Tax incentives – a “TET offensive” is back in the frame

Skipping past the issue about the surplus (this is really only “too much tax collected”), Dr Cullen seems to support the idea that paying people to save in superannuation schemes will increase saving and that, presumably, more saving will contribute to growth and that this will all be good for New Zealand and New Zealanders.

The evidence

These are all quite heroic assumptions. Here is the evidence that I hope the government will at least try to answer. We might even have a discussion about some of these points. That would be a new experience for us all on superannuation issues.

Savings and growth

First, Dr Cullen has seemingly implied a link between saving and growth. In fact, no one really knows whether more saving will produce higher growth. Economists are divided on the issue. It seems that higher savings are probably caused by growth. People apparently save when they have higher incomes rather than save to produce higher incomes. So, Dr Cullen’s concerns about our saving rates may or may not be misplaced but may only be a reflection on the size of our incomes – low incomes equals low saving. That aside, the question is whether tax incentives will actually help to resolve his concerns even if they were justified. Dr Cullen has apparently been unable to convince the Treasury yet that they will help.

No free lunch – the inequity of incentives

There is no free lunch here – my incentive is your higher tax; my benefit is your cost. Tax incentives, in the year in which they are given, cost the country the value of the benefit given (plus administration costs). We will all need to pay higher taxes to pay the cost for the incentives used by the few. Not everyone can afford to save but everyone will help pay the savers, including the low paid. The fact that the government is currently running a surplus is irrelevant in this regard because it can choose to reduce taxes with that surplus and give us some or all of our money back.

Our income tax system asks higher earners to pay more than lower. Income tax is therefore “progressive”. Tax incentives for saving favour the rich because they have more to save and can use the concessions to the maximum, including shifting existing savings around to capture the tax advantage. That makes a tax incentive for saving “regressive”. In the UK, for example, the top 10% of earners collect over 50% of the value of tax concessions for saving while the bottom 10% collect only 1% of the benefit. It is at least curious that a Labour government wants to favour rich New Zealanders in this way.

Tax incentives can be very expensive

New Zealand tends to be proud of the fact that we taxpayers pay our farmers so little to farm. We have the lowest rates of farming subsidies in the developed world with only about 2% of our farmers’ incomes coming from subsidies. Swiss taxpayers pay their farmers about 85% of their incomes.

We don’t pay savers to save either. The tax system is relatively “neutral” as to whether savers use a superannuation scheme or a bank account to save for retirement. New Zealand is unique in that regard but that doesn’t make us wrong. Here is a sample of how much some other countries pay for retirement saving incentives:
United Kingdom - 36% of the cost of the local state pension scheme
Australia - 57% of the cost of the local state pension scheme
Ireland - 66% of the cost of the local state pension scheme

It doesn’t matter how much governments try to limit the cost of incentives, they will be very expensive. Taxing the benefit at the end (TET) gives the government only a proportion of the original cost of the incentives so, overall, they always cost the country more than they recover. Which leads us to the next curious fact …..

Tax incentives don’t seem to work

No one has been able to show that tax incentives actually increase saving. There are two aspects to this puzzle. Most countries don’t seem interested enough to ask whether incentives work. Given the amount they spend on them, that lack of curiosity is quite surprising. But even when they do ask, the best answer seems to be that they might not increase saving but they do strongly influence where people put their savings. Here, for example, is what the 2002 Sandler Review in the UK said:

• “Many tax changes have been influenced by the hope that savings propensity can be enhanced through tax-based incentives because consumers will wish to benefit from what is effectively a gift from the government. There has been considerable academic work to test this proposition. There is little evidence that tax incentives can significantly increase the overall level of saving. But taxation can materially affect the composition of household saving – for instance, tax incentives appear to have significantly affected pension savings in many countries – though the research as is available suggests that these incentives are likely to have limited impact on lower/middle income consumers.”

Whether pension savings are better for a country than other savings is a large topic. But, if tax incentives don’t actually increase saving especially for lower/middle income earners, that’s a bit of a problem for someone like Dr Cullen who seems to think they are a good idea.

The “signals” that incentives send to savers

Saving for retirement is a great idea but I am unsure why, through incentives, public policy should send a message that “this much” saving is good but “that much less” is bad; that this type of saving is “good” and that type “less good”; that you should save “now” and not “then”. I think that citizens should tailor these decisions to suit their personal preferences. They probably need some help to understand the issues but, beyond that, it’s difficult to see how a government can add value to their decisions.

I’m inclined to trust people’s judgements in deciding what they should do with their own money. In aggregate, I think those decisions are likely to be better for the country (make it grow more) than the alternative. I don’t buy the argument that politicians know better than me what to do with my saving dollar. The “neutral” signals sent by our present TTE system effectively leave that decision to savers. TET would change that.

The “signals” that incentives send to the industry

Another problem with incentives is that they tend to encourage bad behaviour in the savings industry – the personal pension scandal in the UK is a good recent example. The upfront concessions in a typical EET environment encourage high pressure selling. Also, savers are locked into the favoured regime. Finally, favouring the treatment of investment income makes savers more tolerant of poor investment performance. In other words, where there are incentives, promoters and fund managers capture some of that comparative advantage. The taxpayer ends up subsidising the providers’ businesses as well as the savers’ savings.

The regulatory costs

If tax incentives are valuable, you can count on lots of highly paid tax advisers and commission-based salespeople wanting to help their customers take maximum advantage of the breaks, often in ways that the government didn’t intend. Tax breaks therefore breed regulation; and regulation breeds more regulation as advisers and the IRD square off against each other over the decades. All of that costs both taxpayers and savers money and creates inefficiencies. And remember that incentives probably won’t increase saving.

Summary

So, tax incentives for retirement saving are unfair; they distort people’s behaviour; they encourage bad habits, they send bad signals and they can be very, very expensive. But worst of all, they don’t actually seem to work. This explains why the 1992 Task Force, the 1997 Periodic Report Group, the 1998 report from the saving industry’s own ISI, the 2001 McLeod Report on tax and on-going advice from the Treasury all opposed tax breaks for retirement saving.

Why are we even thinking about them? Where is the government’s evidence that they will help in some way to achieve whatever it is that the government wants to achieve (and what might that be)?

Based on this government’s past behaviour on superannuation issues, we mustn’t expect any sort of a debate on this very expensive topic. After all, they do know what’s best for us.

Member of the 1992 Task Force on Private Provision for retirement; author of How to Create a Competitive Market in Pensions – the International Lessons (1998).

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