What's wrong with Labour's New Zealand Superannuation Fund proposal?

We are a group of people with an interest in public policy on retirement incomes. We are concerned that Labour's proposal to set up a "New Zealand Superannuation Fund" has attracted little attention. It's a logically flawed proposal that Labour proposes to implement without proper debate or rigorous analysis. Dr Cullen wants to start the Fund with legislation that will take effect from 1 April 2001.

We want voters to understand that the proposed Fund is more likely to increase the cost of New Zealand Superannuation over the next 30 years, taking all things into account. The Fund is more likely to detract from, rather than improve, New Zealand's economic health and increase future governments' exposure to risk.

We hope this paper starts a proper discussion on this flawed addition to the many twists and turns in superannuation policy that New Zealand has suffered from over the last 25 years.

The underlying premise of Labour's superannuation proposals is that a partially or fully funded superannuation scheme can guarantee the security of New Zealand Superannuation over the long run. This view is wrong. The problem of the sustainability of New Zealand Superannuation does not disappear as Labour claims; in fact, Labour's proposals make New Zealand Superannuation less sustainable because they are likely to increase its cost. Labour's funding proposals are economic window dressing. They will rob Peter to pay Paul.

Here, in summary, is what we think is wrong with Labour's proposal:

• Our ability and capacity to create wealth – not the level of savings –is the key to the living standards of present and future retirees.
• An increasing elderly population can continue to be supported at current income levels only by boosting future output, constraining current consumption and investing overseas to fund future imports, and/or by constraining the consumption of the working-age population in future.
• Labour's proposals do not address the problem of the sustainability of New Zealand Superannuation with an ageing population and do not guarantee the future level of New Zealand Superannuation.
• The transfer to the Fund of a dollar of personal tax revenue to pay a dollar of New Zealand Superannuation to an existing superannuitant involves no change of substance. Similarly, the transfer to the Fund of a dollar of personal tax revenue in excess of that required to fund current New Zealand Superannuation, assuming no change in tax or spending, leaves the government's overall operating surplus unchanged. Peter is robbed to pay Paul.
• A surplus in the Fund cannot be built up without being matched by an equal reduction in the surplus on other government activities unless tax is increased and/or existing spending is reduced.
• A change from the present "pay as you go" (PAYG) approach to a fully funded basis requires workers during the transition to pay twice. It is impossible to change to a fully or partly funded superannuation scheme without increasing taxes and/or reducing spending on New Zealand Superannuation or other goods and services.
• Labour proposes to increase the generosity of New Zealand Superannuation by raising its level relative to wages and it is committed not to increase taxes to finance the Fund or introduce any form of income or asset testing. Without the required tax increase and/or cuts in other spending, Labour's funding proposal is essentially the present PAYG scheme with higher superannuation payments, additional administration costs and a lower surplus than otherwise. There are no compelling grounds for fully or partly funding New Zealand Superannuation or similar non-contributory public programmes that are presently funded on a PAYG basis.
• There is no provision in New Zealand's constitutional arrangements that would enable Labour to prevent a future government from reducing or abolishing the New Zealand superannuation tax or using the Fund for purposes other than the payment of New Zealand Superannuation. It would also be inconsistent with New Zealand's democratic principles to attempt to bind a future government as proposed by Labour.
• Most, if not all of the money will need to be invested overseas and that will raise the government's (and the country's) risk profile in both the short and the long term.
• The investment risk remains with the government – it is also very difficult to see how such a large pool of money will be free from political interference.
• The proposed Fund is another kind of compulsory retirement savings scheme.

Labour's proposal is therefore fundamentally flawed. The rest of this paper looks at these problems in more detail.

There are many things wrong with Labour's proposals – from the economic to the political.

• Economic strength matters: The material living standards of people in retirement are largely determined by their ability to consume goods and services. Retirees cannot consume the money represented by public or private savings directly. Those savings must be used to buy goods and services that are produced by New Zealand's working-age population or by workers of other countries (imports). The British economist, Nicholas Barr, expressed this point in these terms:

• How do we support the growing elderly population? An increasing elderly population can continue to be supported at current real income levels only by:

• boosting future output by increasing the working-age population relative to the dependent population (for instance through immigration and by lowering the impact on the retirement/work decisions of New Zealand Superannuation) and by raising productivity;
• constraining current consumption and investing overseas with a view to financing imports in the future; and/or
• constraining the consumption of the working-age population in future, for example through higher taxes, to make more goods and services available to retirees.

• Where will the Fund come from? Labour's proposed Fund is to be built up by a 'tax' to be known as the New Zealand "Superannuation Tax". It will transfer a proportion of each year's personal income tax to the Fund. The new tax is a funding formula rather than a genuine tax. Existing personal income tax is not to be increased to pay for New Zealand Superannuation.

• How much will be needed? The New Zealand "Superannuation Tax" will have to be set at a level well in excess of present spending on New Zealand Superannuation if such superannuation is to be partially or fully funded in the longer term as Labour intends. This requires the Fund to generate a surplus after meeting the annual cost of paying New Zealand Superannuation to current retirees. Surpluses must build up capital in the Fund. The underlying idea of a fully funded retirement income scheme is that a taxpayer contributes over his or her working life building up a nest egg, comprising contributions and related investment income, which is drawn down in retirement. The Fund cannot generate significant investment income unless it makes substantial surpluses, at least until it reaches full maturity in many years' time.

• Current workers pay twice: A change from the present pay-as-you-go (PAYG) approach to a fully-funded basis requires workers during the transition to pay twice. Those workers must meet, through their taxes, the costs of New Zealand Superannuation for current retirees as at present. In addition, they must fund surpluses which, together with related investment income, will provide for their own superannuation when they retire. So it is impossible to change to a fully or partly funded superannuation scheme without increasing taxes and/or reducing spending on New Zealand Superannuation or other goods and services like education, health and welfare.

• Costs will increase: The cost of any superannuation scheme (public or private; pre-funded or PAYG) is the benefits that the scheme pays. It doesn't matter how the scheme is paid for – whether from taxes, contributions paid in earlier years or from investment income. Labour proposes to increase the generosity of New Zealand Superannuation by raising its level relative to wages (reversing the recent reduction introduced by the National government). That will increase its future cost both because of the increased benefits and the larger number of people who will receive them. On the other hand, it is committed not to increase personal taxes to finance the Fund. These two commitments are potentially incompatible with the adoption of a fully or partially funded scheme. The most likely outcome is higher debt than otherwise because surpluses that would be used to reduce debt would be transferred to the Fund.

• Funding or PAYG? The establishment of a fully or partly funded scheme does not reduce the cost of New Zealand Superannuation, other things being equal. A transfer to the Fund of a dollar today that increases in value with net investment income of, say, 5% a year (before adjusting for inflation) to $7 in 40 years' time is exactly equivalent to a PAYG payment of $7 (plus an adjustment for inflation) in 40 years' time. In the latter case the taxpayer can invest a dollar today and earn the same investment income as the Fund to pay his or her tax bill in 40 years' time.

• Entrenching the Fund: Labour says the Fund will not be available to the government of the day to use for any purpose other than the payment of New Zealand Superannuation. It is considering legislation to ensure that future governments cannot "break the ring-fence around the Fund and choose to use the money for some other purpose." Labour knows that this is impracticable. There is no constitutional power to entrench legislation in New Zealand. Any Act of Parliament that required, say, a 75% majority to alter the Fund can itself be repealed by a simple majority. A future government cannot be prevented from reducing or abolishing the New Zealand Superannuation Tax or using the Fund for purposes other than the payment of New Zealand Superannuation. It is inconsistent with New Zealand's democratic principles to attempt to bind a future government as proposed by Labour.

• Where will the money be invested? The extra amount of tax required each year to achieve Labour's objective could well peak at $3 billion a year during the build up period of about 35 years. For a number of reasons, nearly all of that money will have to be invested overseas. The New Zealand market will not be able to absorb much but, even if it could, the main reason for investing outside New Zealand is a lack of local diversification. We don't have the range of companies and industries that such a large pool of assets will require.

• Investing the money: Labour proposes that the Fund be managed independently of the government on a "commercial" basis. All the risk will, however, remain with the government because the level of New Zealand Superannuation payments will continue to be determined by the government. The cost of those future payments will not be directly related to the level that would be actuarially prudent given the levels of the Fund, the New Zealand Superannuation Tax and income tax. Over time, political pressures will influence the Fund's investment strategy. For example, will the Fund be permitted to invest unlimited amounts offshore? Will it be required to hold government debt, or will it be allowed to invest in companies that engage in genetic research or produce genetically modified products? How many worthy local "investments" like new bridges, schools or motorways will form part of the Fund's portfolio?
• Another version of compulsion: Labour campaigned vigorously against the Compulsory Retirement Savings Scheme in 1997. It objected to the idea that the government should force New Zealanders to save particular amounts in specified ways. The proposed Fund is compulsory retirement savings in another guise. The government is still telling New Zealanders where retirement savings should be invested. But this time, the government knows better than New Zealanders who should invest the money.

• The lessons of history: History is also against Labour's proposal. The social security charge was intended to fund the contributory health and welfare programmes that were charged to the Social Security Fund in terms of the Social Security Act 1938. Legislation passed by Labour in 1958 credited the successor to the charge, the social security income tax, to the Consolidated Fund to which social security and other spending was then debited. The separate tax was eventually abolished on the recommendation of the Ross Committee because it reflected "an artificial splitting of tax receipts" and social security spending had consistently exceeded the level of the tax. History would be repeated if Labour is elected and implements its superannuation policy.

Here are the things that Labour (and all the other parties) should promote if it is genuinely concerned about the security of future retirees' incomes:

Above all else, the government must help to grow the economy. That's the only way that we can all help to support tomorrow's larger retired population in the manner the community decides that we should aspire to.

Labour affirms its support for a publicly funded and provided retirement income scheme as the basis for all New Zealanders’ retirement income provision now and into the long-term future.

The guarantee of an adequate income in retirement is amongst the most fundamental duties of the modern state. Labour will restore the relationship of New Zealand Superannuation to the average wage to what it was before National’s cuts.

Labour will ensure that New Zealand governments now, and in the future, will be able to fulfil these commitments. But, at present, New Zealanders lack a sense of security about the future of New Zealand Superanuation, partly because people cannot be assured of where the money will come from. This is particularly disturbing for those already retired.

It is also a problem which, if nothing is done, will become more serious. The 'baby boom' generation will start retiring early next century and that, combined with lower birth rates, will mean that there are fewer and fewer people in the workforce for every retired person. Our ability to afford superannuation payments out of current taxation revenue will therefore be significantly reduced.

Labour will not introduce any new form of income or asset testing or raise the age of qualification beyond 65 years of age.

The centrepiece of Labour’s solution to ensure its commitments are met will be the creation of the New Zealand Superannuation Fund.

The Fund will be managed on a sound commercial basis to ensure that there are strong long term returns. Surpluses will accumulate in the Fund at a sufficient rate to assist in the future payments of New Zealand Superannuation.

The Fund will be overseen by the Guardians of New Zealand Superannuation - a board selected to represent the interests of senior citizens, those at present in the workforce, and the state. Payments into the Fund will come from New Zealand Superannuation Tax.

New Zealand Superannuation Tax will not be in addition to existing income tax. It will replace an equal part of the income tax on personal income.

The full rate of New Zealand Superannuation Tax will be set so that at a constant level it will be sufficient to fund New Zealand Superannuation over a sixty year timeframe. In order to ensure that there is no increase in the level of personal taxation, New Zealand Superanuation tax will be phased in over time if the fiscal situation makes that necessary.

The problem of sustainability disappears. All New Zealanders can live in the security that New Zealand Superannuation is sustainable as far into the future as any of us can forecast.

Senior Citizens organisations such as Grey Power, Age Concern, and the RSA will be invited to nominate people to be Guardians of the New Zealand Superannuation Fund.

The Fund will not be available to the government of the day to use for any other purpose than the payment of New Zealand Superannuation.

Labour is also considering legislating to ensure that future governments cannot, on their own, break the ring-fencing around the Fund and choose to use the money for some other purpose. This could be achieved by having the provisions governing this aspect of the Fund "entrenched" so that they would require a vote of 75 per cent or more of the Parliament to effect any change. If, after further consideration, this option is favoured, Labour would ensure the question of "entrenchment" of provisions was put to voters as a referendum question before it was bought into force.

The Fund and the Tax will begin operating on 1 April 2001. As soon as the government is formed after the election, Labour will begin work on the necessary legislation as well as engaging in consultation with all other political parties.

This legislation, the New Zealand Superannuation Bill, will be timetabled for introduction into Parliament by 1 June 2000 and enactment by the end of that year. The New Zealand Superannuation Act will thus be able to come into force on 1 April 2001 and will provide the complete legislative basis for the new scheme which will be entirely separate from social welfare provisions.