4.2  Households

4.2.1  Incentives and disincentives for household saving and building wealth

The following incentives and disincentives affect both the amount households save and the composition of assets that they choose to hold their wealth in:

• Asset price inflation: When asset price inflation is high – as in the mid-2000s when house prices in New Zealand were rising strongly – households try to increase wealth by borrowing to buy rapidly appreciating assets, rather than by saving part of their income. The effect on saving from the purchase and sale of assets of this type depends on how fast the new owner pays off the loan and how fast the seller consumes the proceeds. Generally, low rather than high house price-inflation is a better environment for strong household saving.
• Interest rates: Nominal interest rates began to decline in the early 1990s, as CPI inflation fell to low levels. Other factors encouraged the decline, such as the deregulation of the financial sector both here and overseas, which increased competition among loan providers. Growth in the surpluses of emerging economies and oil-producing countries also provided a growing source of funds for developed economies and also had a downward impact on interest rates. For the household sector, low interest rates tended to make saving, especially saving in bank deposits, less attractive. Conversely, together with deregulation, they made borrowing and the advance of consumption more attractive.
• Monetary policy: Interest rates were reduced sharply following the onset of the GFC (GFC) to stimulate the economy. So savers who were using interest-bearing instruments seemed to miss out twice – firstly during the earlier period of faster credit growth and relatively low interest rates - when higher interest rates might have had a useful moderating influence, and secondly during the post-recession period when nominal interest rates were very low to encourage growth. Savers lost out at both ends!
• The rise in household debt: The fall in nominal interest rates that began in the early 1990s meant that households could borrow more to buy houses. While banks would still set limits on borrowing – such as mortgage costs not exceeding 35% of household income – households could now borrow significantly larger amounts than previously, within the lenders' criteria. However, the rise in borrowing was accompanied by a rise in total interest payments, and these payments have over the years risen as a proportion of total household income. They have therefore had a downward impact on disposable income, which in turn has reduced the household sector's ability to save.
• Contractual saving: Research indicates that households are better savers when there is a regular contractual commitment – such as contributing to a superannuation scheme or paying off a mortgage. Payments into superannuation schemes began to decline after tax concessions ended in 1989, although they have risen again recently with the introduction of KiwiSaver. Home ownership rates have been falling in New Zealand since 1990, so a smaller proportion of the population can use “repaying the mortgage” as a saving strategy. More interest-only loans, especially during the period of high house price inflation in the mid 2000s, also reduced repayments of mortgage principal and therefore saving.
• Subsidies: Theintroduction of the KiwiSaver scheme has made saving more attractive to households as employers and government, as well as employees, make contributions to it. Some housing subsidies are available to first-home buyers, but the scale of these subsidies is less than in other countries, such as Australia - and housing subsidies have not prevented a fall in home ownership.
• Taxes on saving: Under an income tax, income that is saved gets taxed twice – when first earned and then as tax on the returns to savings (e.g., interest, dividends etc). In addition, the money will be taxed again under GST when it is spent. In contrast, income that is spent immediately is taxed only twice – as initial income and when it is spent. This differencedistorts the decision to save and delays consumption spending. For this reason, national saving is likely to be enhanced by lowering income taxes and raising expenditure taxes. Other tax issues arise from the tax treatments of capital gains, owner-occupied housing, and rental housing; and the over-taxation of interest income and over-deduction of interest expenses because of inflation. Further discussion of these tax treatments follows later in the Report. Overall, an incongruous and distorting outcome of current tax policy is that simple saving products, such as a fixed-term bank deposit, which produce no capital gains or opportunities to write off expenses against taxable income, end up having the highest effective tax rate, by a substantial margin over, for example, housing.
• The New Zealand share market: Households tend to have a home-market and domestic-company investment bias but there is a limited choice of New Zealand stocks in the small and slow-growing New Zealand market. The NZX market capital-to-GDP ratio is about a third of the ratio in Australia, the UK and the US, and total returns from the New Zealand market over recent decades have been lacklustre, compared to other investments such as housing, and more volatile. Overall then, investing in the share market has not been a driving force for saving, although the thinness of the New Zealand share market might also be partly due to the low levels of domestic saving.[6]
• Financial market events: A large quantity of savings has been lost since 2007 from the failures of non-bank finance, property and other companies. Some savers were severely damaged and discouraged by this experience and there has been a fall in confidence in markets, institutions and advisors. While some steps have been taken to increase the oversight of non-bank finance companies it is not yet clear that these are adequate or will be effective. The wider impacts of the GFC have also reduced confidence in financial institutions and their saving products.
• Housing market events: A positive impact of the GFC on saving has been the strong recent moves by households to increase housing equity. Prior to the recession, households had been withdrawing equity from their houses, increasing mortgages for more spending money. But, since late 2008 the household sector has been increasing its equity in housing by paying down the principal on mortgages and this turnaround is showing in household saving figures. However, this effect may well be largely cyclical and short term, and go into reverse when normal economic growth resumes. In addition any increase in interest rates will make it harder to repay debt.
• Disclosure, confidence and other issues: Information on saving products is often not clear, complete, easy to understand or appropriate for products in the retail market, and information on fees and charges generally may not be clearly, fully or accurately stated. Essentially, the superior knowledge of the industry must be balanced by the quality of disclosure and the rights of customers. The recent experience of numerous company and other failures, large losses and a loss of confidence in advice, is a serious disincentive to saving. In addition, many household investors are likely to have difficulties in finding suitable information and advice on investing offshore: tax returns – accounting for overseas investments – are complicated, and currency risk is a factor.
• Financial literacy: A low level of financial literacy, and a lack of understanding about the relationship between risk and reward, can result in bad saving experiences and inhibit further saving. But, if disclosure is to a high standard, then the responsibility should lie with the customer, who should have a reasonable level of financial literacy.
• Growth in household incomes: In general, people will find it easier to save when incomes are high and rising, but New Zealand incomes have been relatively low by OECD standards, and slow growing particularly in the lowest five income deciles. On the other hand, periods of slow growth and uncertainty are likely to encourage precautionary saving.