy right.