Let's not borrow to save

NZ Herald
7 July, 2020

The Government’s plan to recover from the Covid-19 crisis has essentially been about finding new ways to spend. As a result, public debt is expected to increase from 19% of GDP in 2019 to a whopping 54% by 2024 and remain elevated for decades to come.

Borrowing to this extent comes at a significant cost. It means Kiwis must set aside a larger portion of their income to service the new debt. It also increases the country’s vulnerability should another crisis or natural disaster hit because it might not be so easy to secure lending the next time around.

It is more important than ever to consider if the country’s wider policy priorities remain the same. Low-value public spending should be cut and more efficient ways to meet policy objectives should be explored. An obvious place to start is with New Zealand’s retirement income policy settings, the contributions to which are presently going on the country’s credit card.

Introduced in 2007, KiwiSaver is a voluntary, defined contributions savings scheme. It’s goal, as set out in the KiwiSaver Act 2006, is to encourage Kiwis to form a “long-term savings habit and asset accumulation by individuals who are not in a position to enjoy standards of living in retirement similar to those in pre-retirement” – the target population. Key features include automatic enrolment of new employees, a minimum employee contribution rate, compulsory matching contributions by employers and other Government incentives to join and contribute.

The Government spends about $1 billion each year on KiwiSaver subsidies but it’s not clear this represents good value for money. In fact, KiwiSaver’s performance has been rigorously evaluated against its stated objectives by two major studies. It was found wanting.

The first study by Law, Meehan Scobie used a survey designed specifically to evaluate KiwiSaver. The second by Law and Scobie used administrative data from Inland Revenue matched to the Survey of Family, Income and Employment (SoFIE) which followed a large group of individuals over an eight-year period. The beauty of using SoFIE was that it measured changes in individuals’ assets and liabilities both before and after the introduction of KiwiSaver.

The studies found that only a third of contributions to KiwiSaver were new savings, while two thirds would have happened without the scheme due to substitution between KiwiSaver and other forms of saving which would have occurred anyway (such as paying down a mortgage).

What matters even more are effects on wealth, but the data showed KiwiSaver membership had no effect on net wealth accumulation on average. That’s even after controlling for other wealth accumulation factors such as income, age, gender, ethnicity, family circumstances, home ownership and previous levels of wealth.

The studies also looked at the efficiency with which KiwiSaver reached those it was intended to help. Again, KiwiSaver performed poorly. For every success, fourteen other KiwiSaver members were merely along for the ride. To put this in perspective, it would be just as efficient to give every member of KiwiSaver’s target group a cheque for about $200,000 rather than continue subsidising the scheme.

In the current dire economic context forcing the Government to borrow heavily, it would make a great deal of sense to instead end Government subsidies to saving through KiwiSaver. If this could be done in 2021, Government debt as a share of GDP in 2034 would be approximately 4.5 percentage points lower, all else being equal.

The New Zealand Superannuation (NZS) scheme – the country’s universal Government-funded pension – is an even bigger ticket item.

Currently, the age of eligibility for NZS is set at 65 and payments are linked to wages. NZS reduces old-age poverty rates but comes at a considerable cost. In 2019, spending on NZS was approximately $14.6 billion, or 4.7% of GDP. But due to population ageing, Treasury predicts by 2060 the scheme’s costs will rise to 7.9% of GDP.

Many of New Zealand’s peers in the OECD have already reformed their superannuation systems to account for life expectancy increases and population ageing. Since the last changes were made to NZS (increasing the age of eligibility from 60 to 65 between 1992-2000) life expectancy has increased by about two years and will continue to rise. Now would be a good time to act.

Thankfully, long-term population projections from Statistics New Zealand suggests even relatively modest changes to NZS could mean significant expenditure savings over time.

If, for example, the Government raised the age of eligibility for NZS by two years from 2025 and slowed the growth of individual payments slightly from next year, Government debt as a share of GDP in 2034 could drop by 12.4 percentage points.

Of course, asking people to rapidly plan for an extra two years before they hit retirement would be tough. But phasing in such changes over a longer period would help achieve a similar outcome.

Taken together, ending subsidies to KiwiSaver and making some relatively modest changes to NZS could reduce Government debt to about 25% of GDP in 2034, instead of 42% as is currently projected.

Incidentally, before Covid-19 reared its ugly head, debt between 15-25% of GDP was what the Government considered prudent.

But wait, there’s more.

The public mattress is also storing $44 billion in the New Zealand Superannuation Fund (NZSF), a public savings vehicle created to help meet the future cost increases to NZS due to population aging.

While superannuation costs as a share of GDP will continue rising, they won’t come near the OECD average. And if changes to NZS are made today, the case for keeping the NZSF would be even weaker.

In any event the rainy day caused by population ageing is not forecast for decades, so it is odd that, despite the Covid-19 crisis, the Government still plans to extend the overdraft further and borrow another $10.4 billion for contributions to the NZSF over the next five years.

At the very least, contributions to the NZSF should be suspended, as happened during the 2008 Global Financial Crisis.

But, by 2024, the NZSF is expected to be worth about $60 billion – enough to pay for the Government’s Covid-19 recovery – so serious consideration should be given to winding up the fund early.

New Zealand is under serious fiscal pressure and serious decision-making is needed. Taking a careful look at how the country collectively spends its resources and whether that spending still stacks up after the Covid-19 crisis is vitally important to get the country back on track.

Retirement income policy is a great place to start.

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