Cullen:Speech to Assoc of Superannuation Funds NZ
31 May 2005
7.30am Tuesday 31 May 2005
Speech to Association of Superannuation Funds NZ
Wellington Club, The Terrace, Wellington
This month’s budget contained some important developments which should augur well for the future of our financial markets and for increasing sophistication in financial services in the years ahead.
Indeed this morning I would like to argue that we are creating the best of all possible worlds for the New Zealand financial services industry. That is, a combination of four things:
An economy that is on a steady long-term growth path;
A government that is committed to long term fiscal stability, based on maintained prudent levels of public debt;
A populace that understands the value of savings and wealth management and is literate in respect of their options for meeting their financial goals; and
A tax and regulatory regime that ensures that decisions are made on the basis of real value, rather than tax advantage or game-playing.
I will address each of these in turn.
The New Zealand economy, as you know, has spent the last five years as something of an outlier within the OECD, posting annual GDP growth in excess of 4 per cent on average.
That has been translated into rates of employment and income growth not seen in this country since the boom years of the 1960s. Between March 2000 and March 2005 the economy added on some 260,000 more jobs, of which 218,000 were full-time and 42,000 part-time. Labour force participation is now at 67.6 per cent, while unemployment is 3.9 per cent. These are close to record levels in the 19 year history of the Household Labour Force Survey, and we now have the second lowest unemployment rate of OECD nations with comparable data.
Incomes have grown alongside of employment, with real per capita incomes up 11 per cent since the March 2000 quarter.
That increase in income is being spread throughout the community. Average weekly income for New Zealanders aged over 15 rose from $442 in June 2000 to $554 in June 2004. Most of that increase was attributable to increases in wages and salaries. The contribution of government transfers remained static over the period.
Like most forecasters, the Treasury now expects the economy to slow over the next two years to an annual growth rate of around 2 ½ per cent. This is due to the lagged impact of recent interest rate increases, the lagged effect of the appreciation of the exchange rate, slowing net migration and a period of weaker trading partner growth.
A growth rate of 2 ½ per cent still keeps us well up the OECD league tables, however, and it exceeds our performance for much of the 1980s and 1990s. The underlying picture is of strong economic fundamentals, and a surprising degree of resilience illustrated by our continued growth despite a difficult external environment.
The strength of our dollar reflects in part the strong relative performance of our economy, but is driven primarily by the weakness in the US dollar. And that in turn is something of an object lesson in fiscal policy, since while there are many positive signs of recovery in the world’s largest economy, the US continues to suffer from large current account deficits in combination with a fiscal deficit that is only barely under control.
That brings me to my second point, in that the hard lesson being faced in the US is that cutting tax without cutting expenditure is merely a recipe for burdening an economy with more debt, increasing its vulnerability to external shocks, and undermining investor and consumer confidence. It is a hole that is easy to dig, but getting back out of it involves difficult, painful and politically costly decisions.
We in New Zealand know that because we have had to do it the hard way. For the past five years we have carefully managed government expenditure as a proportion of GDP and have run surpluses so as to reduce public debt.
Gross sovereign-issued debt has now fallen from 35 per cent of GDP in June 1999 to an estimated 22.6 per cent at the end of June this year. Alongside this, the accumulated assets in the New Zealand Superannuation Fund will stand at around $6.5 billion.
The cash deficits forecast in the Budget flow through into a flattening of the debt track just above 20 per cent of GDP. The net debt track is likewise somewhat flat around 7 per cent of GDP, while the Crown is forecast to move into a net positive financial asset position for the first time ever in 2006-07.
While we have not yet completed the task of building up assets to manage the cost of the demographic transition, the message is very clear: this government is managing public finances in a way that will reduce the vulnerability of the economy to future shocks and will minimise the risk of unexpected tax increases to meet essential public services such as health and pensions.
Sadly there are those in parliament who are willing to apply a high discount rate on future stability, and to send debt on to a long term upward path in order to fund across the board tax cuts. In the current environment of low unemployment and capacity constraints, tax cuts that are not targeted specifically at increasing productivity are likely to be nothing more than a temporary burn-off of liquidity.
I believe most New Zealanders realise that would be a backward step.
The third key aspect of the budget I want to discuss is the savings package.
This is not a compulsory scheme like Australia’s, but it is a definite tilting of the playing field towards participation. New employees will automatically be enrolled in the KiwiSaver scheme and will have to opt out if they do not wish to participate.
The emphasis from the contributor’s point of view is on choice, with competing providers and a capacity for contributors to specify their preference for risk. In return, there are clear expectations that savings will be locked in for retirement or, under certain circumstances, for the purchase of a first home.
Our working assumption is that 25 per cent of the eligible workforce will have enrolled in KiwiSaver by 2012. All things being equal, the scheme should lead to a general increase in the liquidity of New Zealand’s capital markets. It represents a significant opportunity for financial intermediaries at both the retail and the wholesale level.
I imagine you are familiar with the concept of the KiwiSaver, so I will not revisit the details. However, there are three issues I want to touch on:
First, how KiwiSaver relates to existing superannuation funds;
Second, how KiwiSaver will impact upon employers with existing schemes; and
Third, the rationale for some of the key design features.
On the former point, KiwiSaver is a generic framework for workplace savings consisting of mechanisms for encouraging enrolment, modest incentives for those who do, and a collection system that minimises transactions costs. It establishes, as it were, a common gateway enabling employees to access a range of schemes which conform to a basic set of requirements.
Those schemes may offer a wide array of options, and may target particular sectors of the market with tailored services. Our intention has always been that, within the parameters of the basic scheme design there would be room for a thousand flowers to bloom.
That intent will be carried forward in the next few months in the detailed policy work regarding how schemes qualify and how existing schemes migrate into the KiwiSaver framework. We are committed to a fair deal for existing schemes, and there will be opportunities to work with providers on this issue during the coming months.
Inevitably there may be some perceived inequities in the transition, as new entrants benefit from incentives that are not available to those who have been saving for some time. This is to be expected, and we should bear in mind that the purpose of KiwiSaver is to induce more people to save, not to induce savers to shift their existing savings to a different form.
That brings me to the issue of employers with existing schemes. There is nothing in the new policy that seeks to dissuade employers from continuing to support existing superannuation schemes. If that scheme satisfies the KiwiSaver features, employers can convert it into a KiwiSaver product and access the benefits in terms of government contribution to new entrants, collection via IRD, and so on.
In addition, employers will be able to apply for an exemption from automatic enrolment for new employees, provided that they have an existing superannuation scheme that:
Has total contributions of at least 4 percent (vesting immediately);
Provides full coverage to permanent employees; and
Allows employees to transfer balances to other comparable schemes.
On the broader question of the design of the scheme, you will understand that it involved some difficult choices. We decided early that we did not want to go down the compulsory savings route. While that has advantages in terms of participation rates, it introduces some troublesome incentives and tends to create an overly conservative mindset with respect to tailoring products to meet consumer needs.
Amongst voluntary options we considered the Irish model of compulsory offer, but decided to go with automatic enrolment with opt out on the basis that such programmes appear to have had greater uptake.
We were also very aware of the need to make the scheme simple for employers, and hence chose to use IRD’s systems for automatic deduction. This was also the rationale for assignment to a default provider. One of the issues that has arisen with the Irish scheme is that the array of accounts has become far more complex than they had originally intended. We need to be aware of the important educative process that new savers undergo, and ensure that they are not swamped with information at too early a stage.
It is important to bear in mind that KiwiSaver is an attempt to starting a savings culture in New Zealand. Its impact will exceed the total balances that accrue in KiwiSaver accounts. Making workplace savings a common feature of New Zealand life should have something of a multiplier effect, encouraging ordinary working New Zealanders to become more financially literate and seeing their stake in the country extending beyond the labour market and the residential property market.
This is an important opportunity for the superannuation industry to work with the government to create a win-win situation with both economic and social benefits.
An important corollary of encouraging and facilitating savings is the need to have a financial services industry that operates with a fair and transparent taxation regime and a robust regulatory environment.
Budget 2005 made important moves towards this goal through addressing the issues raised last year by Craig Stobo in his report on the taxation of investment.
As you are aware, direct investments in New Zealand companies are presently taxed at the company level, with imputation to alleviate double taxation. For most direct investors, these investments will be on capital account, with the result that capital gains on sale are not taxable income.
Investments through a financial intermediary, such as a unit trust or superannuation fund, are typically taxed according to the nature of the intermediary as a business and are on revenue account as a result. This means any resulting capital gains are considered taxable income. As a result, direct investments are generally in a superior tax position relative to indirect investments.
The 2005 budget included announcements to solve the distortion against using financial intermediaries. In particular, investments by intermediaries that qualify as Collective Investment Vehicles, because they take portfolio investors and facilitate access to portfolio investments, will generally be on capital account so that investments through such vehicles are not disadvantaged relative to direct investments.
This treatment will apply to equity investments, and is not designed to change the treatment of debt, where similar distortions do not exist. Equity investments designed to exploit the boundary between debt and equity, will remain on revenue account. This is important to prevent the reform adding new distortions, and to maintain the relative desirability of interest bearing investments.
While domestic equity investments will have an impediment removed, these investments will still face tax at the New Zealand company level, as is appropriate.
As stated in the budget, the taxation of offshore investment is a much more difficult matter, but it is one that is critical to get right if we are to avoid New Zealand's scarce domestic capital being encouraged to chase offshore tax advantages. The government will shortly be releasing a discussion document with proposals to address this issue.
Taking stock of the budget announcements, I am the first to admit that it means a heavy workload in the next couple of years. I trust that, while we may have some differences on the best means, the government and the superannuation industry share much common ground on the ends we want to achieve.
I look forward to an ongoing and productive dialogue; but I look forward even more to getting KiwiSaver in place and seeing New Zealanders hooked into a more deliberate regime of accumulating and managing assets so that they can achieve the long term financial security they seek.