Littlewood responds to Cullens claims on superannuation

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Monday, August 27th 2001, 4:49PM

Littlewood responds

The New Zealand Superannuation Bill is two thirds of the way through its passage through the House and the debate is heating up.

Today I would like to take some time going through the Bill with you and talking through some of the more outrageous claims and myths that have grown up around the Bill over the past year. I can then answer any questions you may have at the end of the session.

My colleague Steve has handouts of this presentation and they will be made available for you.

It is a simple fact that New Zealand's population is ageing. Now 12 percent of us is aged 65 or over. Within the next 50 years, that ratio will have risen to 25 percent.

Not only will the proportion of retired people to workers increase but, as life expectancies continue to grow, the average period spent in retirement will also increase. This is a myth or, at least, it is not the fact that the Minister would have us believe. The average period in retirement is certainly influenced by mortality but is also significantly affected by the retirement age. The Minister assumes that today's average "retirement age" (and we really have no idea what that is) will stay at today's level. What evidence does the Minister have for his assumption? On what basis does he make the projection that today's behaviour will persist? Why, for example wouldn't tomorrow's want to retire later (especially if New Zealand Superannuation were increased for late retirement)?

The cost of providing New Zealand Superannuation will make a much bigger claim on the public purse in the future than it does now. That assumes maintenance of current terms and continuation of current retirement patterns. Now it commands about 4 percent of all activity in the economy. By 2050, it will command around 9 percent. And, on the same guesses, will top 10% by 2100. So will health spending which will follow a similar age-related pattern.

Basically there are only two ways to reduce this burden: either cut the pension or smooth the costs of it by putting money aside now. And, on the same argument, there are only two ways to deal with the future cost of health care - cut future health benefits or smooth the cost by putting aside money now. Having begged all the important questions on retirement income provision (retirement preferences and patterns; appropriateness of current state provision etc), the Minister now expresses the issue on a basis that he knows will push political buttons. It doesn't, however, help the debate, if that's what he wants to happen.

National's intention is to cut the pension. You may not know that because they are not very honest about it. They don't shout it from the rooftops. Instead they talk very softly about how they will not cut entitlements for current retirees and say nothing about their longer-term plans. And neither can the government, given its refusal to discuss the important issues. The Minister restates the myth that, in creating the Big Cullen Fund, the government has resolved the issue of cost. The government has not done that (more on this below) so the basis of its criticism of National is misstatement founded on myth. But then, what's new in this debate?

They have a faultline running right through their policy which is why they need two spokespeople. Bill English talks for the future retired. Someone else altogether talks for the currently retired. They have two tongues on super' because they are two-tongued on super'. Oh dear. While this sort of stuff may be amusing in the bear pit of the debating chamber, it's less than helpful here, particularly for this audience (Grey Power) that hasn't been known for its even-handed views on some issues. It's the Minister's typical ad hominem debating style.

The Labour Alliance Government starts from the premise that a society should be judged on how it treats both its youngest citizens and its old. That is one way of judging a society but it begs a question or three. Another way of judging a society is by economic growth, or by its standard of education. Both of these would allow governments the resources to treat its youngest and oldest citizens in the ways this government would prefer. No prizes for guessing which is the more important. Governments may dispose of wealth but they don't create it.

The entitlements contained in Part One of the New Zealand Superannuation Bill now before the House are, we believe, the minimum necessary to allow superannuitants an adequate standard of living and the opportunity to participate in their community. On what basis? Where is the evidence? A recent survey shows that retirees seem reasonably contented with their lot but that would probably be the case if NZ Super were 10-20% more or 10-20% less. I don't know that, of course, but neither does the Minister.

National had reduced the wage floor from 65 percent to 60 percent of the average, after tax, ordinary time weekly wage. That was a silly thing for National to do and the way it went about it was even sillier. We have taken it back to 65 percent. Without asking why it's that number or whether some other number (or numbers) might do just as well.

But it is important to remember that the 65 percent is calculated for the married rate. A single pensioner gets around 60 percent of that, or around 40 percent of the average wage. The point being?

You cannot cut that without forcing some people into hardship and this Government will not do that, especially as almost half of this generation of retirees depend on the pension as their only source of income. Alternative ways of ordering things (like a more generous pension [say, 80%] but income tested) would make people in hardship better off and could also lower costs. Where is the debate? The consideration of different ways of doing things? This is an idea-free zone. And frankly, there is no reason to expect that ratio will change significantly in the next few years. I agree but the NZ Superannuation Fund has nothing to do with pensions for the current retirees. In fact, it has nothing to do with future retirees either for reasons I will identify shortly.

So Labour and the Alliance explicitly reject National's cost-cutting agenda. This is a straw man argument.
The Government acted with integrity in, having committed ourselves to maintaining the pension at current entitlements; we then found a mechanism to pay for that commitment. No way, José. At the most, the NZ Super Fund will contribute no more than 15% of the cost of any year's NZ Super. And, when the Fund is completely spent by 2100, the net cost of NZ Super will be 2½ times what it is today and 11% higher than it is expected to be in about 2050 (the peak draw down period). So tomorrow's taxpayers will be left with the issues that today's government refuses to discuss. I guess that's politics. It doesn't make it sensible.

The proposed New Zealand Superannuation Fund does that. Anyone who believes that is, in Rob Muldoon's words, a believer in the tooth fairies. Our political opponents - and particularly Mr English - attack the plan constantly not because they think it will fail but because they are scared it will succeed. They simply cannot allow the Labour-Alliance coalition to pull off an achievement of that size.

The Treasury has done excellent work in designing the structure and governance arrangements for the Fund. But does the Treasury support it? I suspect it does not. These are incorporated in Part Two of the Bill and were recently described by a leading international expert in superannuation funds are "a world-class solution." Source?

Let me now go through the Bill in some detail.

The New Zealand Superannuation Bill is in three parts:

• Part 1 covers existing NZS entitlements,
• Part 2 deals with arrangements for establishing the New Zealand Superannuation Fund and
• Part 3 covers the processes for political sign up to the legislation and making changes to the legislation.

No change to current entitlements
There will be no change to current New Zealand Superannuation entitlements. By this the Minister means no present change. He has already said that a government of the 2020s may need to think about raising the state pension age - presently 65. This is what he actually said on this:

"We recognise that changes in life expectancy and medical science may lead some future government to consider raising the age above 65 but would expect that any such review would be 25-30 years away."

In the Minister's own words, the government is being "two tongued". Raising the age is just as much a cut to NZS as any dastardly alternative that the wicked Tories may be cooking up.

Existing legislation relating to NZS entitlements has been taken out of the Social Welfare Transitional Provisions Act and placed alongside the funding elements in the New Zealand Superannuation Bill.
This transfer has been used as an opportunity to correct some drafting in the old legislation. The wage-floor of NZS has been set in the legislation at 65% of the average wage.

The drafting of the Living Alone rate of NZS has also been clarified:

Superannuitants who are living alone receive a higher rate of payment than superannuitants who are married or are sharing accommodation. Originally this was provided in the form of a 'living alone payment' but this was subsequently incorporated into the Living Alone Rate

In previous drafting there were in effect two 'entry points' to receiving the living alone rate- the rate set out in the first schedule of the Act and the criteria for receiving the living alone payment.

In the Bill it is clear that the criteria for receiving the living alone rate are the appropriate entry point to the rate.
Part of the eligibility criteria for the Living Alone rate is that a pensioner must be resident in one of a number of specified types of accommodation. These accommodation types are listed in the legislation. In previous drafting it was unclear that the list is intended to be exclusive, and not a set of examples. This has also been clarified.

This is all rats and mice stuff alongside the really important issues.

Key Elements of Fund Design
Part 2 of the Act establishes the New Zealand Superannuation Fund and sets out how it will be financed.
The key elements of the design of the fund are that:

• There is a transparent process for determining the contribution required for the fund
• The contribution to the fund will be based on a legislated formula with a long time horizon
• The board of the fund will have independence from government in determining its investment strategy and processes
• The board will be required to meet commercial investment objectives
• The fund will smooth the increase in the cost of New Zealand Superannuation over time

Transparent Annual Funding Process
The contribution to the fund will be assessed annually as part of the Budget process. And Treasury will calculate the rate that is required.

• The contribution is calculated by determining the costs over a forty year period and making an annual contribution into a New Zealand Superannuation Fund that would be sufficient to meet costs for 40 years, if it was applied in each of those 40 years but will not exceed an estimated 15% of any year's costs when the draw down from the Fund is at its peak. The other 85% of each year's costs will be met from that year's tax take, as now.
• Contributions will be determined as a percentage of GDP.
• Each year, the rate will be recalculated and will exclude the past year and include the next year 40 years in the future. In this way it will be calculated on a 40 year rolling horizon.
  

Independent Governance

• There will be "double arm's-length" between Minister and Fund. This overstates the "Guardians'" independence. Apart from the fact that the government will be making the appointments, the Minister has made the position of "independence" clearer elsewhere:

"Because the Board will be independent from the Crown, it will be required to have regard to rather than give effect to directions from the government." (his emphasis)

"Double arm's-length" is polly-speak for "not under day to day control".

 

• Prudent commercial management, and consistent with "avoiding prejudice to New Zealand's reputation as a responsible member of the world community." That was an attempt to satisfy the Greens. Given that they have now voted against the Fund, what do these weasel words actually mean or add?
• Minister appoints from a shortlist prepared by a nominating committee. More jobs for the faithful.

Investment Objectives
The board will set its investment strategy in the context of the investment objectives set out in the Act. The Fund is to be managed on a prudent commercial basis.

While the board will set the investment strategy, it is anticipated that it will do so on the basis of best practice portfolio management.

The board must be mindful of risk in determining its investment strategy and any impacts its investments may have on New Zealand's reputation as a responsible member of the world community.

The Fund is to be used to meet NZS payments only. It will not be used to meet other government objectives. Yes but those other objectives can be met or not from reduced expenditure on New Zealand Superannuation and a greater draw down on the Fund. Again, the Minister overstates the position, the genesis of yet another myth.

Smoothed Pay-As-You-Go Funding
We currently have what is called a "pay as you go" system, where NZS is paid out of the Government's current tax receipts. The form of pre-funding we are considering is "smoothed pay as you go". This will involve creating an investment fund that will accumulate and invest funds. These funds will be drawn on to augment the "pay as you go" system to pay NZS as costs increase in the future. And they will continue to increase even allowing for the draw downs - more on the issue of "cost" in a moment.

Now, let me deal with some of the criticisms of the Fund and the myths that have arisen in recent months.
Opponents of the Fund raise two criticisms. They say the Fund will only ever supply around 14 percent of New Zealand Super costs. In fact the total share will be closer to 25 percent.

They are counting only the amount which will be directly drawn from the Fund. They are forgetting the further - substantial - revenue stream the Government will receive through the taxes paid on the Fund's earnings. The Minister is disingenuous. He either doesn't understand the issue or is deliberately misleading. The Fund is able to put money aside only because the government has to collect more taxes from New Zealanders than they would otherwise have paid (in the absence of the Fund). That is what a surplus is. Too much tax collected. So, the question the Minister leaves unasked and therefore unanswered is what would have happened to those taxes had the government not collected them?

New Zealanders might have spent the taxes that they wouldn't have paid (GST collected; vendors of products and services pay taxes on extra profits; economy grows in those places where the money is spent). They might have invested the uncollected taxes either in financial investments (income tax on investment income), or in their business (economic growth, more taxes) or in paying off debt or getting an education (higher earning prospects, more income taxes in the future). The Minister should ask the Treasury to do a full analysis of these issues. He hasn't or, if he has, he hasn't released the results.

We have never claimed the Fund would fully meet Super costs and have always been careful for this reason to describe it as a partial pre-funding scheme. But a 25 percent contribution is a lot better than nothing. And 14% (the maximum "real" contribution expected by the Treasury) is a lot less. Almost trivial, relatively speaking despite the huge sums involved. Without it, a future government would have to cut spending, raise taxes or opt for a combination of the two. No mention of the risks that the government (also known as "all us taxpayers") runs with this approach.

As to the larger debt issue, this Government's objective is to keep net debt below 20 percent of GDP and the budget has us achieving that with room to spare while we simultaneously put savings into the Fund. What is the magic of 20%? Why not nothing? Or 40%? Have we had a debate about that?

The second criticism can be just as easily dismissed. Political opponents argue that, because the dollar level of government debt is rising, the government is borrowing to pay into the New Zealand Superannuation Fund. That is nonsense.

I have always said that the contributions to the Fund will come from the operating balance and the latest budget shows this is achievable. It has operating surpluses of $1.4 billion in fiscal 2002, and $2.4 billion, $3.1 billion and $3.7 billion in subsequent years.

These forecasts are fully adequate to, indeed they are 72 percent above on average, projected transfers into the Fund of $600 million in 2002, and $1.2 billion, $1.8 billion and $2.5 billion in the years following.

This is a fiscal word game, as the Minister knows and the Opposition has already pointed out. In nominal dollars, debt will rise at about the same rate as the contributions to the fund over the next four years. If the contributions were not needed for the Big Cullen Fund, debt would not need to rise by that amount. It's really quite simple stuff.

Let me finish with a little myth busting:

MYTH: The Fund will be monstrously large
The purpose of the Fund is to partially smooth out the cost of NZS to the rest (? - what is the "rest"?) of the Crown over time. The cost of NZS now is less than its expected cost in the future, so the Fund builds up and is drawn back down as the Crown adjusts to the higher ongoing cost of NZS later this century. No - the cost of any superannuation scheme - state or private; defined benefit or defined contribution; funded or "pay as you go"; pension or lump sum - is the benefits paid. That will always be the case regardless of where the money comes from.

The government refuses to countenance any debate about the benefit design of New Zealand Superannuation and so the government has fixed the cost of NZS (for now at least).

What the Minister is actually talking about is the incidence of that cost. That may sound like a small point. It is not and the Minister's statement shows how little he knows about this subject or how little he is saying.

The single year's cost for any year in the next 100 years (the lifetime of the Big Cullen Fund) must be drawn from the economy of the day whether that means from taxpayers of the day or from investors of the day who have to buy the investments that the Big Cullen Fund will be selling or from lenders of money to the government. There are no other sources of money. Whichever way, it will be the economy of the day (not of today) that re-adjusts to the impact of that year's full cost of NZS.

At its peak, the Fund is expected to grow to about 50% of New Zealand's GDP. This expected level of the Fund is fairly robust. Meaning? If the key drivers are calculated largely as percentages of GDP, we shouldn't expect any other result.

If you lower assumptions about expected rate of return, a higher capital contribution is required so these even out in the expected Fund level. However, with decades of compounding actual returns, reasonably wide confidence intervals need to be placed around this expected level, perhaps in the range of 30% to 70% of GDP. There is not a target level for the Fund; its level is just a consequence of smoothing the cost over a forty-year rolling-horizon. So, where is the argument about the consequences of this "monstrously large" fund? It will be by far the largest single pool of investment assets in the country. For example, it will be larger than the whole of the New Zealand share market is today. It will totally dominate the New Zealand investment scene - why else have fund managers been so silent about what a daft idea the Minister's Fund is? No one can blame them for that (they have their shareholders to think of) but it illustrates the huge impact this "monstrously large" fund will have in a miniscule capital market.

The Minister has given not the sniff of an indication that he is aware of the reasons that others are concerned about this.

MYTH: It is better to pay off debt
This myth sees paying off Crown debt as an equivalent form of public saving that could be used to achieve the same ends of building a more robust Crown financial position to help cope with the increasing demands expected on the public purse later this century.

If the planned savings in the Fund were instead put to paying off debt, net debt would be down to zero before the end of this decade and so it is only a few years until the issue would need to be faced of how to best govern a growing pool of financial assets.

Debt is already down to comfortable levels. Paying down debt is no longer the fiscal imperative it has been in the past. Without a formal process to increase public saving, Budget demands will mean that net debt is unlikely to improve.

The Minister slides past the wider point that any contribution paid into the Fund (whether out of a "real" surplus or not; whether current levels of debt are "comfortable" or not) and in the presence of any debt at all is the same as borrowing to invest.

Borrowing to invest is a risky business - would the Minister raise a mortgage on his own home and put the proceeds into international share markets? I don't think so. Well, he shouldn't be doing that for the country. In this case, the arguments that should counsel an individual investor against such a risky approach apply also to the country.

If the Minister is really worried about his seemingly profligate fellow ministers then my point will be covered if the first ten years' contributions (roughly) were entirely invested by the Big Cullen Fund in New Zealand government debt. But that would then expose the Fund to the charge that it's really a smoke and mirrors exercise which it really is.

Finally, let's look at what's to stop future government's raiding the Fund.
The law will require governments to make sufficient annual contributions to the Fund to meet the annual costs of NZS for at least the next 20 years. Translation - what currently comes entirely out of the government's general funds will now be passed through the Fund and only a fraction will be left behind. The Fund will gradually build up during this time, and its size will be the best indicator of the security of future NZS. Any government that tried to raid the pensions of the next generation would suffer at the court of public opinion.

The experience of successful schemes overseas is that consensus developed, not before, but after the scheme was established. Evidence? Is this the government's justification for refusing to engage in a proper debate about any of the principles and then failing to gain the support of parliament without some sort of a deal (unannounced) being done with New Zealand First to squeeze more than 60 votes from MPs. Again, as the fund built, people began to derive a sense of security from it and were anxious to see it protected and maintained.

I am confident that will also be the case in New Zealand and that - finally - we will have succeeded in putting superannuation above the political game. The Minister could not be more wrong about this as time will tell. Rob Muldoon thought he had "put superannuation above the political game" with National Superannuation in 1977. He had not. The present Minister thought he had succeeded in putting superannuation above the political game with the "Guaranteed Retirement Income. He had not. The previous National government thought it had done the same with the Accord. It had not.

In fact, the Big Cullen Fund will continually focus the attention of New Zealanders that we have not had the debate in 2000/01 that we should have had. It will be only the latest monument in the superannuation graveyard. It will remind Generation X and its successors that the baby boomers have, once again, tried to secure their position at the expense of everyone else.

The only way that the government (today and tomorrow) can secure the incomes of tomorrow's retirees is to grow the economy. That's so tomorrow's larger generation of pensioners can exchange tomorrow's pensions for things that allow them to survive. There was not one word in the Minister's speech about this absolutely key issue. As Nicholas Barr puts it:

"Given the deficiencies of storing current production, the only way forward is through claims on future production. What matters therefore is the level of output after I have retired. The point is central: pensioners are not interested in money (i.e., coloured bits of paper with portraits of national heroes on them) but in consumption - food, clothing, heating, medical services, seats at football matches and so on. Money is irrelevant unless the production is there for pensioners to buy." ("Reforming Pensions: Myths, Truths and Policy Choices", IMF Working Paper WP/00/139, August 2000.)

In the absence of growth, the increasing proportion of New Zealanders who aren't producing (the retired) will make larger proportionate claims on tomorrow's economy and so must reduce the living standards of the producers (from what they might otherwise have been). The only alternatives are for everyone's standards to fall or for pensioners' standards to fall more than the producers'.

Now, how will the Big Cullen Fund help us grow? How will it help to resolve the inevitable inter-generational debate on who gets which part of tomorrow's economy?

The Big Cullen Fund will probably be a negative influence in both of these key areas.

So much for "debunking super myths".

This is the copy of a speech Finance Minister Michael Cullen made to Grey Power in Palmerston North.

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