Michael Cullen Superannuation Speech
Minister of Finance
Life Brokers Association
Brentwood Hotel, 16-20 Kemp Street, Kilbirnie
Superannuation policy is back in the limelight. I have said this many times before, but it is worth repeating: a well-rounded policy on superannuation rests on three pillars: the basic pension provided by the government; the level of pensions that people qualify for through employment based savings schemes, and the amounts generated by voluntary individual savings.
I suppose that you are more interested in the third of these components of retirement income. There is, of course, a major debate about whether individuals save more or less in response to the level at which the government sets the first tier of retirement income. Economic purists often argue that we need to scare people into saving: if New Zealand Superannuation is too comfortable, individuals will live for today.
I reject that argument. My personal belief is that it is a duty of the modern state to ensure basic income security in retirement. If the modern state discharges that duty, people have a more stable basis on which to plan life-time decisions on consumption, investment and saving. All other things being equal, they are likely to improve the quality of those decisions, and that, in my book, translates into more robust personal savings.
We also need to put the argument into perspective: an assumption that generous New Zealand Superannuation will discourage private savings implies that the current scheme is generous. It is adequate, but not generous. I often remind people that the 65 percent of the average wage formula is a married couple rate. Each partner gets only half of that: one third of the average wage.
The recent survey of living standards of older New Zealanders concluded that in general, few retired New Zealanders experienced deprivation. More significantly, those that did experience deprivation tended to experience a mix of factors like low incomes in working life, high accommodation costs, or some life cycle shock, like redundancy or ill health or bankruptcy shortly before retirement. This suggests to me that NZS is adequate if people enter retirement in relatively stable personal and financial circumstances: there is not the slack to cover over the damage done by pre-retirement bad luck.
I have said that we should not see a solution to the debate on NZS – whatever that may be –as closing out policy on retirement income. There is still much to be done to restart employment based pension plans and to improve individual savings habits. I am frustrated that every time I try and move the debate on to these next levels, it is dragged back to the issue of New Zealand Superannuation. I am happy to answer questions on these other aspects of retirement income policy, but seeing where the current political and media focus is, I want to revist some of the core issues around New Zealand Superannuation and the plan to partially pre-fund it.
The opposition to the proposed partial pre-fund of New Zealand Superannuation is based on two propositions:
We can’t afford it, and
There are better uses for the money.
This isn’t logical, even at the most simple level. If we can’t afford to put the money in the fund, we can’t afford the other things that politicians say they would rather spend it on.
It is important to remember that the allocations to the Fund are in the nature of a capital transfer. They are not operating expenditures, and do not form part of the total spending limit that the government has established for this term of office. Earlier in the year, I was attacked for a so-called budget blow-out when, for perfectly logical reasons, I lifted the spending cap from $5.9 billion to $6.125 billion. That was a $265 million increase over three years. If anyone intends to spend the $600 million that is allocated for transfer into the Superannuation Fund, it would make the increase in the spending limit three times larger than the increase that has been attacked so vigorously by Opposition parties.
Normally, an increase in basic spending, or the equivalent in tax cuts, is ongoing. This means that a $600 million dollar additional spend this year is equal to $1,800 million extra spending over a three year period.
Those numbers seem sensationally large, but the scary thing is that I am not sensationalising. That is the sort of end result that you get when you try and spend the same dollar three times: paying for super; cutting taxes and spending on health, fighter planes and laptop computers.
The suggestion that a capital transfer can be used instead for an increase in annual ongoing current spending is fiscally irresponsible to an alarming degree. Any party that plays politics with this is at great risk of permanently damaging its reputation as a credible fiscal manager.
The argument about whether New Zealand Superannuation is affordable deserves a closer look. The whole purpose of the super fund is to ease the burden of the cost of New Zealand Superannuation as the population grows older.
One argument is that it will not make enough of a difference in meeting the future cost of super. But if we cannot afford to pre-fund, and pre-funding doesn’t make a big enough difference, how can any party then agree to maintain existing NZS levels? If we cannot afford the 14 or 25 percent – depending on how the tax paid by the fund is counted – of the cost of NZS, how do we guarantee the 100 percent?
Any party that says it will not commit to prefunding at least part of the future cost of NZS inevitably commits to cutting NZS in the future. At least Act is consistent in this regard. There is absolutely no way around the inevitability of that conclusion. The only remaining questions are when and by how much.
I am told that one of the visiting experts at the recent Retirement Commission seminar on superannuation joked that if we didn’t do something about NZ Super it would become New Zealand Supper: enough for one meal a day! Opponents of pre-funding are heading down the road of converting super to supper.
The argument about whether the government can maintain contributions to the fund rests on the claim that we have not run operating surpluses of the required size in the past, so are unlikely to run them in the future. At least the debate here is starting to focus on the real issue: can we run operating surpluses sufficient to cover transfers to the fund?
This is a major advance on the silly argument about borrowing to put money into the fund. Saying that we cannot transfer funds if nominal debt is going up because of the funding arrangements for the capital programme, is in effect saying that the size of the operating surplus is irrelevant: it is the level of capital expenditure that is crucial. This is not logical. If it is forbidden to increase nominal debt while putting money into the fund, why is it legitimate to maintain any debt and have money in a fund?
By way of example, some of the increase in nominal debt is a result of the government taking over the debt of hospitals, because the government can borrow more cheaply than they can. Does this mean that we must choose between putting money into the super fund and reducing the borrowing costs of hospitals? Obviously not, yet that is where the borrowing to put money into the fund chant leads.
The opposition keeps stopping short of where that logic ultimately heads, and there is an obvious reason for that. Where the logic ultimately heads is patently absurd.
So we are talking about the issue of whether we can maintain operating surpluses big enough to cover the annual contributions to the fund. Surpluses will rise and fall over the course of the business cycle. The question is what is the projected level of the structural surplus – the surplus over the course of the cycle, or put another way the surplus during normal times.
The last Budget showed rising structural surpluses. It is true that we have not run large surpluses very often during recent decades. That is almost entirely because past governments have dissipated structural surpluses as they have emerged. Muldoon did it with SMPs and Think Big, and the last administration did it with rounds of tax cuts. It has persistently been Labour and the Labour-Alliance coalition that has rehabilitated the public finances and recreated a sound structural foundation for the public accounts.
Both history and current intention point to a clear message: structural surpluses will be sufficient under a Labour Alliance government and will be at risk under a centre-right administration.
This leads me to the question of why we shouldn’t delay the transfer of resources to meeting future costs of NZS. Part of the answer is that we have delayed too often, and too long. If we delay further, I can see the problem becoming so large that we will never be able to face it. The other part of the answer is that by moving now, we enlist the power of compound interest.
Compound interest follows the rule of seven. A dollar invested today will double in ten years if it earns seven percent a year (or it will double in seven years if it earns ten percent interest). So a dollar today doubles to two dollars in ten years time, to four dollars in twenty years time and to eight dollars in thirty years time. Delaying putting that dollar away today could require my successor to find eight dollars in thirty years time.
Of course tax and inflation intervene, and so the final dollar will not be as large in real terms, but by the same token we can reasonably expect the nominal earnings on the fund to be nearer nine than the seven I have used.
I am tempted to say that a number of my opponents actually want to spend the dollar I am putting into the fund a fourth time – paying off government debt. The pay off debt argument does come up so let me say why it is prudent to build up assets in the fund at the same time as the government continues to hold debt.
There are two reasons. One is that a diversified fund will, over the timescale we are talking about, earn more than the government will save by paying off debt. The second is that a dedicated fund is both more demanding on contributions and easier to defend. Under the scheme we have in front of Parliament, there is a formal calculation made about what needs to be paid in each year to meet the costs of NZS over the next forty years. If the government does not put that money in, it has to do two things: explain why, and explain how it is going to get back on track.
It is a bit like having an insurance policy. You cannot decide, each year, at the end of the year, if you have enough money left over and nothing better to do with it. If you do that, you are not covered.
Paying off debt is something that you do if you feel like it at the time. It is also a programme that future governments can suspend if they choose to follow short-term expedient policies like cutting taxes before an election.
An argument that I often hear is that we will be exporting capital at a time when we need more investment here. The alternative, of course, is to cut taxes or to increase spending on other things. That will inevitably result, at least in part, in an increase in imports and a deterioration in the balance of payments position. The fund actually increases national savings and deepens capital markets, so compared with the alternative, it increases national savings and domestic investment.
The fund will be invested on a prudent commercial basis, and because I am confident that in the future a number of New Zealand ventures will be the best on offer for investors, a portion of the fund will no doubt be invested onshore. How much will depend on the decisions that the Guardians of the Fund make. It is important that they invest to get the best returns for New Zealanders - and it is equally important that politicians do not meddle in the investment decisions they make.
I am disappointed that the Greens have signed up to entitlements but not to the means of paying for them. This is especially disappointing from a party that makes sustainability its watchword. Sustainability has a financial as well as an environmental aspect. It is every bit as destructive to set in train a financial programme that will run out of resources as it is to set in train a productive process that will run into resource difficulties.
The main basis of the Green’s opposition seems to be that they say that there is no problem. That is precisely the sort of denial and short-term thinking that they accuse the environmentally myopic of. They cite the argument that more old equals fewer young, so the overall dependency ratio does not change much. I anticipate that in the future we should and will need to spend much more per young person in education. In addition, much of the cost of supporting young people is borne by parents but most of the cost of supporting retired people is borne by the government in the form of NZS. Treasury estimates that one over 65 year old costs the government almost four times as much as one under 16 year old, and it is the cost to the government that determines the fiscal sustainability of any level of dependency.
The final argument is growth: that somehow money spent wisely now will grow the economy and a bigger economy produces more for everyone. True, but there are two problems. Are we sure that money diverted from NZS will have positive effects on growth? I am not. For a start, it will result in a lower level of national savings, and a low level of savings does retard growth. In addition, I am not convinced that another spend up will produce the goods this time. I think back to SMPs, Think Big and tax cuts for the better off as three recent magic bullets that have all retarded rather than stimulated growth.
Of course we need growth. Of course we need quality investment. Sound public finances and a longer term discipline contribute to both. But even if the economy did grow, the issue for the debate we are having now is will this help the government meet the future cost of New Zealand Superannuation?
The answer is no, unless a future government breaks the link between NZS and the average wage and lowers the 65 percent floor – again. As the economy grows, average wages grow. As average wages grow, NZS grows, so growth improves the living standards of the retired: it does not reduce their numbers or the relative cost of NZS as a proportion of GDP, and tax revenue.
Even if we did take a punt on growth, we are going for long odds – we have to beat compound interest and the rule of seven!
In many ways I am encouraged that super is again back in the spotlight. It means that contrary to some commentaries, New Zealanders are not apathetic about their futures and they do not live for today. They do care about the future and they do want a settled framework for retirement income policy. NZS is an important part of that future, but it is only a part. There is still work to do on the other pillars.
I wish you well for your conference, and hope that it, too, will advance the debate on this vital aspect of our collective future wellbeing.