Section 5 - NZS Unsustainable?

5.         Is New Zealand Superannuation ‘sustainable’?

New Zealand Superannuation (NZS) is one of the simplest, most elegant Tier 1 pensions in the developed world.  Every New Zealand resident qualifies for NZS from age 65 as long as they have been resident:

  • at least 10 years after age 20[17], including
  • at least 5 years after age 50.

NZS provides a net 66% of the net national average wage for a married couple and about 42% for a single person who lives alone[18].  It is adjusted annually to reflect changes in inflation but with an underpinning link to the national average wage.  The grossed-up amount is taxed as ordinary income.

The Retirement Commissioner expressed recent concern about the escalating cost of NZS:

“NZ Super costs were $10.4 billion (net) in 2015/16, which is 14% of core crown expenses and 4.1% of GDP.  Treasury predict that it will rise to 7.1% (net) of GDP in 43 years.  If we play that scenario today using 2015/16 numbers (7.1% of $251 B) the bill for super would be $17.87 billion, which begs the question, where would we draw the additional $7.43 billion from?”[19]

NZS truly isn’t ‘unsustainable’, if by that we mean it can’t survive and must reduce.  We should stop saying that.  It is even questionable whether NZS, on its present terms and without the two recent changes, is ‘unsustainable’.

We know that the population aged 65+ will about double over coming decades[20] and that the costs of healthcare and NZS will increase substantially if current settings remain.  These two major government programmes will be the most directly affected by the ageing population.  However, we also know that New Zealand’s economy will grow and, barring catastrophes, we should as a country be able to afford more than we currently pay for the age-related programmes.

The Treasury makes projections of the impact of all these influences on government spending at least every four years.  The most recent estimates from the Treasury[21] show the government’s ‘primary core Crown operating spending’ changing from 28.4%[22] of Gross Domestic Product (GDP) over the 45 years 2015 to 2060.  The Treasury looked at two major scenarios:

  • holding total tax receipts at about 29% of GDP (roughly the current level), rising from 28.4% of GDP in 2010 to 36.1% (what the Treasury calls ‘Historical Spending Patterns[23]).  This would see an estimated fiscal deficit of 1.2% of GDP by 2030, growing to 6.1% of GDP by 2060.
  • what the Treasury calls ‘Spending Path to Maintain Net Debt’.  This says that future trends in spending are constrained to reduce government debt down to about 20% of GDP and then maintain it at that level.  It would require the estimated fiscal deficits under the Historical Spending Patterns model to be eliminated by reduced government spending (equivalent to 6.1% of GDP by 2060).

[17] If the government’s recently announced changes become law, the 10-year minimum period will become 20 years with full effect from 2037.  All immigrants after 2017 must complete 20 years’ residence or have qualifying residence from one of the countries with which New Zealand has a social security agreement.  It is unclear how existing residents will be treated – whether the new 20-year test will apply from 2017 or be phased in between 2017 and 2037.
[18] Those over age 65 and with equivalent overseas’ pensions will receive lower amounts of NZS - see section 8 (‘Overseas’ pensions and section 70 deductions).
[19] 2016 Review of Retirement Income Policies, Diane Maxwell, accessible here at page 3.
[20] There were 698,000 over age 65 in 2016.  The number in 2068 is expected to be between 1.6 and 2.1 million (depending on assumptions – median estimate is 1.8 million).  The increase as a proportion of the population is likely to be lower: at present, 14.9% of the total population is over age 65; by 2068, that is expected to be between 24-33%, again depending on assumptions - StatsNZ National Population Projections 2016-2068 (accessible here).  StatsNZ also expects the number of over-65s to grow by 1.85% p.a. (up from the previous estimate of 1.65% p.a.).  That means the number will double in 38 years (by 2054) rather than 43 years (by 2059).
[21] The Treasury’s 2016 Statement on the Long-term Fiscal Position, Government report, Wellington (accessible here)
[22] The equivalent number in the 2013 analysis as of 2010 was 32.2% of GDP (Affording Our Future – Statement on New Zealand’s Long-term Fiscal Position, The Treasury, Wellington (available here).  In the space of just five years (2010 to 2015), that starting figure has fallen by 3.8 percentage points to 28.4% or by about one-ninth.
[23] This says that government expenditure will follow historical growth rates, allowing for demographic changes.  The base case also assumes that tax collections stay at about 29% of GDP and that deficits will be financed from borrowing so that government debt is unconstrained and will reach 205.8% of GDP by 2060.  We know that this scenario is theoretical because a future government would change policies to ensure it did not happen.  That has already happened: the government has a fiscal surplus and is focussed on, among other things, reducing debt.

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These projections do not paint the grim fiscal future that some predict, but they are large numbers.  In 2015, 28.4% of GDP was nearly $68.6 billion (each 1% was equivalent to $2.4 billion).

In 2060 dollars, the Treasury estimates that the net cost of NZS will be $105.4 billion.  By 2060, estimated GDP will be a nominal $1,487 billion.  Bringing those numbers back to 2015 dollars at the assumed inflation rate of 2% p.a. suggests that the economy will grow in real terms by about 153% over the 45 years[24].  In the meantime, the total population will have grown by about 39%[25].

The difference in the two Treasury scenarios is an expected total government spending of 6.1% of GDP by 2060 (28.4% to 34.5%).  We expect to spend a net 7.1% of GDP on NZS alone by then (see section 4 above) so the difference of 6.1% in overall spending is a significant number.

However, none of these numbers establishes a case that New Zealand faces an imminent fiscal crisis, remembering that government spending was 32.2% as of only 2010.  We know that an ageing population will require an increase in taxes unless current programmes (not just those directly affecting the old) are cut.  We also know that what we have has worked reasonably well and costs less than many other countries currently spend on the old[26].

But here is the real question – looking just at NZS, do we expect that taxpayers in 2060 will be happy to pay a net 7.1% of GDP, shared out amongst everyone over age 65?  If we think that 2060’s taxpayers might object, then we could expect them to cut benefits and those changes could be made with little warning.  New Zealand’s own experiences with changes to NZS, the 1985-1998 surcharge and the introduction of KiwiSaver illustrate that clearly.

[24] The 2060 estimated GDP in 2060 from the LTFM is $1,487 bn.  Discounting that back to 2015 at 2% p.a. (to take inflation out) brings it back to $610 bn.  The actual GDP in 2015 was $241.6 bn.
[25] From 4.69 million in 2016 to 6.52 million in 2068- StatsNZ National Population Projections 2016-2068, median estimate (accessible here).
[26] As explained in the RPRC’s PensionBriefing 2012-3 We all have to talk about New Zealand Superannuation (accessible here), of 31 OECD countries that reported pension costs in 2010 and expected costs in 2060, only six countries presently spent less than New Zealand, ignoring the amount those other countries spent on tax subsidies for private provision.  That number is very low in New Zealand whereas in Australia, for example, the cost of tax subsidies is about the same as the amount spent on the Age Pension - see Building super on a fair foundation: Reform of the taxation of superannuation contributions, Peter Davidson (2012), Australian Council of Social Service (accessible here).

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Rapid changes to a long-term programme like NZS are undesirable because New Zealanders build their private savings arrangements on this ‘Tier 1’ state pension.  If the cost of NZS must be cut, we need to give as much notice as possible so that people can make appropriate changes to their retirement saving plans.  That’s why we need to talk about NZS now and to run that discussion on a regular basis in the future.

NZS currently costs a net 4.2% of GDP and the Treasury says that, without the recent changes, this will increase to a net 7.1% by 2060.  That’s a lot of money today and even more tomorrow.  However, let’s put those large numbers into perspective.  The Treasury expects New Zealand to spend (in 40 years) less than the average of all OECD countries spend on pensions today.  The OECD reports that, in 2011 (six years ago), the average cost of public spending on old age and survivor pensions was a net 7.3% of GDP[27].

So what makes our Treasury’s 2060 estimate ‘unsustainable’?  As ever, it will be a question of priorities – will 2060 taxpayers be happy about spending that much on pensions for the old?

Health spending will have a similar trajectory to the cost of NZS.  The gross government’s health spend was 6.2% of GDP in 2015.  The Treasury’s 2016 Long Term Fiscal Model expects that to be 9.7% by 2060[28].  We don’t say that health spending is ‘unsustainable’ and must reduce today.  What makes NZS different in this regard?

Even if we think that 2060 taxpayers might be unhappy about either the cost of NZS or of health in 2060 (or both), it will still be an issue for 2060 taxpayers to resolve, not 2017 taxpayers.  Each year’s taxpayers effectively make those spending priority decisions every year and that will be the case in 2060 as it is now.

If we worry about what the cost of NZS might be in 2060, why aren’t we questioning today’s cost?  Taxpayers spend a net 4.2% of GDP today – that’s more than $11 billion.  Is that a good use of taxpayers’ money?  Have we got the design of NZS right?  The next section 6 suggests not.  We should talk about those design issues rather than guess what 2060 taxpayers might think of 7.1%.

And, as explained in section 7, resuming contributions to the New Zealand Superannuation Fund (NZSF) will not help.  Putting an extra $27.7 billion into the NZSF between 2021 and 2035[29] really won’t matter.  The partial pre-funding of NZS through the NZSF does not change the future cost of NZS by one dollar but only slightly re-arranges its incidence (more cost today for possibly, but not guaranteed, slightly less tomorrow).  The cost of NZS today (and tomorrow) is the benefits actually paid.  If we want to cut the cost of NZS, we must reduce the value of the pension paid.  So, even if contributions to the NZSF resumed, that doesn’t change the sustainability or otherwise of NZS at all.

We need a research-led discussion to test whether New Zealand has the best Tier 1 pension in the world (nothing less will do) and whether taxpayers get good value for the net $11.1 billion we spend on NZS today.  The next section 6 lists all the things we need to talk about in that regard.

So, let’s think about the things we can control and not worry about what might happen in 2060 (or even 2037).  That’s up to those with the power to control things then.

[27] Pensions at a Glance 2015, OECD at page 181 (accessible here).
[28] Health costs based on the ‘historical spending patterns’ scenario – accessible here, at page 60.
[29] As the Treasury’s ‘NZSF Model v34’ anticipates – see here.

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Questions New Zealand needs to discuss on the sustainability of NZS:

  1. What is ‘unsustainable’ today about NZS as it exists today?
  2. What definition of ‘sustainability’ should we adopt for today’s NZS?
  3. Do we need to concern ourselves about the cost of NZS in 2060 or should we leave that for taxpayers in 2060 to resolve?
  4. If we need to be concerned about the long-term ‘sustainability’ of NZS, should we be equally concerned about the 2060 costs of health, education, police, prisons and all the other categories of government spending?  In other words, is there something about the age pension that makes it special in this context?