Education key part of savings
In this speech to the Savings and Fund Management Conference Finance Minister Michael Cullen, explains the Government's latest thinking on superannuation.
Tuesday, April 29th 2003, 12:23PM
Saving is a means to an end, not an end in its own right. In New Zealand’s economy it has two major purposes. First, it finances investment, and investment matters for increasing income levels. Second, saving as deferred consumption is crucial to retirement income provision, particularly at present given the prospect of population aging. In the past, retirement saving as a mechanism was confined to the private sector. Now, with the advent of the New Zealander Superannuation Fund, the government too has added a savings instrument to its portfolio of retirement income policies.
I would like to focus first, on the linkages between saving, investment and the government’s objective of increasing the living standards of New Zealanders.
A key factor in labour productivity performance – the level of output per “worker” – is the quantity and quality of capital, that is, the tools, machinery, plant, computers, and the like, they have to work with. Growing the stock of capital that people have to work with requires investment, and investment needs to be financed. It is saving that finances investment.
New Zealand investment levels, overall, have not been out of line from those of similar countries, even though there may be some pressure points, for example in the areas of transport infrastructure and energy.
The stand-out feature of New Zealand’s investment and capital stock compared with most other countries is the extent to which it is financed from foreign as opposed to domestic savings. Financing of domestic investment from domestic saving has been correspondingly low.
The immediate question is: does this relatively low level of domestic saving constrain the level of quality of investment in our economy? The short answer is not much, if at all. New Zealand has good access to the savings of the rest of the world through the international capital markets. That use of foreign savings, as represented by New Zealand’s net obligations to the rest of the world, now stands at about 75 per cent of GDP, the highest in the developed world.
This level of use of foreign savings raises some issues about external vulnerability. Much analysis has been done on this issue, and it is something that needs to be monitored closely. But best assessments are that it is not a cause for current concern. Moody’s recently upgraded the rating ceiling for New Zealand borrowers – effectively the sovereign rating – to AAA, and the IMF in its annual assessments of the NZ economy has been satisfied about New Zealand’s external liability position.
However, that, of itself, does not make me entirely sanguine about New Zealand’s low level of saving. How close we are to, or how far away from, insolvency is not the only consideration. We also need to consider whether, and how, our use of foreign savings is contributing to the growth of our incomes.
Three points are worth pondering:
First, as already mentioned, New Zealand has good access to foreign savings, and hence our investment is unlikely to have been constrained by a lack of savings to finance it. There may be some issues around whether heavy reliance on foreign over domestic saving has biased the allocation of investment toward areas that foreign investors, who are unfamiliar with the New Zealand economy, will be more comfortable with, for example, industries that are already well-established. These industries may not always be the strongest drivers of growth. But, be that as it may, we need to recognise that without access to foreign saving, the expansion of the economy, and of employment, that has been achieved in recent years would not have been possible.
But – and this is the second point – accessing foreign saving is not a means by which we can help ourselves to a "free lunch". It may seem that accessing foreign saving provides a way to maintain a level of spending (on consumption for now, and on investment for future growth) that exceeds our current income, without having to pay a price for that.
But we know that "free lunches" are never "free". If we want to fund our investment and simultaneously avoid the discomfort of foregoing consumption, we need to accept that it will be foreigners who accrue some of the income, that is, the interest and dividends, from the investment they finance. Those returns to foreign-provided capital, net of returns earned by New Zealand abroad, for some time now have amounted to 6 to 7 per cent of GDP (although for the year ended March 2002, they fell back to about 5 ½ per cent of GDP). While accessing foreign saving has enabled the economy to grow, some of the income from that growth has accrued to the foreign providers of capital, not as income growth for New Zealand residents.
Third, we need to think about how to maximise the benefits of inwards investment, relative to its cost. Foreign investment that includes the taking of an ownership interest, that is foreign direct investment (or FDI), holds out particular potential in this regard. This government has been emphasising the importance of New Zealand being globally connected, and FDI is an important part of that. FDI is a vehicle by which the New Zealand economy can connect up with foreign management, international marketing networks and world technological progress. By being well-connected, we can strengthen innovation within the local economy, and deepen our marketing connections with the world.
FDI in New Zealand during the 1990s predominantly took the form of the acquisition of existing New Zealand enterprises. That generally will have been positive in terms of connectedness, and much of the local capital freed up will have been re-invested. But the FDI that generally makes the greatest contribution is that which involves expanding, not just taking over, an existing enterprise, or – even better – new so called “greenfield” investments.
One of the most significant barriers to the development of export industries has been the lack of a significant venture capital market in New Zealand. Traditionally, New Zealanders have produced innovative products and ideas in the equivalent of a suburban garage or back shed, and have then turned them into modestly successful but still, by world standards, small businesses. Scaling those kind of businesses up so that they can service global markets is a risky business, but one which is aided by a deep capital market which makes finances available at all points along a risk/yield curve.
In New Zealand we have found it difficult to get such a market going. Some have argued that, if New Zealanders saved more – either of their own volition, or through compulsion or tax-breaks – then the capital needs of our businesses would be solved. This is clearly false, as it puts the cart before the horse. The problem has not been a lack of available savings, either domestic or foreign-sourced, but a lack of strength and sophistication in the institutions which comprise the market.
Deeper capital markets will themselves attract more savings; and achieving this is very much on the government’s agenda. For example: To maximise the benefits from inwards investment, we also need to satisfied that we have the appropriate domestic regulatory regimes in place. For example, if FDI results in a loss of, or impedes the development of, competition in the New Zealand economy, then monopoly profits will accrue to the investor, and these may well end up exceeding the benefits to the New Zealand economy.
As a general proposition, I think we have to accept that the New Zealand economy has access to sufficient pools of savings, both domestic and foreign, to make the investments that are needed for the future. The immediate priority has to be to provide a greater range of opportunities for those savings to be invested in the New Zealand economy.
That leaves the question as to whether we would be better off as a nation if New Zealanders saved more themselves.
Clearly, if we saved more and, in consequence, financed more of our own investment – or, as a diversified investor might do, invested more in assets abroad – more investment income, whether from within the domestic economy, or from abroad, would accrue to us. Saving is not just about foregoing consumption now in order to be able to consume later; it is also about foregoing consumption now in order to be able to increase our consumption later.
As I said earlier, I am not convinced that government should turn its back on the question of how much New Zealanders save. That is especially the case given what we know about the ageing of our population.
The basic facts around population aging by now will be well known. By 2040, about a quarter of New Zealand’s population will be 65 years or older. This is twice as high as the current proportion of about 12 percent. The change arises largely from increasing longevity and falling fertility.
Much has been said about the issues that arise, but there is a key point that tends to get lost sight of. If growth in standards of living is to be maintained as the population ages, and the labour force becomes relatively smaller, income growth will need to be bolstered from other sources. Technological progress doubtless will deliver some of that income growth, but saving and investment for future income growth is also needed, not least because new technologies tend to be embedded in new investment.
To help the Crown’s finances adjust to the costs of population aging, the Government has established the New Zealand Superannuation Fund. The Fund will be built up from fiscal surpluses, and, importantly, from the earnings on the Fund’s investments, over the next 30 years or so, at a time when the fiscal cost of New Zealand Superannuation remains relatively low. It should be stressed that much of the growth in the Fund is expected to come from the earnings of the Fund.
It follows that a critical element in the success of the Fund will be the level of long-term investment return it generates. In this regard, careful attention has been given to the design of robust institutional arrangements. The Fund is managed by a Crown entity – The Guardians of New Zealand Superannuation. As for all significant Crown owned funds, the key principles applying to the governance of the Fund are autonomy and accountability. The Guardians have full control of the Fund’s assets and will be held accountable for the Fund’s performance. This arms length management allows the Fund to be managed on a prudent and commercial basis in a manner consistent with best practice, maximising return without undue risk or influence from political pressures.
The Guardians have commenced work on asset allocation and portfolio construction and will probably begin investing in the September quarter of this year. The Guardians will decide on how much to invest in New Zealand and how much to hold in overseas assets.
There have been some suggestions that the establishment of the Fund is resulting in some people concluding that they no longer need to save for their retirement. It is hard to say how much of this is fact and how much is fiction, but either way, the record needs to be put straight.
The New Zealand Superannuation Fund will only partially cover increases in the future cost of superannuation. It is designed to moderate, not eliminate, the pressure that future superannuation costs will put on the fiscal position. Contrary to the impression some people have, the primary beneficiaries of the Fund will not be future retired people. They, after all, will not receive any larger entitlement to New Zealand Superannuation because of the Fund. Instead, the beneficiaries will be the taxpayers of the future, who will not have to face the steep rises in tax rates that would be otherwise needed to maintain New Zealand Superannuation.
The NZSF is a prudent step in the direction of making the existing level of basic retirement income provision for all sustainable, but in no way reduces the need for those aspiring for a retirement income above a basic level to save for their retirement. I do not doubt that some may misunderstand the purpose of the Fund, and be less inclined to save for themselves. Conversely, we might argue that the fact that the government is pre-funding a portion of its future expenditure highlights the fact that there is little chance of a state pension that exceeds the current 65 percent of the average wage for a married couple.
Successive Governments have sought to encourage private provision through education programmes run by the Office of the Retirement Commissioner. These have included public advertising campaigns, education in schools, and a very useful website that includes financial calculators for managing debt and achieving saving targets. The website also contains information on how employers can help staff plan for their financial future.
The Retirement Commissioner’s programmes appear to have been effective in raising awareness of the importance of saving for retirement, but it seems that they may have been less effective in translating that awareness into actual saving. Research on the psychology of saving suggests that saving is something that many want to do, but is also one of those things that gets put off until “tomorrow”.
This Government, besides supporting the education initiatives of the ORC, is focussed on ensuring that government policy does not impede, or discourage private saving for retirement. We are also keen to ensure that the institutional structures for saving for retirement are working.
These priorities are reflected in the terms of reference for the recently commissioned Periodic Review Group (PRG), which is charged under the Retirement Income Act 1993 with reporting on the retirement income policies of the Government. The PRG has been asked to consider mechanisms that would promote employer-based superannuation, and on the impact of the tax system on the private provision of retirement income.
Employer sponsored superannuation plans used to be a much more significant part of the institutional framework in New Zealand for private provision for retirement than they are today. They provided a painless mechanism for getting people into an early savings habit.
For a number of reasons, employer based schemes have been declining. Later this year, I propose to hold a forum, in partnership with other interested parties, to discuss ways to revitalise employer-based schemes. The objective is to coordinate efforts to help New Zealanders supplement the state pension with their own retirement savings through their workplace. Ideally, this group would develop a framework upon which to proceed in this area, and ensure broad contribution to any proposed initiatives.
Concerning tax policy and saving, I have always been cautious but open to the notion that improvements to the tax system may be required. At the very least, we would like to ensure that the tax system does not discourage people from saving for their retirement.
We are currently making progress on this front. Employers’ contributions to their employees’ retirement savings are currently taxed at a flat rate of 33 per cent. This results in the over-taxation of employees earning below $38,000 per annum, as their marginal income tax rates are much lower than that. This is an inequitable outcome and may discourage them from participating in employment-based superannuation schemes. Therefore, we will soon be introducing legislation to deal with that concern. This legislation will ensure that contributions to workers with annual salary/wages and superannuation contributions below $38,000 are taxed at the appropriate marginal tax rate. Some have raised concerns about imposing further compliance costs on employers – especially at a time when employers are increasingly concerned about the cost of providing superannuation schemes. For this reason, the legislation will make aligning the rate of tax on employer contributions with the employee’s marginal tax rate permissive rather than mandatory.
Another issue of concern involves the taxation on returns to savings in superannuation funds. Currently, all returns are taxed at a flat rate of 33 per cent. Taxing savings returns at that rate penalises low-income earners through over-taxation. Having a system that eliminates this inequity would be ideal. Past work in this area, for example on the TOLIS approach, demonstrates that such a system may result in increasing compliance costs associated with managing employer schemes. This may in turn lead to a reduction of employer-based schemes if employers find the costs of offering them to be too high. While I have asked officials to review the potential for change in this area, I am mindful of the potential costs.
I am also conscious that retirement savings generally may be reduced by the current general level of taxation on returns to savings, under the TTE regime. Of course, taxation in general causes a number of distortions to behaviour so the effect of taxation on saving is not unique. One concern with reducing taxes on the return to savings is the resulting decrease in government revenue or the offsetting distortions that would be caused by raising the required tax revenue through other means. I am searching for the appropriate balance in this area.
As many of you will be aware the government has been looking at how to better align the GST treatment of the financial services sector with that of other industries. To this end a discussion document was released in October last year which proposed among other things the zero-rating of business to business supplies. This proposal was well supported by the financial sector as it would increase for many the ability to claim back the cost of GST on the goods and services needed for their businesses.
This proposal is planned for inclusion in a tax bill to be introduced shortly.
I know that one proposal in the discussion document relating the treatment of brokerage and other 3rd party fees was not popular. Having considered the submissions made on this issue by your industry, including the costs that it would incur, I have decided that this issue will not be advanced as part of the government's tax policy work programme.
These changes, and the options for changing the taxation of employee super schemes, will go some way towards removing some of the potential obstacles to growth in the savings industry. You will have noticed, however, that I have scrupulously avoided any mention of tax incentives for retirement savings. As I have made clear throughout my tenure as Minister of Revenue, I am sceptical about the value of incentives, but willing to listen to reasoned arguments.
I do not dispute that a well-designed tax incentive would increase the amount of money flowing into whatever savings instruments qualified for it; but there is little evidence forthcoming that such a flow would be a net increase in the level of savings. A tax incentive worthy of the name would have a significant cost in terms of lost revenue; but if its effect is primarily to prompt those who are currently saving to redesign their portfolios, then we have gained nothing in exchange for that cost.
What we need is a shift in the savings culture; and there is no easy way that such shifts can be bought. So long as there is a relatively low level of awareness amongst New Zealanders of the respective merits of different savings options and of the quantum of savings they need to provide the kind of lifestyle they want in retirement, no set of savings policies can have much hope of success.
Once we have removed tax policies that may discourage saving, and ensured that the institutional environment is supportive of long-term retirement savings, I suspect that the next set of gains will be by a long, hard process of education. That is a process that both the government and the savings industry are committed to, and I trust that we can find ways to coordinate our respective efforts in the years to come.
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