The government has resumed contributions to the New Zealand Superannuation Fund (NZSF). Over the years 2019-2035, it anticipates contributing a total of $24.45 billion[1].
“These are important intergenerational investments, which look out beyond 30 years and beyond the electoral cycle. By resuming Government contributions to the super fund, we are helping to protect the Government’s ability to keep the super age at 65 and showing that we care about future generations. The super fund—the Cullen fund—is a great legacy to New Zealand.”
Grant Robertson, Minister of Finance, Parliamentary Questions, 31 October 2018.
Most seem to agree that this is appropriate. For example:
The Retirement Commissioner said that the NZSF “…helps contribute to the long term affordability of [New Zealand Superannuation]…”[2]
The last government agreed, the only issue being when contributions should resume.
The NZSF was set up in 2001 to, in the words of then Finance Minister, Michael Cullen, “…smooth the future increase in the cost of superannuation over time”[3].
However, the NZSF will not reduce the future cost of NZS by one dollar – it may very partially ‘smooth’ the incidence of funding that cost but doesn’t change it. Re-starting the government’s contributions won’t change the cost; neither will a stellar nor a poor investment performance by the NZSF’s Guardians.
As stated in section 4 (How much will New Zealand Superannuation really cost?), the cost of any pension scheme, private or public, is the benefits actually paid by the scheme (plus administration costs) and that doesn’t have anything to do with how it is paid for. So, in the absence of a reduction in the NZS pension itself, having the NZSF doesn’t change the economic implications of an ageing population. On current settings, the Treasury expects the cost of NZS to grow from a net 4.1% today to a net 6.75% by 2060. The NZSF does not affect those numbers.
The last government wanted to reduce the future value of NZS by shifting the pension age from 65 to 67 between 2037 and 2040; also by increasing the residence period from 10 to 20 years. It estimated that would cut the cost of NZS by about 10%[4]but, again, the presence or absence of the NZSF wouldn’t have changed that number.
The Treasury’s New Zealand Superannuation Contribution Rate Model HYEFU 2018[5]assumes that the government’s contributions to the NZSF will increase from $500 million in 2018 to about $2.5 billion by 2022 (about 0.7% of 2022 GDP); that the annual contribution will reduce over the years and will stop in 2035 after a further $24.5 billion has been contributed. That means taxes will need to be $24.5 billion higher than otherwise needed over the next 16 years.
When the drawdowns start in 2035, the total amount in the NZSF, in tomorrow’s money, will be about $153 billion, the equivalent of 25.6% of GDP in 2035 compared with today’s 14.4%.
According to the Model, the maximum drawdown from the NZSF over the coming 100 years will be about 1% of GDP or 12.9% of the net cost of NZS in 2078 and 2079. The simple average of 80 years’ drawdowns in the Model (2035-2116) is 0.66% of GDP a year or roughly 8.9% of the average net contemporary cost of NZS across the same period.
Most assume that the NZSF was intended to smooth the costs associated with retiring baby boomers, but it is actually a ‘perpetuity’ fund. The Treasury’s Model shows that there will be more in the NZSF in real terms in 2116 than there is today (30.75% of 2116 GDP compared with 14.4% today). So why precisely do we need such a fund? It will apparently still be with us long after the last of the baby boomers and their children has died.
The most that can be said about the NZSF is that it slightly changes the incidence of the cost met from current taxation of NZS but NZS will cost the same. However, instead of asking tomorrow’s taxpayers to foot the full bill, today’s taxpayers are paying twice – once for today’s NZS and then extra to put in the NZSF. The Treasury’s Model suggests that today’s taxpayers will pay $2.5 billion more in 2022 (making 2022 taxes $90 billion[6] rather than $87.5 billion) just so that taxes from 2035 onward will probably be slightly less for tomorrow’s taxpayers.
There is a lot wrong with the idea of partially pre-funding NZS - here are the main problems:
(a) Constrains tomorrow’s decision-makers: If we think NZS will be too expensive for tomorrow’s taxpayers without the NZSF then it should be their decision to cut benefits, not ours to constrain change (‘we baby boomers paid more taxes to protect our pension’). Adding the NZSF could be seen as an attempt by us to limit their ability to reduce future NZS pensions.
(b) 100% leveraged: Although the contributions to the NZSF came from higher taxes over the 2003-2034 period (not directly borrowed for the purpose) when we look at the money held in the NZSF from year to year, the argument changes. Investing in the presence of debt is exactly the same as borrowing to invest. In 2019, the government should treat every dollar in the NZSF as effectively a dollar borrowed. That’s because, at any time, it could sell those assets and repay debt. The government has effectively raised a mortgage of about $42.9 billion (April 2019) on New Zealand’s total assets (including the NZSF’s assets) to invest in financial markets. The return on the NZSF’s assets must at least equal the most expensive $42.9 billion of the government’s borrowings (the ‘hurdle rate’), plus the costs of running the NZSF, before there is any net gain to holding those assets rather than repaying the debt.
(c) Leverage magnifies risk: The investment risk is very high with a 100%-leveraged portfolio. Leverage magnifies both good and bad results. This is a financial risk that the government doesn’t have to take and shouldn’t. Unless the NZSF achieves a return that, over the long term is at least equal to the ‘hurdle rate’ then the presence of the NZSF will make NZS more expensive than its pure pay-as-you-go alternative.
However, just achieving that hurdle rate is not enough. The risks associated with a 100%-leveraged portfolio also need to be paid for. In other words, the ‘hurdle rate’ should be risk-adjusted[7]. While the NZSF may have its own internal measures of success, the government should separately calculate a risk-adjusted hurdle rate and publish that on a regular basis to justify, or not, the government’s policy decision to maintain the NZSF in the presence of debt. The NZSF should not choose the measures for that calculation because it does not run the risks associated with missing the hurdle rate.
Just looking at the ‘equity risk premium’ or ERP and putting to one side the issue of 100% leverage, the government’s independent calculation of the ERP would put that at between 4 to 7.5 percentage points above the 10-year bond rate[8]. The Treasury itself uses 4% in its assessment of the projected capital returns from the New Zealand Superannuation Fund[9]. Most alternative measures would be higher than the NZSF’s own internal measures[10].
(d) Cookie jar economics: The NZSF is a good example of ‘cookie jar economics’ – if we tuck this money into a jar labelled ‘superannuation’, we can all save together for our collective retirement. For the reasons explained in section 4 (How much will New Zealand Superannuation really cost?), it’s not possible for a country to defer consumption or ‘save’ in this way. The government’s consolidated audited accounts put all of its financial activities into one spot. With the NZSF, the government’s financial statements for the period ending 28 February 2019 (accessible here) show that we taxpayers owe the rest of the world $115.8 billion. Without the NZSF cookie jar, that debt would be $74.6 billion. Having the cookie jar and higher debt does not improve New Zealanders’ future retirement income security which is normally the point of pre-funding.
(e) Total taxes higher over long-term: Long term, total taxes collected will probably be higher in the presence of the NZSF than if it had never started. We know that governments since 2003 have collected too much tax from us to pay for just NZS. Those excess taxes were $14.88 billion in 2017[11] and now should have added the $500 million that this government contributed in 2018. So, $15.38 billion currently sits in the NZSF together with investment income (less tax and expenses).
We need to anticipate what might happen when the capital drawdowns start. The Treasury’s Model suggests that the first payment from the NZSF in 2035 will be $179m or just 0.03% of GDP in that year. Those drawdowns will average 0.66% a year of nominal GDP in the 81 years between 2035 and 2116, the equivalent of about $1.98 billion in today’s terms. For tomorrow’s governments, that will look like ‘free’ money. Unless those governments make a conscious decision to reduce the overall tax take by the amount of the drawdowns, the economic underpinnings of the NZSF concept will disappear (higher taxes today for lower taxes tomorrow). Instead, total taxes will be higher over the long run in the presence of the NZSF.
There are other important, difficulties:
1. Deadweight cost of tax: Collecting taxes is not costless to the economy. Higher taxes (including higher taxes than are currently ‘needed’) impose indirect costs, such as the ‘dead-weight costs’ on the economy. People change their behaviour as a result of tax changes and that has a direct cost to the economy. Each extra dollar of tax has a measurable direct and indirect cost of collection to the economy[12]. Those extra costs (amortised) should be added to the hurdle rate discussed in (c) above.
2. No domestic investments; no bonds: Investing domestically makes no economic sense for the NZSF and not much investment sense unless it leads to genuine higher economic growth. If the NZSF were all invested locally, its performance would echo the country’s economic performance. In an economic downturn, when everyone is tightening their belts, negative performances from the NZSF could put the security of NZS payments at risk and magnify the impact of the downturn. The NZSF should effectively be an insurance fund that offers some economic protection against New Zealand’s poor performance, relative to the rest of the world. This suggests that all investments should be overseas[13] and none should be invested in fixed interest securities (because the money used for that investment is effectively all borrowed[14]). At 30 June 2018, 13.9% of the investments were in New Zealand (see here at page 42) and 20% in ‘global fixed interest’ (ibidat page 32).
3. No useful economic impact: The presence of the NZSF does not increase the capacity of the New Zealand economy to cope with larger numbers of ‘non-producers’ or to improve the affordability of tomorrow’s NZS. The presence of the NZSF can only be justified in this wider context (improving the sustainability of NZS) by increasing output, raising productivity or constraining the output of future workers (to make more consumption available to retirees and other non-workers). If it were entirely invested overseas, the NZSF cannot achieve any of those objectives.
4. Why pre-fund just pensions? There are no particular grounds for pre-funding NZS as opposed to pre-funding other government programmes like health, infrastructure, policing or the armed forces[15]. What particularly is it about the age pension that deserves this special treatment?
5. Behavioural impact: New Zealanders may be negatively influenced in their own saving decisions by the presence of the NZSF. Its presence might suggest that New Zealanders do not have to save for retirement for themselves – the government is doing that for us all
6. Politicises sustainability: The presence of the NZSF politicises the issue of the sustainability of NZS. Everyone thinks they have an investment answer to the future affordability of NZS[16].
Tomorrow’s taxpayers will (and should) decide on their government’s spending priorities that will, as now, balance all the different claims against revenues, electoral appeal etc. That will be the case for health, defence, policing, prisons, education and all of the government’s ‘other’ activities.
And that should also be the case for pensions, both to the old and to the dependent young.
Nothing that today’s taxpayers decide should interfere with that process in 2060 – and it will not, even in the presence of the NZSF. That is the essential pointlessness of the NZSF which, if it achieves anything at all, will only get in the way of ‘sensible’, contemporary decisions.
Some might ask ‘what about intergenerational equity?’ The baby boomers have benefited from all kinds of things (education, jobs, housing, growth etc.) why shouldn’t they help pay for their own state pension through the build-up of the NZSF?
If there is anything in the partial pre-funding argument about intergenerational equity, that doesn’t apply to the NZSF. It is an ‘in-perpetuity’ fund so the higher taxes paid by baby boomers in the years to 2034 will be still there for the grandchildren of the baby boomers. As already mentioned, there will be more money in the NZSF, in real terms, in 100 years than there is today. The NZSF has nothing to do with intergenerational equity.
If effectively borrowing $42.9 billion (as of 30 April 2019) to invest in financial markets makes any economic sense then, rather than making contributions, why doesn’t the government borrow another $42.9 billion today? We hope that’s a rhetorical question.
We think the government should wind the NZSF up, sell the assets and repay $42.9 billion of its current $115.8 billion in debt (at 28 February 2019). That way, it will also save the $34.6 million in salaries and bonuses that the NZSF’s 130 staff received in 2018[17]. They may have deserved those, but New Zealand really doesn’t need the NZSF.
We do not necessarily criticise the Guardians or the staff of the NZSF for the job they have done; we just suggest it’s a job they should not have been given because it doesn’t need to be done.
Terms of reference for 2019 Review
There was no mention in the Terms of Reference for the Retirement Commissioner’s 2019 Review of the issues we have raised with respect to the inability of the NZSF tohelp “…protect the Government’s ability to keep the super age at 65 and showing that we care about future generations.” (Grant Robertson, Minister of Finance, 31October 2018).
It would be nice to see the economic case for the NZSF addressed in the 2019 Review but the Terms of Reference do not require that. However, a future government will not be able to ignore the following questions.
Questions New Zealand needs to discuss on the role of the NZSF:
New Zealand needs a complete and independent review of the underpinning logic of the NZSF’s existence. How precisely does higher government debt and associated financial assets improve the security of future superannuitants’ pensions? What risks might this strategy involve? How should those risks be priced?
Even if, despite our recommendation to wind up the NZSF, it continues as now, how well has the NZSF performed against two key measures:
a. The government’s most expensive debt in each measurement period (that could be repaid if the NZSF were wound up)?
b. On an agreed risk-adjusted basis?
- in either case, allowing for the deadweight costs of extra tax incurred by the contributions.
If the NZSF continues, how can we assure today’s taxpayers that, by paying more in taxes today (between 2019 and 2034), they will see a reduction in the taxes they will have to pay once the drawdowns begin?
Can we assure tomorrow’s taxpayers that the presence of the NZSF does not constrain, in any way, their ability to reduce NZS?
Does the presence of the NZSF increase the economic activity above the level of growth that otherwise would have occurred?
[1]The Treasury’s New Zealand Superannuation Contribution Rate Model HYEFU 2018, accessible here.
[2]The Retirement Commissioner also recommended that the NZSF cease paying tax on its investment income “…while contributions are also suspended.” (2016 Review of Retirement Income Policies here at page 20. This is probably the worst reason to allow the NZSF to be tax-free and ignores the institutional effect of creating a tax-exempt investor, New Zealand’s largest investor, in New Zealand’s financial markets. We strongly disagree with this unsupported, throwaway recommendation (also made in the 2013 Review of Retirement Incomes here at page 56). The last government, in its response to that recommendation of 7 June 2017 (accessible here) said “…the Government is still of the position that taxing the New Zealand Superannuation Fund investment returns provides better investment signals for those managing the Fund.” We agree. The Tax Working Group also supported the tax-exempt status in its February 2019 report (accessible here) at page 81. “The Group therefore recommends that the Government give favourable consideration to specifically exempting the NZSF from New Zealand tax obligations on the basis it is an instrument of the Government of New Zealand.” The recommendation seems based on issues associated with administrative inconvenience – why should the government collect tax from itself? We have explained why that should be so.
[3]Michael Cullen, Minister of Finance, speech on the first reading of the New Zealand Superannuation Bill (2000) accessible here.
[4]The reduction would have been 0.6% of GDP by 2040, according to Steven Joyce, Minister of Finance in a press release of 6 March 2017 Lifting NZ Super age the right thing to do, accessible here. Before the changes, the 2016 NZSF contribution model expected that the net cost of NZS in 2040 would be 6.0% of GDP; so 0.6% on 6.0% is one tenth of the cost.
[5]The Treasury’s 2016 NZSF Contribution Rate Model is accessible here. It takes no account of the previously proposed 2037-2040 changes.
[6]Source: The Treasury’s2016 Statement on the Long-term Fiscal Position (available here).
[7]The NZSF itself compares its performance with 90-day Treasury bills (usually the government’s cheapest debt) and, separately, against “…the Treasury Bill return +2.7% p.a. over any 20-year moving period.” (see here). Neither of these adequately compensates taxpayers for the risks associated with a 100%-leveraged portfolio. The most recent pre-tax returns since inception (to 30 April 2019) are 10.3% p.a. (see here). The 90-day bill measure was 3.93% p.a. while the Treasury Bill + 2.7% comparator was 6.44% p.a. over the same period. We suggest that the achieved returns and the two comparators do not adequately compensate taxpayers for the risks.
[8]Bart Frijns in Equity Risk Premium (accessible here) suggests that the pre-tax ERP for a New Zealand portfolio should be 4.76%, based on share prices, dividend yields, inflation rates and 10-year government bond yields from 1899 to 2016. A post-tax ERP that the NZSF fund requires would be higher.
[9]The Market Equity Risk Premium (2005), The Treasury – accessible here.
[10]As already mentioned, the NZSF’s own internal “performance expectation is now NZ Treasury Bills + 2.7% pa” over a rolling 20 year period (see 2015 Reference Portfolio Review (2015) NZ SuperFund here). The Guardians also compare the NZSF’s performance against a self-constructed ‘Reference Portfolio’.
[11]Source: Undated Cabinet paper on New Zealand Superannuation from Minister of Finance of March 2017 para 67 at p. 9, accessible here.
[12]Estimates of the deadweight cost depend on the calculation basis used. In the Treasury’s Guide to Social Cost Benefit Analysis (July 2015, accessible here) at page 15, it observed that “Attempts have been made at estimating these effects, with estimates varying from 14% to more than 50% of the revenue collected…This guide suggests a rate of 20% as a default deadweight loss value in the absence of an alternative evidence based value. Thus public expenditures should be multiplied by a factor of 1.2 to incorporate the effects of deadweight loss.”
[13]Domestic equity-style investments could be justified only on the basis that they will add to New Zealand’s economic welfare by creating new jobs or improving productivity, not simply that it is a ‘sensible’ investment.
[14]Borrowing to invest in equities is risky but has a prospect of returning net gains over the cost of debt. That prospect is reduced or even eliminated if the borrowed money is used to invest in bonds.
[15]On similar grounds, there is no economic or fiscal point in pre-funding the Accident Compensation Corporation’s liabilities, nor for re-building the EQC Fund. On the ACC, see the RPRC’s PensionCommentary 2009-1 – Why does the Accident Compensation Corporation have a fund?, Michael Littlewood, accessible here. On the EQC, see the RPRC’s PensionCommentary 2011-1 – Why does the Earthquake Commission have a fund?, Michael Littlewood, accessible here.
[16]And asking New Zealanders what they think about the NZSF helps to politicise the issue. In A Practical Approach to Well-being Based Policy Development: What do New Zealanders Want from Their Retirement Income Policies? by Joey Au, Andrew Coleman and Trudy Sullivan (Treasury, 2015 accessible here), the authors found that, based on a survey of 1,066 New Zealanders, “…a policy that more aggressively prefunds New Zealand Superannuation by immediately raising taxes is supported by a majority of people of all ages and income groups.” From the report, we cannot tell precisely what questions induced this response but we can probably assume it did not include a statement along the lines that the NZSF that receives those higher taxes will not change the future cost of NZS by a dollar. As the report itself says, “One issue that underlies the whole survey is framing. It is well known that the way questions are framed can have an enormous effect on survey responses.” (at page 12).
[17]Employee salary data and employee numbers from the Annual Report 2018(accessible here) at pages 190 and 32.