The Politics Of Retirement Incomes

Chapter 5 of The Whimpering of the State: Politics After MMP. Does not contain diagrams or endtnotes.

Keywords: Social Policy;

It was not macroeconomic policy that proved politically disastrous for Winston Peters. NZF’s economic policy unravelled over retirement policy.

Retirement provision is not actually about transferring resources (or income) through time – from when a person works to when a person is retired. It is about the allocation of production at a point in time. An economy has a certain amount of goods and services available for consumption. Some is consumed by its workers and their children, and some is consumed by the retired. The more the retired consume (be it by their having higher relative incomes or a bigger relative share of the population), the less for workers and their children. Whether the elderly obtain the means to finance their consumption by a public transfer funded by tax, or by a private transfer funded by the return on capital, the material standard of living of the younger generation still suffers. If all the elderly were to die one night, the remaining population would be materially – but not necessarily spiritually – better off. They would pay less tax since New Zealand Superannuation would not have to be funded, and they would inherit the private savings of the elderly, and receive the unearned income. On the other hand, were the labour force to disappear, the elderly would be worse off.

But while retirement provision is not about transferring real income through time, it is about transferring social obligations between generations, which makes it a very political issue.

Tiers and piers

New Zealand has generally had a tier approach to retirement provision, the expression arising because the components are layered as shown in Figure 5.1.

[Figure 5.1 omitted. Basically it shows three layers on top of one another – the three tiers below]

First tier (state) provision is a flat-rate payment by the state out of general taxation. Since 1993 this has been known as ‘New Zealand Superannuation’ (NZS). (Previously it was called ‘National Superannuation’. Before 1976 it was a combination of the Age Benefit, introduced as the Aged Pension in 1898, and Universal Superannuation, introduced in 1938.) [1] If the first tier is taxed, then everyone in the eligible age category will receive some additional income, with those on higher other incomes (and hence paying higher marginal income tax rates) receiving less than those on lower incomes. If the first tier is abated, then there will be some who will be eligible in principle, but will receive no additional income because their high other income will mean that the entirety of the tier is abated to zero. From 1984 to 1997 National Superannuation was abated by a politically contentious ‘superannuation surcharge’.

Second tier (occupational) provision involves workers making earnings-related payments (often deducted directly from their pay and often with an employer contribution), which are invested into a fund which pays an actuarially based annuity on retirement. (Typically any second-tier income is taxed as ordinary income, and so is never fully abated out.) The schemes may either be compulsory, as the result of state legislation, or voluntary by individual choice (or as a part of employment conditions). Because the contributions are earnings-related, the pension will also be earnings-related, and so the retirement benefits will be higher for well-paid contributors than for poorly paid ones or those without work.

Third tier (private) provision covers a miscellany of savings activities including house purchase, life assurance, and investment in financial instruments such as bonds and equities. There may be government support and subsidies for all or some of these activities.

Many retirees – typically most women and many low-paid men – do not have a substantial enough work and income record to have contributed to second and third tier schemes enough for an adequate retirement income. This means that any comprehensive system has to have some first-level provision, even though it may be a primitive one.

An alternative is a pier system (Figure 5.2).

[Figure 5.2 omitted. Basically it shows two legs (piers) holding up a the third layer,. Like a table.]

One pier is typically a state-provided one, not unlike the first tier of the New Zealand system, but of a minimalist nature. The second pier is a compulsory contributory occupational scheme (not unlike the second tier). In principle, a person is only eligible for one of the two piers, but since many workers end up with an inadequate second-pier provision, they usually get some state first-pier supplement (which typically involves very high abatement rates). One might think of such people as falling between the two piers. A third tier of private provision remains on top of the two piers.

A brief history of recent public policy on retirement provision[2]

Royal Commission on Social Security (RCSS)
* The 1972 Royal Commission on Social Security recommended a two-part first tier, similar to the existing arrangements, simplified to
Either: From age 60: An abated first tier (called the ‘Aged Benefit’), advantageous to those on low market incomes.
Or: From age 65: A taxed first tier (called ‘Universal Superannuation’) of benefit to the rest.

Individuals could make their own second-tier and third-tier provisions (house ownership being very important for the latter). There were some tax subsidies on savings. [3]

The Third Labour Government (New Zealand Superannuation 1974)
* From age 60 to 65: An abated first tier, for those on low market incomes.
From age 65: A first tier, and a compulsory second tier (both taxed).

When in opposition in the late 1960s, the Labour Party had looked at the European retirement provision schemes of the two-pier type. A major consideration was the substantial investment funds that would be invested in New Zealand. Once in office, the Third Labour Government initially wanted to abandon the existing first tier (of the RCSS scheme above), but following official advice its scheme was changed to a second compulsory tier called the ‘New Zealand Superannuation Scheme’, which was on top of the first-tier universal superannuation from age 65.[4] The officials had probably calculated that the required contributions for Labour’s original scheme would be too high, while the transition problems between the existing and proposed schemes would be complicated. They also probably recognised the likelihood that at some stage the government would find itself supplementing the private contributions when the return on the investment of the funds was lower than promised.

National Superannuation
* A taxed first tier (i.e. universal) from age 60.

In 1976 the Muldoon government replaced the Third Labour Government’s scheme with ‘National Superannuation’, which (ironically) had been the scheme promised by Labour in 1935, but found to be too expensive. Note that it is, in effect, the second part of the RCSS scheme except that it commenced at 60 rather than 65, and had to be at a higher level in order to be beneficial to those already receiving the abated first tier.[5] The assumption remained that individuals would voluntarily pursue second-tier and third-tier provision, with the tax exemptions on savings remaining but diminishing in real value because of inflation. (The exemptions were revoked in 1988.)

The Fourth Labour Government introduced an income-tax-based abatement, called the ‘superannuation surcharge’ in 1985. (National tightened it in 1992.) On each occasion, there was much genuine political outrage, for when in opposition each party had promised not to impose a surcharge. In government each broke their promise, claiming fiscal necessity.

The Accord: New Zealand Superannuation (1990s)
* A first-tier provision with age eligibility raised progressively to 65 by 2001, abated with a superannuation surcharge.[6] The married couple rate was set at between 65 and 72.5 percent of average wage (all measured net). Within this range, the rate would be increased by the consumer price index annually. Those below the age of eligibility were still entitled to an unemployment, sickness, or invalid benefit, and there was also transitional retirement benefit.

In 1993, all parliamentary parties except NZF agreed to the ‘Superannuation Accord’, renaming the state support NZS.[7] Again the arrangement had parallels with the RCSS proposal, but the over-65 arrangements were better integrated with lower effective tax rates, although the scheme was more costly.

The Accord did not endure past the 1996 election campaign, for Labour – but not National – announced they no longer supported the superannuation surcharge. It was abolished by the NZF/National government as a consequence of the coalition agreement. (NZF had never agreed to the surcharge, and had stayed outside the Accord.)

The Act Scheme: Commercialisation by Two Piers
* The proposal is for a compulsory occupational scheme, with an opt-out once an individual’s fund reached a level that would generate a particular annuity. There would be a minimalist abated first-tier scheme for those who did not generate sufficient contributions to reach the annuity.
The Act proposal came from the radically different two-pier tradition. In some ways it was a return to the pre-1973 Labour scheme, resurrected by Roger Douglas, who had been a major supporter of it. The proposal became the basis of Act policy. But Act found its compulsion unsatisfactory, and modified it so that an individual only had to contribute up to the point where the individual’s fund could pay an annuity equal to the current level of NZS, at which point the individual could opt out. Given that individuals would be closely involved in managing their own funds, and that the funds would have a private corporate management, the Act proposal amounted to a substantial government withdrawal from involvement in retirement provision, a commercialisation of state superannuation.

In order to make the Act scheme appear attractive, it was presented as a benefit-determined scheme (where the retirement income is set independently of the contribution – if any), even though it was designed as a contribution-determined scheme (that is, one where the retirement income is determined by the contribution plus returns on investments, annuitised over the expected life of the retiree). First-tier provision is necessarily benefit-determined, for there is no personal contribution, and the state promises a particular level of income. Third-tier provision is necessarily contribution-determined, since the contributions plus the return on investment determine the eventual income to the retiree. In principle, second-tier provision is contribution-determined, but it is often misleadingly presented as benefit-determined – that is, contributors are assured that if they join this scheme they will receive a particular income (benefit) level at retirement. It is possible to make a second-tier scheme benefit-determined, but that requires a guarantee from an external agency – typically, the government [8] – since no market investment can ensure the return to give the required benefit level. [9]

To make the scheme appear even more attractive, the advocates project exceptionally high returns on the funds (without mentioning that workers would have to pay higher interest on their house mortgages). They use the average adult wage as the benchmark, although almost three quarters of working-age adults have an income less than the average wage. [10] Thus many people would still need first-pier state support, so that it is a two-pier scheme. Fully implemented, the scheme would favour the rich (Act’s main constituency) by lowering their taxes (since the first pier would cost less than a first tier), while the poor and middle-income groups would be worse off.[11]

The New Zealand First schemes

NZF’s proposal for retirement came from two different sources. One was Winston Peters’ promise to repeal the superannuation surcharge, imposed in 1985 and increased in 1991. Second, NZF’s economic nationalism included concerns with the purchase and increasing ownership of New Zealand productive assets by foreigners. To restrain or reverse this, it was necessary to increase domestic savings.

Initially the party considered a compulsory contributory earnings-related provision not unlike the pre-1973 election Labour scheme. However the proposal proved unattractive, for the same reasons that the Labour scheme was abandoned: it required high rates of returns, did not give a guaranteed minimum, and the transition problems were horrendous. So while in opposition, NZF shifted support to a scheme similar to the 1974 Third Labour Government’s scheme, in which there would be a universal first-tier scheme on top of which there would a second tier of a compulsory contributory earnings-related scheme (both being taxed but not abated). Anybody familiar with this NZF two-tier scheme would be well aware that it was deliberately designed to be very different from the Act two-pier proposal.

Peters stated that he saw this scheme as a defining characteristic of the party. During coalition negotiations both National and Labour separately agreed that a contributory retirement scheme would be put to a referendum in 1997. However, the ‘Retirement Superannuation Scheme’ (RSS) announced for the referendum was not the NZF proposal but the Act one. Of course it had greater detail than Act had proposed, but basically it was a two-pier scheme in which individuals could opt out of the contributory scheme once their fund achieved the target annuity. How did this come about?

I have read the officials’ papers that went to the Treasurer. They do not distinguish the various alternatives – say, between piers and tiers – and the reader of the official papers could well have been confused by the presentation. One is left with the impression that the designers had their own vision for retirement provision. One might understand how the right wing in the National–NZF cabinet might have been attracted to the Act-type scheme, but it is a puzzle why Peters dumped the NZF scheme in favour of the Act one. Given a common policy framework of commercialisation, it is conceivable that the Treasury had a parallel proposal to the Act one at the time of the 1996 election. Moreover, the RSS scheme was consistent with the general Treasury approach to reduce taxation and reduce its (i.e. the government’s) exposure to future risk. The RSS scheme shifts responsibility for retirement provision from the state (via NZS) to individuals (via their compulsory contributions). Given that the transfers involved in NZS are large (about 8 percent of GDP), the Treasury might be expected to find attractive a proposal to shift to a scheme in which it had less involvement. However, I am informed that the Treasury preference was quite different. The origins of the RSS are a mystery.

The RSS referendum and its political consequences

Attractive though the scheme was to the commercialisers, it was unattractive to the public – exceptionally unattractive. In summary, the RSS scheme meant that over half of the population (including most women) would not be beneficiaries, since their second-pier lifetime contribution would be insufficient to provide the target annuity (equal to the current NZS level). They would get a top-up from the government to give them the target annuity, so that their lifetime contributions would be of no value whatsoever, because irrespective of how much they contributed they would get the same retirement income. Moreover, the paid superannuation was to increase with prices but not with wages. Historically wages have grown at about 1.5 percent p.a. faster than prices, and so as people aged their relative income would fall under the RSS. Only the very wealthy would benefit from the scheme, because of the lower taxes. On average individuals would pay higher taxes (including their contribution to the fund) up to the year 2030.[12]

After a lacklustre campaign, for the outcome was seen to be a foregone conclusion, the referendum was lost by 91.8 percent to 8.2 percent, on an 80.3 percent turnout. It was a devastating defeat of the Act scheme, although it was NZF, rather than Act, which suffered the ignominy. The distinct economic policy component that NZF appeared to offer had been decisively rejected. What positive and progressive policies did NZF now stand for? It was left as a party of grievances in opposition, which might – or might not – remedy them in government. Arguably the RSS referendum was the point where NZF lost any chance to offer a distinctive economic alternative to National. In the rest of its short future in government, it was consigned to representing the centre flank of the National-led coalition.

The referendum failure also led to the demise of NZF in government. Cabinet ministers were allowed to express personal views on the referendum. Jenny Shipley publicly rejected the proposal, giving herself a public launch pad for the strategy which eventually toppled prime minister Jim Bolger, who had supported the RSS. Shipley then used her premiership to out-manoeuvre Peters politically, leading to the end of the coalition government in July 1998.

And yet retirement provision was to damage Shipley politically. In October 1998 her government announced and legislated that the married couple rate would be allowed to go below the 65 percent of the net average wage – the agreed floor of the 1993 Accord. The new floor was to be 60 percent, and there were hints that it would eventually be lowered to 55 percent. The government argued that it was continuing to increase the benefit in line with inflation, as had been occurring since 1991, so NZS’s real value was not diminished (but its level relative to other incomes would be). It claimed that no one would be worse off, but that it would save $2.5 billion over ten years, an achievement greater than the miracle of the loaves and the fishes. The public saw this as a betrayal and, to compound the irony of ironies, the fortunes of NZF lifted.

The rejection of the Act scheme by referendum was evidence of the strength of MMP. Arguably, had National been returned with a majority WTA government, the RSS scheme would have been proposed, accepted, and blitzkrieged into implementation. The referendum process prevented any blitzkrieg. The referendum outcome was a triumph for MMP.

The future of retirement provision: an accord?

The commitment to a universal first-tier retirement provision appears to be a fundamental part of the culture of New Zealanders. First discussed in the nineteenth century, and implemented from 1938 by stages, it has become such an integral part of their vision of themselves and of their governance that it could not be abolished. Even tampering with it can be unpopular, as the Third Labour Government found in 1975.

The failure of the RSS referendum, plus the break-up of the 1993 Accord, put retirement policy into a limbo. The policy instability meant that there was an uncertainty as to whether the existing provisions would continue long enough to enable people to plan with any confidence. A popular demand – arising from that fundamental culture – is for a new accord, but an old-style accord probably cannot be reconstituted. It was created under an FR/WTA parliament, when only the two main parties mattered. Parties seeking votes are analogous to firms seeking market shares. Under FR/WTA, there are really only two firms in the market, since any other entrant is unlikely to win sufficient seats to be an effective part of government. It is in the interests of oligopolists to reach agreement on the conditions of sale of any particular product they are both providing (especially where the cost, as in the case of retirement provision, is very high, without a great return – vote winning is a zero sum game; for every vote or seat one party wins, another loses it). Thus the Accord was a means whereby Labour and National could limit fiscally expensive competition over retirement policy. Not surprisingly, the Accord broke up as soon as MMP loomed. Smaller parties had an opportunity of winning sufficient seats to have a chance of influencing government.

In principle, any party which creates a policy attractive to five percent of the population (to get across the party-list threshold) will have that chance. The elderly are a rising 12 percent of the voting population. However, while there is a tendency to treat the elderly as homogeneous, they have diverse interests, so that subgroups may be targeted. For instance, the removal of the surcharge was beneficial only to the top third of the elderly, at a fiscal cost of around $2.5 billion over ten years.[13] Shortly after having eliminated the surcharge, the government changed the rule for calculating the benefit level, with a net fiscal gain of around $2.5 billion over ten years. In effect, the income of the bottom two-thirds was being lowered, to increase the incomes of the top third.[14]

In the long run, political parties will cease seeking support from all the elderly, because it is too costly – in any case, no single party is going to win them all – and instead will target segments which are compatible with the overall party philosophy. Because of the competitive process, there cannot be an old-fashioned accord – that is, a comprehensive agreement on retirement policy agreed by all the significant parties – for it will always be in the interests of at least one party to break away and offer another deal to attract a greater share of elderly (or other) voters.

Instead, a more flexible version is likely to evolve. The signatory parties might agree as follows:
* there should be a first-tier government-provided universal retirement benefit called ‘New Zealand Superannuation’;
* there would be an age of eligibility;
* the benefit would be treated as taxable income;
* the rate of NZS would be set according to a formula based on price and wage indexation;[15]
* the rates for couples and singles would differ according to a fixed formula;
* those below the age of eligibility would be entitled to an abated benefit if their circumstances warranted it;
* second-tier provision would be either voluntary or compulsory;
* there would or would not be specific subsidies (or exemptions) for second-tier and third-tier provision.

Each signatory party would attach a schedule which would describe how it would meet the optional provisions. The advantage of such an accord would be that it provides a framework for agreement and disagreement. By setting down a set of key parameters, it makes clear and easily comparable what each signatory party stood for. It seems likely that at least one significant party would not be a signatory, since judging by the referendum result there appears to exist a group of between 5 and 10 percent of the population who do not favour tier provision, but prefer an RSS/Act pier-type scheme. Conversely, such an accord can exist because 90-odd percent of the population support its structure, even though they may not agree on the details.

But is such a scheme, or indeed any retirement scheme, sustainable, especially as the porportion of the elderly in the population increases? The crucial issue is the share of the available consumption which goes to the elderly. When there are proportionally more of them, their share goes up, unless their relative standard of living falls. There is a case for trimming the cost of NZS, which means – even if the politicians won’t say so – reducing the share of available consumption of some of the elderly. There are three broad options.

First, the level of benefit could be cut relative to other incomes (as occurred in the October 1998 change which reduced the floor of the benefit relative to the average wage).

Second, the age of eligibility could change. It is being phased up to 65. The long-term age could be raised further to, say, 67, on the basis that people in their sixties are fitter and have a longer life expectancy now than in the 1890s, when the age of 65 was first chosen. In effect, people would be expected to work longer into their sixties, and to provide some private retirement cover up to 67 if they choose to retire early. Any raising of the age of eligibility requires adequate warning, and there needs to be a scientific debate on the biological, social, and economic aspects of ageing in the 60–69 age group.

And third, some abatement (such as a superannuation surcharge) on the high-income elderly could be reintroduced. [16] This particular policy option will not go away, and it is sufficiently logical to lead to the question of how it may be imposed. To be sustainable, it has to be announced in an election before it is implemented (in contrast to the 1984 and 1991 impositions which were surprise reversals of election promises). The abatement on the rich elderly will probably be proposed by a party whose voters are at the lower end of the income spectrum, and who will offer some offset to the poor elderly. It cannot just be presented as a fiscal saving measure. One possibility would be to phase in the surcharge from 2001, the year after the age of eligibility reaches 65, but to impose it only for those in the age range of 65 to 74, so that a universal unabated benefit would be available for the oldest elderly.

Prospects for a compulsory second tier

The 1993 accord assumed that any second-tier provision would be voluntary. Is there a place for a compulsory second-tier scheme, on top of NZS (as proposed by the Third Labour Government and by NZF out of government)? Any early introduction seems unlikely given the rout of the – albeit radically different – RSS in the referendum. A possible path is through the incremental development of voluntary occupational schemes.

To make such schemes more attractive, there is a case for converting them to a type where contributions and fund earnings are tax-exempt, but annuities and other payments from the fund are taxed. This is known as EET, in contrast to the current TTE arrangement, where fund contributions and earnings are taxed and payments are exempt.[18] The current arrangement suits the Treasury, but the alternative is likely to be more acceptable to contributors since they do not trust the politicians not to change the rules and tax (or double-tax) their retirement incomes. The fiscal balance aspects could be largely covered by requiring these EET funds to hold 20 percent, say, of their assets in government securities (matching the contingent asset implicit in the EET system, and maintaining fiscal balance).

People do not behave with the rationalism of the economic theory on which commercialisation was based, especially over their savings. The standard economic theory of individual behaviour is contradicted by the evidence of irrationality (or ‘quasi-rationality’).[18] In practice, as has been attested by numerous studies, the major predictions of economic rationalism fail.[19]

Richard Thaler’s summary of observed human savings behaviour gives the following rules:
1 Live within your means. Do not borrow to increase consumption except during well-defined emergencies (such as unemployment).
2 During emergencies cut consumption as much as possible.
3 Keep a rainy day account equal to some fraction of income. Do not raid the account except in emergencies.
4 Save for retirement in ways that require little self-control.
5 Borrow only on the security of a real asset.

Each rule, widely practised and generally thought prudent, infringes the economic rationalists’ theory. The fourth point has significant implications for retirement policy. We are not very good at saving unless there is a contractual element. We save by paying off the house mortgage or contributing to an occupational pension or life-assurance scheme. Berating us, as economists and government officials are wont to do, will not markedly raise savings, unless it induces us to contract into a compulsory long-term savings scheme (even though the contracting may be voluntary). Despite our best intentions, putting a little something aside each week for our old age will not generally succeed in providing a decent retirement income, unless we are forced to do so. On current policies it would appear that many New Zealanders are going to have a miserable old age.

The behavioural logic suggests that there is some merit in a compulsory second-tier retirement provision. Such proposals outrage economic rationalists. They have imposed their ideology’s narrow conception of the human condition on the public. Those who do not share it should be punished with an impoverished old age. Despite their claims to be liberals, the economic rationalists are fascists about personal behaviour, demanding ‘behave according to our rules, or our policies will punish you.’

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