Guest Post: Ten principles relating to pension reform

A guest post on Kiwiblog by Michael Littlewood:

New Zealand has an aging population. We need to talk about that but we can’t yet because we don’t know enough about what New Zealanders are doing.

There are some things that we can get straight in preparation for that debate. The following ten principles may help.

1. The cost of any retirement income scheme is the benefits paid

It doesn’t matter how a retirement income scheme is organised (public or private; defined benefit or defined contribution; pension or lump sum; workplace-based or personal; fully (or partially) pre-funded or PAYG), the cost of the scheme is the benefits actually paid.

The only way to reduce the future cost of any scheme is to reduce benefits.

2. Pre-funding pensions doesn’t change their cost

It doesn’t much matter when (or if) money is set aside to meet the benefits (as with the New Zealand Superannuation Fund or any private pension). Pre-funding changes the incidence of the pension’s cost but does not, of itself, change that cost.

Government pensions should be ‘pay as you go’, in line with all other government spending (education, police, defence, health etc). A private pension should be pre-funded as the employer probably won’t be there to meet all the pension payments.

3. Private provision is no more secure than public provision

Private (pre-funded) saving schemes seem superficially more secure than future claims on taxpayers through unfunded public provision. Economically, there is in fact little to distinguish them. Each arrangement represents a set of claims on the contemporary economy that must be converted to cash to meet the living standards of the elderly. Regardless of how those claims are framed, it is the economy’s contemporary strength, during the saving or accumulation period and then as they are consumed in retirement, that will determine their real ultimate value.

4. Preventing poverty in old age

The only reliable way to eliminate (or reduce) poverty in old age is for the government to provide a universal, taxable pension, regardless of income or means, where the annual amount payable is linked to an inflation-related measure, such as average wages. The pension should be paid to everyone above the ‘state pension age’, regardless of work status and should be taxed as ‘ordinary’ income.

Means-tests are superficially logical but are complex, expensive to administer and generate unintended consequences (the Australian experience). Paying a pension to someone who doesn’t ‘need’ it may seem wasteful but the virtues of universality tend to outweigh the purities of targeting.

5. Governments are relatively powerless

Generally, governments cannot force, or encourage, citizens to save more for retirement than citizens want to save. Policies that either require or encourage people to save in a particular way will affect the make-up of their savings but probably won’t change the overall picture.

Governments may be able to control ‘approved’ or ‘compulsory’ retirement saving accounts but have no control over how citizens behave with respect to the rest of their financial decisions. They will take account of their regulated accounts and will probably reduce unregulated savings (or increase debt). That is the Australian experience.

6. Governments should concentrate on things that only governments can do

Governments should focus their policy decisions on those things that only governments can do. This is a quite short list and includes:

• the provision of a universal age pension (item 4 above);
• the maintenance of level tax playing fields (so that all ‘income’ is taxed at the appropriate rate);
• the appropriate regulation of securities’ offerings;
• the production of high-quality data on what citizens are doing about their financial security (present and future) and
• the development of high-quality information/education programmes that help citizens make appropriate decisions.

Everything else should be left to citizens, their employers and financial service providers.

Twenty years ago (before KiwiSaver), the government discovered that New Zealanders were probably over-saving for retirement. Might that still be the case? We need to find out.

7. Citizens will act rationally

We must assume that citizens will act in their own best interests. That includes making decisions about whether, when, where and how to save for retirement; and then what to do with those savings. For many, not saving for retirement will be perfectly rational. Reducing debt may be more important than setting aside money in saving accounts.

8. Employer-subsidised schemes are flawed

Employers must decide how much and how to pay their employees. The state should have no direct role in that, other than to facilitate the enforcement of employment contracts. However, the state should at least raise questions about schemes that subsidise employee contributions for retirement benefits. Paying a member of a subsidised scheme (such as KiwiSaver) more in total just by reason of the employee’s membership of the scheme seems fundamentally wrong. Employers need to understand that.

9. Economic growth is the only thing that really matters

Underpinning all discussions about the future costs of an ageing population should be ‘how do we grow the economy by more than currently expected?’ A bigger pie means there will be more to share for all parts of society, including the retired. It also allows the country more choices about that future.

‘More savings’ does not automatically mean more growth. ‘More savings’ means different economic claims.

10. We need to talk about it

We need to talk about these things. Before we can do that, we must gather and disseminate high quality data, currently missing. The questions that need answering will become clear once the evidence is available. The answers to those questions will probably be obvious and uncontroversial.