I have put this post together effectively as my view of the rationale for the NZ Super Fund's existence in the first place. I find it frustrating that it is currently discussed in terms of rates of debt/return/Govt fiscal position etc without any reference to the smoothing effect it has on long-run superannuation costs - the entire reason for its existence. I do, however, note some very solid analysis has been done on the rates of return to rates of funding etc.
At present, in New Zealand, there is only one person in eight over the age of 65. In the longer term there will be a sharp increase to one in four. Currently, the net cost of directly funding annual superannuation is 3.5% of GDP. The aging population indicates that by 2030, staying on the normal "pay-as-you-go" model this cost will be about 5.6%, and by 2050 about 6.6% of GDP. Please note these are percentages of GDP - i.e. how much of what the country earns that will go to maintain superannuation payments. It has nothing to do with Government spending, taxation or debt levels (beyond the assumptive drivers of those factors on GDP).
Pay-as-you-go vs Smoothed
Superannuation payments now are funded straight out of the Governments accounts. It's a simple case of "x people need superannuation payments this year, here you go". As mentioned above, the proportion of money earned by the NZ economy that this will entail rises from 3.5% of GDP now to 5.6% in 2030. Note that GDP grows (hopefully!) over that time so this represents a nominal increase in superannuation payments from about $6b to about $16b based on an average 3% GDP growth rate in that time.
Now the clear issue for any forward-looking Government with that is regardless of what your spending priorities or tax structure preferences may be, the NZ economy is going to be handing a much bigger chunk of it's earning to superannuitants. These includes Treasury’s assumptions of growth in the economy so if you want to instead assume that your economy is going to magically grow ABOVE those assumptions then you should be walking down to the Treasury boys and ask them why they haven't got that memo.
It was this clear forecast of an ever-increasing drag on the NZ economy that saw Cullen, Treasury et al decide to move to a "let's average it out over 40 years and pay accordingly" method. Effectively it means each year, we "pay" the 40-year-average superannuation amount - at the moment where it is still relatively cheaper that means we overpay; the additional amounts get put aside. By about 2025, the superannuation demand on Govt spending would be above that average and that money put aside would then be added on to Govt contributions to smooth it back to that 40 year average.
So for now, there is a bunch of money set aside because we’re overpaying our superannuation cost. What do you with that little pile of money?
Option A: Take it out as coins, fill the Beehive and swim around in them ala Scrooge McDuck
Option B: Invest it. With managers tasked to deliver returns over the relatively longer time-period you are faced with it until you need it.
This is where the Super Fund comes from – it’s not a DRIVER of superannuation policy, it’s a CONSEQUENCE of policy. So by cutting contributions to that you are explicitly refuting the policy – you’re saying that smoothing the burden of accelerating superannuation costs on the NZ economy is a (very) low spending priority. The National Government’s actions here specifically show that they believe a smoothed Govt-funded superannuation bill is a low-to-non-existent spending priority against EVERYTHING ELSE they didn’t cut (dollar-weighted of course).
Debt-funded?
When you (properly) treat the capital contributions as part of our superannuation spending (just viewed over a longer time period) then those capital contributions simply become yet another piece of Government spending, driven from policy. It “joins the queue” with Working for Families payments, ACC payments, road building etc.
As such, to claim that this spending alone is funded by debt is a diversion. It should be viewed as a “Cost of Capital” - I’m not sure of the Government term but presume there is one to reflect the total cost of all funding sources, including taxation, realised investment return, borrowing and potentially some quantitative view of opportunity cost.
The only possible way for the Government argue to that it is solely funded by debt is to rank it at the very end of the spending list – if you were to say high-ranked spending was funded from taxes and you borrowed for the rest*. This would be based on a “this spending is so low priority that it’s not competing against other spending for funding – there’s nothing else worth spending that money on” argument. So there’s the Government’s real position on it.
But even this means debt is NOT the rate you should use to assign a “cost” to that spending priority over anything beyond the immediate year. If you were to use that, it means in times of Govt surplus that the cost of money going into the Fund is zero – I’m not sure that many taxpayers would agree that taking money off them should be viewed as “sweet, free money!” by the Government.
* But I’m simply putting that up to try and see the argument – I can see a bunch of flaws (why is taking tax off your citizens “better” than borrowing; if borrowing is so bad then perhaps it’s only left over for high priority spending where the business case is better etc)
Cost of pre-funding vs pay-as-you-go
Keith Ng has done probably the most solid and genuine analysis I’ve seen of the numbers, even utilising a full cost of debt, rather than spending Cost of Capital (which may end up being the same rate). I fully support that position in terms of what it means for assumed financial position based on the policy positions.
But, even given that the money being put aside for the next 15 years is a direct-to-GDP nominal amount, the Fund really only has to cover off that Cost of Capital – the case for partly pre-funded GDP still stands up without the Fund making additional money above that. If we don’t put aside this money, we’re going to have to come up with it in 15 years time (and beyond). Taking the (necessary for analysis) ceterus parabus view of the world, we’d have the same tax/debt mix of funding at that point and the same spending levels and priorities. So we’d have to go out to the debt markets to fund that extra spending there and then.
The case for some level of return is that you have to risk-adjust for the investment profile. I think this is accurate, so when I say zero-cost I mean an actual realised zero-cost at the end point. An investment manager would be looking for returns above the risk-free rate to help guarantee that.
So at the point of (realised) zero-cost, you have no financial argument either way. But I think you do have political, ethical and risk arguments for pre-funding – a smoother demand on the country’s output is a positive thing, placing more of the burden of future superannuation on the annual books of the taxpayers who will benefit is a positive thing, and pre-funding some of an easily-forecast ramping up in cost can mitigate possible future risk. These arguments are simply bolstered by the financial case that Keith has laid out.
Things I’m taken as given (but not necessarily supporting)
- The central Government providing universal, un-tested superannuation payments (they shouldn’t)
- The retirement age staying at 65 (it shouldn’t)
- The necessity of the Govt themselves funding 65% of the average wage at the time (they probably should ensure people’s retirement funds meet a level somewhere around that)
I actually believe we should move to a compulsory Kiwisaver model with a means-tested national superannuation payment that does aim for that 65% as a minimal base.
Putting aside a small part of future superannuation now is solid policy that pays real dividends within the next 15 years. The current Government have directly reneged on that policy position whilst still explicitly supporting a 65% average wage from tax without raising the retirement age. In doing so, they have put real pressure, risk and cost on the future NZ economy.