Michael Cullen Address To Super Funds Conference
Dr Michael Cullen
19 July 2000
Speech
Notes
BIIA 2nd Annual Superannuation Funds
Conference
DR MICHAEL CULLEN ADDRESS TO BIIA 2ND
SUPERANNUATION FUNDS CONFERENCE
WELLINGTON TOWN
HALL
I am delighted to talk to you today about an issue which is important to both of us, central to your business and close to my heart as a politician. I have a long track-record in superannuation, and have put solving the problems associated with maintaining an adequate level of public pension into the future high on my agenda as Finance Minister.
I am now working toward a deadline of July 1, next year. I to want start the new scheme on that date. Earlier I was talking of April 1 which has led some commentators to talk of a delay. In fact, the change to a July 1 deadline reflects a change in the proposed funding formula.
Labour Party policy, as
you will know, was to fund the scheme through a dedicated
income tax, carved out from the existing tax take. But we
have abandoned this idea as it did not appeal to either the
Alliance or the Greens. The proposal now is to fund it
through a proportion of gross domestic product.
The effect of this change is twofold. First it moves the
accounting basis for the fund from April 1 and the tax year
to July 1 and the Crown financial year. Second, it reduces
the administrative complexity of setting the fund up.
A tax-based fund would need to be legislated for at least
three months before implementation to allow enough time for
the tax arrangements to be put into place. A fund based on a
direct transfer from the consolidated account needs much
less lead-time, and could be quite simply established.
That said, I would like to get a proposal before Cabinet as
soon as possible so that we have a solid proposition to take
to the other political parties - particularly New Zealand
First and the Greens but also National.
National's
response will be interesting and will tell us a lot about
the motivations driving the National caucus. National may
see a short-term political advantage in trying to torpedo
the scheme, simply because it is being led by Labour.
But I still think it possible that they will let a higher
ethic prevail. Potentially at least, there is some common
cause amongst politicians on the issue of retirement income.
Retirement can be a time of intense personal
insecurity because the core options for earning income are
effectively closed. This creates an obligation on
governments to establish an environment that restores a
level of confidence that there will be an adequate income
when people retire.
Confidence about personal security in
retirement is assisted if retirement income policy is
relatively stable.
Most political parties would
sign up to that. It is surprising then, that in an area
where stability of policy is vital, policy has been so
unstable. There are obvious political explanations for this.
I think, though, that there is a deeper source of
instability in policy on superannuation.
That source of
instability is the conflict between the current and the
future costs of maintaining a given level of entitlement.
New Zealand Superannuation, net of the income tax that the
government reclaims from pensioners, costs about 4 percent
of GDP per annum, or about a ninth of total government
spending. On the other hand, pensioners make up about a
sixth of the voters. There is a type of short-term political
benefit to cost ratio of 1.5 to one operating here. It is
tempting for political parties to see some margin in the
pension vote.
Frankly, on current rates, and with
current costs, New Zealand Superannuation is affordable. It
doesn’t squeeze other programmes too heavily. What is more,
as the age of eligibility creeps up to 65, and as those born
in the low birth years of the depression and war retire, the
relative cost of NZS actually starts to fall slightly. In
ten years time, it is virtually the same as it is today.
This is the comfort zone. The problem is that from about
2011, the baby boomers start to retire. The cost of NZS
starts to accelerate. By 2035 it is eight percent of GDP -
double the current cost. When the population structure
matures around the middle of the century, the cost is nine
percent of GDP.
At this point, the comfort is long
past.
If nothing else is done, New Zealanders will
face three stark choices:
reduce the level of
New Zealand Superannuation, particularly in relation to
average incomes in the rest of the community;
introduce tighter eligibility criteria by, for example,
raising the age of eligibility, applying income and asset
tests or withholding NZS from those who are still
economically active;
increase average tax rates
to cover the additional costs.
The government does not believe that any of these options are desirable, defensible or politically sustainable.
The only way
to sustain universal superannuation is to start saving now
so that there is a source of income available in the future
to augment the money raised from taxes. The problem, for the
government as for any individual saving for retirement, is
that time is of the essence. Delays are costly: putting off
decisions until later makes the cost of dealing with the
problem much higher.
Therein lies the problem. At
precisely the time when the short-term costs make it
tempting to delay putting more into NZS, the long-term
evidence makes it imperative to save rather
aggressively.
As a society, we need to get out of
denial or wishful thinking.
There are some trite
answers that are often trotted out to justify inaction on
the funding question. Firstly, that the problem is only
theoretical: these are forecasts and the future is
uncertain. The population projections are not guesses. We
can virtually name the people who will be over 65 in
2050.
Second, immigration can change the
patterns and keep a flow of young people sufficient to meet
the costs of the retired citizens. Immigration will not make
much of a difference. There are nearly four million New
Zealanders. 20,000 new immigrants only add half of a percent
to the population.
It takes vast numbers of
migrants to change the age structure of a population. In our
recent past, the migration risks are, as Treasury might say,
on the downside: there is probably a bigger risk that
outward migration will increase rather than decrease the
proportion of the population who are retired in fifty years
time.
Third, that all we are facing is a switch
in the composition of government spending: less spent on
education and unemployment benefits, more on retirement
benefits. I seriously question this. My expectation is that
as time goes on, the demands for education, training and
lifelong retraining will increase, certainly in per person
terms, and probably in aggregate. Plus there are likely to
be health and other direct costs associated with supporting
a larger population of retired citizens.
Next,
the view that economic growth can solve the problem. It will
not. Normally, as an economy grows, incomes grow. Wages tend
to follow the trend growth in incomes. NZS is linked to
average wages. Therefore, as the economy grows, the
individual level of NZS grows.
The only way
growth can lower the relative cost of NZS is if we break the
link between NZS and relative incomes in the rest of the
community. If we are prepared to cut the elderly adrift, and
shut them out of participation in the dividend that a
growing economy and technological advances deliver, then
growth can solve the problem.
I suspect, though,
that this is a nonsense. Even if a future government was
prepared to confront that issue on some sort of moral basis,
the political realities of the demographic structure would
reassert themselves.
Finally, we can simply hike
the tax rate to generate the revenue needed to pay nine
percent of GDP alongside the other health, education and
similar functions of government. The numbers involved are
not convincing. A pay-as–you-go NZS needs nine percent of
GDP compared with the present four. Five percent of GDP is a
fifteen percent hike in the present tax rate. It involves
more than that on whatever tax base is selected – GST,
income tax or whatever.
It might be an option –
if anyone is still around to pay the tax! In an age of
mobility and skill scarcity, hiking the tax rate above
generally prevailing aggregate levels can easily drain the
country of its skilled and more highly productive
people.
So we cannot tax, or grow, or migrate our
way around the problem. It is a real problem and we cannot
fix it by robbing young Pamela to pay Pauline a pension.
Which ever way you look at it there is a basic policy
question to confront. Cut the pension for the next
generation, or start to save for it.
Before I get
on to the policy questions that relate to how to construct a
savings regime, let me make a few comments about what I
think we should not be saving for.
The proposed
New Zealand Superannuation Fund is not intended to be a
complete answer to income adequacy in retirement. It will
provide a basic standard of living, but New Zealanders
should aspire to a retirement income that is better than
that offered by NZS. This means that they should save to
augment NZS.
The amount of current income that
people are happy to trade off in order to supplement their
state pension will vary from person to person. The role of
the government in facilitating private savings will have to
be faced once we get the universal pension issue finalised.
I look forward to talking with the industry on this project
in the near future.
To return now to the central
fund. It will not be an individualised entitlement linked to
tax paid or some other measure of contribution. That would
create all sorts of problems with migration, death and the
like. I am talking about a general contribution from public
revenues to fund part of the emerging future cost of
NZS.
We are not funding the complete future cost
of NZS. A large part of NZS will always be funded out of
current year revenues. The scheme is partial pre-funding: a
little bit more than is strictly necessary to finance
current year entitlements in order to allow a little bit
less than is necessary to be collected in meeting the higher
costs in the later years.
This leads me to design
issues.
The core question is what sort of money
has to go into any fund and where is it going to come
from?
I can pose the policy dilemma this way.
The aim is to increase confidence that NZS will be available
on roughly the same basis - a universal, non-means tested
income set at 65 percent of the net average wage for a
couple, payable from age 65.
If too little
goes into the fund, the uncertainties and the lack of
confidence remains. It too much goes into the fund, there is
an unhealthy reduction in necessary spending on health,
education and economic development, among other things.
Certainty increases if governments are locked into a
contribution, but this can mean too little flexibility.
Flexibility is needed to respond to changing economic
circumstances, trends in wages, and changes in labour force
participation. It is also needed to deal with unusual
economic circumstances – say financial windfalls, very
strong revenue growth or the onset of an economic recession.
As I have said, the details of dealing with this
are still under discussion within the government. Without
wanting to pre-empt that process, I want to take this
opportunity today to outline to youdo not want to pre-empt
that process But without pre-empting the outcome of that
debate
The proposed scheme is forming around five
core elements. Firstly, a forecasting time horizon over
which the government attempts to smooth the costs of NZS.
Secondly, an independent or at least transparent calculation
of how much has to go into the scheme to meet the costs of
NZS over that forecast period. Third, a review mechanism to
regularly – and by this I mean probably annually – to review
the required contribution rate. Fourth, an obligation to pay
the assessed contribution into the fund, but with an
opportunity for the government to pay more, or less, in, in
exceptional circumstances, but with an obligation to explain
any variations to Parliament. Finally, a mechanism to assure
Parliament and the wider public that any contributions are
fiscally and economically affordable.
This will
put a discipline on other government spending. The issue
though is that if that discipline is not there, a spending
pressure will emerge that the government will have enormous
problems dealing with, and which it cannot transfer onto the
retired by way of default on their NZS entitlements.
Let me conclude by responding to two issues that are raised
around this issue. One is why the government doesn’t cut
taxes and let people save for their own retirement. The
second is why I don’t repay debt first.
There is a
simple response to the tax cut argument. Nobody who asks for
tax cuts offers to give up rights to NZS. Tax cuts make it
harder to finance NZS. It is NZS that is the emerging
problem. The alternative is to match tax cuts with an income
related reduction in NZS. That would either be
self-defeating, or it would mean people saving to save the
government money via lower NZS, not for a second tier income
supplement of NZS.
The argument on debt repayment
is more complex.
My justification for establishing a separate fund alongside nominal public debt at roughly existing levels is threefold.
Firstly, I cannot accept that government bonds are the highest yield option in town. Assume that the government decided to repay its debt. What would it do? It would go out into the marketplace and buy government bonds.
What would a stand-alone
superannuation fund do? It would go into the marketplace and
buy a mix of bonds and equities, government and corporate.
So if government bonds were the best deal in town it would
buy them.
It cannot do worse than earn the same as
repaying debt, only better.
This is why all fund managers only keep a portion of their assets in government bonds.
The second reason is that a stand alone fund is much more secure from political raiding for short-term advantage than is a general run down of debt. As debt reduces, borrowing head-room increases and it is much easier and more tempting to make one-off decisions to expand the debt again.
The third reason is that paying off all debt does not deal with the problem of meeting the costs of the emerging population structure. Even if the government had no debt the basic options still stand: build up financial assets, or increase the average tax rate dramatically in the future, or cut superannuation entitlements, or introduce a savage income and assets test.
Building up financial assets is the only option that is politically sustainable.
I do not want to overstate things, but in many ways our approach to New Zealand superannuation will define the contribution that this generation of politicians makes to the longer term wellbeing of New Zealand's social structure.
Our challenge is to make decisions that will constrain us as we fight elections and will only deliver benefits many years after we have left the political stage. It is a big ask.
It does, though, have two attractions. One is that it will represent the triumph of logic and responsibility over short-term electoral expediency. The other is that it is the defining issue on which so much of the integrity of the political process and confidence in the system of government has been destroyed in the past, and has so much to offer in restoring trust in government.
I am confident that we can forge an historic political consensus on this issue. We owe it not so much to ourselves as to our children and grandchildren to do so.
ENDS