Does New Zealand Superannuation provide an adequate income for older Kiwis?

New Zealand Superannuation has many appealing features#

What I am going to say now may sound shocking:  We at the Treasury are fans of New Zealand Superannuation. We think it’s a good way to ensure that New Zealanders have a decent standard of living when they retire.

But we also recognise that New Zealand Superannuation is a cost in the Crown accounts that will increase very significantly over the coming years. We must find ways to manage the cost and make the trade-offs necessary to ensure that New Zealanders have a good standard of living when they retire.  I’ll talk about some of these trade-offs later. 

New Zealand Superannuation has many appealing features.  It is universal.  If you satisfy a residency test, you receive it from your 65th birthday, whether you have been in paid work all your adult life, or worked part time, or not at all.  And it doesn’t depend on your previous income.  You receive it even if you are still in paid work and so it has much less effect on your decision to work, or not, than other pensions around the world.

The amount you are paid rises with inflation or the average after-tax wage.  So in general you keep up with the rising standard of living through the remainder of your life.  Those are powerful positives.  At present, if you stop working on a less than a half of the average wage, New Zealand Superannuation replaces that wage level well.  If you are working on higher wages, New Zealand Superannuation payments may need some top-up from your savings if you want to maintain your standard of living. 

Older Kiwis have the lowest poverty rates in the OECD#

Using the OECD's income poverty measure of half of median household income, the latest available figures show that New Zealand has the lowest poverty rate for people 65 and older in the OECD.  And that reflects on the adequacy of New Zealand Superannuation.  We are doing something right.  We wouldn’t see these results, I believe, if New Zealand Superannuation payments didn’t grow at least with inflation or the levels were reduced.

So far, New Zealand has been able to fund New Zealand Superannuation from current tax dollars.  It costs about 3½% of GDP after tax and that’s a modest cost for a publicly funded pension in the OECD. [1]

People are living longer#

So far, so good.  As with many other countries, our demographic projections indicate that our life expectancy will continue to rise.  A person turning 65 in 2050 would expect to live another 24 years if mortality rates stayed the same from that point onwards.  That’s 4.3 years more on average than a 65-year-old now. Contrast this with the situation in 1950 when a person turning 65 could expect on average to live a further 14 years.  So 60 years ago, at 65 you could expect you had 18% of your life left.  In 2011, that’s risen to 23% and could rise to 27% in 2050. 

What’s more, you are likely to live more of these extra years in good health.  Some positive health trends are the falling incidence of smoking and cardiovascular disease, but the negative trends of rising rates of obesity, Type 2 Diabetes, and dementia such as Alzheimer’s are cause for concern.  Overall, though, the projected longer and generally healthier lives are a welcome result of population ageing.

Longer lives mean growing numbers of people 65 and older.  Statistics New Zealand projects that this group will grow from just over half a million now to 1.3 million in 40 years’ time.  Combine that with projections of who will be working in the future:  more people 65 and older will be in work, based on current trends.  We assume this rise will continue, and it places New Zealand around the top of the OECD for older people choosing to continue working.  For many, that’s a good result and points to better health, maintaining independence for longer, more connectedness, and more savings for the time when we wind back from work. 

Because the proportions of people working fall after age 60, as the share of the population over 65 grows, the numbers of those working in the population and overall hours worked will tend to fall, even though we assume more and more older people will choose to continue working.  This means that output growth and hence tax revenue growth will slow with population ageing.

Living longer is one driver of population ageing.  The other is lower fertility.  Over the two decades after World War II, we saw a flurry of fertility – the baby boom – that has had a profound effect on the structure of population, the labour market and the shape of our cities.  For a time, it lowered the average age of the population. It led to a surge of activity in the education system.  It boosted the growth of suburbs, and later led to the renewal of the city centres as places to live.  And now the children and grandchildren of the baby boomers are flowing through the education system.  Fertility fell in the 1980s and is now just above the replacement rate.  This lower fertility adds to population ageing in the future.

Statistics New Zealand expects fertility rates to settle back a little over the next decade.  As a result, population projections show a falling share of those of school age in the population. 

Poorer social outcomes for children#

Our children aren’t doing as well as our older citizens. The OECD estimates that in 2004 15% of New Zealand households with children aged 17 and under lived on an income below half of the national median.  In addition to relatively high child poverty levels, we rate poorly in the OECD for children’s health.  Despite New Zealand’s good average educational performance, gaps in education between the top and bottom performers are higher than they need be, according to the OECD.  And many of those emerging from tertiary education have high large levels of debt.

So we have a picture of growing proportions of people 65 and over, living longer and healthier lives.  At the same time, we also have relatively fewer younger people, often doing more poorly than their grandparents, and a static, or even shrinking, labour force, despite the rising numbers of older people remaining at work longer than the previous generations.

Population ageing puts increasing pressure on government budgets#

Population trends affect government spending and revenue.  One way of looking ahead is to take past spending and revenue trends and combine them with the population projections.  Under this scenario, spending on benefits could fall as a proportion of total income because the growth of benefit payments is closer to inflation rather than income growth.  Changing the way we administer and target benefits may also reduce the overall numbers.  Spending on education is likely to be less than overall income growth because we are unlikely to see student numbers growing as fast as total population.

Spending on health will rise, because of higher proportions of people moving into the parts of their lives when they need greater health care and long-term care, and because of rising costs of new health technology. With the numbers of people receiving New Zealand Superannuation more than doubling, we expect a doubling of the cost of New Zealand Superannuation as a share of total GDP over the coming 40 years.

Our spending priorities today are not the same priorities of a generation ago.  Without some rethinking of priorities in the future, these population trends imply overall spending growing faster than revenue. This means increasing deficits, rising debt, feeding back into larger borrowing costs and deficits and more debt. 

That’s a fairly simple picture that assumes no response to an increasingly unbalanced position that couldn’t be sustained for long.  Already changes are happening that may mean that a simple trend extrapolation won’t be where we’re heading.

Within the next decade, for example, people who hadn’t saved much in the past may have accumulated tidy nest eggs in their KiwiSaver accounts.  Working a bit longer will also help.  Both of these changes may mean they would be able to pay more of their accommodation, health and livings costs without government assistance after they stop working. 

On the other hand, part of New Zealand’s achievement of low poverty rates among older people is due to the fact that they have managed to pay off all or most of their mortgages by the time they stop working.  Recent reports suggest, however, that home ownership rates are falling.  This could mean that when they turn 65, more people will still be renting or have relatively large mortgages and will use more of their income to pay for accommodation. 

Debt run-up cushions impact of earthquakes and global slowdown#

The Government has announced it wants to get budgets back into surplus earlier than was indicated in the 2009 Budget.  Earlier surpluses will give us more time to get debt down before the pressures from an ageing population begin to mount. 

New Zealand is facing some hard choices over where to spend our tax dollars.  Spending pressures are growing in the wake of the Christchurch earthquakes and a stronger but riskier international picture.  In the Treasury’s mid-year projection, net debt was expected to be just under 29% of GDP in 2015, but we would expect the Christchurch earthquakes, a generally sluggish economy and international events would be likely to push this higher, if additional savings were not made.

NZ faces choices over how to restore the long-term debt buffer#

As a country, we have a set of broad choices each with trade-offs to ensure debt levels grow more slowly than GDP in the long run.  We could allow debt to rise, but then we’d face rising financing costs squeezing other spending. On the other hand, we could push debt down as a ratio of GDP to, say, 20% in the longer term to restore a cushion against adverse events (such as another major earthquake or another global recession).  20% has been the government anchor for some time.  This lower debt might be achieved by putting up taxes to pay debt down and also to pay for the rising spending pressures.

Further out, we could pay for rises in health and New Zealand Superannuation via higher taxes ...#

We have looked at how much tax would have to go up to counter spending pressures from the growth of New Zealand Superannuation, health and other areas.  Our estimate is that from the early-2020s onwards the GST rate might need to rise to 19% from the present 15%.  As in the last rate rise, those on lower incomes would require some assistance to compensate for the higher GST.  And a higher rate might prompt more tax avoidance.  So not all of this GST rise would be available to hold debt down over the longer term.

If, instead of a higher GST rate, the rise occurred in our personal taxes, then we’d need to pay an extra 3 percentage points across the board to achieve the same debt track.  For a person on the average wage, the tax rise would be around $30 a week in today’s money.

The downside is that higher taxes could see reductions in investment and income growth generally and perhaps a further exodus of younger, skilled people across the Tasman, or to places beyond.

Bluntly stated, the choice faced by the young and old in 15 years’ time could be: Pay higher taxes to maintain New Zealand Superannuation and heath spending at today’s settings, and grandparents may increasingly need to fly to Melbourne to visit their children and grandchildren.

Another approach might be to improve productivity – get more output per hour worked – in the overall economy, and in particular in the delivery of public services.  A recent speech by my colleague Andrew Kibblewhite at the Institute of Policy Studies reviewed Treasury thinking on the role of public sector performance in economic growth.  If public sector performance lifted, we could afford to pay more collectively for education and health, or we could maintain these services as population ageing pushes up demand for them.  A counter to this approach is that we haven’t seen a sustained rise in overall labour productivity in the past.  And measuring public sector productivity and efficiency is tricky.

... or we could trim or reprioritise spending#

What else could we do?  We could look for ways of reducing spending, perhaps in areas where priorities aren’t quite as high as they were in the past, or by directing spending more towards people who need the help.

Suppose, for example, we keep New Zealand Superannuation and benefits as they are now, hold tax rates as they are now and set a target of maintaining net debt at around 20% of GDP over the long term.  Then that would require reducing the average amount of other government spending per person by about 7.5% in today’s dollars from the early-2020s and onwards.  Keeping debt under control will require some cut backs in spending and these will affect different age groups differently. 

If the reductions occurred in welfare spending, then we’d likely see a rise in child poverty as this is concentrated now among beneficiaries. On the other hand, we could reduce spending in those levels of education where attendance is not compulsory – at the early childhood and tertiary levels.  The downside of this might mean lower skills and lower labour productivity growth in later years. 

You see these are not easy choices. They all involve pluses and minuses.

What’s a fair share in spending between the old and the young?#

Where should we set the balance between maintaining low poverty rates of older people and the high poverty rates experienced by children?  How do we balance the levels of education many people aged 50 and older received in the past, against some of the poor educational outcomes among our young people from early ages?  How do we decide between cutting the quality of public services for all, or providing better services just for the poor and vulnerable?  Perhaps we might trade off paying New Zealand Superannuation to everyone 65 and older, but with slower growth in levels, versus paying New Zealand Superannuation, growing as it does now, but only to those who are less well off.

We could also save more collectively in the New Zealand Superannuation Fund, once we return to surpluses, and take advantage of good investment returns here and abroad.  From the mid-to-late-2020s, we could then draw from the Fund to help pay for New Zealand Superannuation.  In other words, use it as it was designed, but increase the contribution rate. This would take some of the pressure off future budgets. This is not costless:  Larger contributions to the New Zealand Superannuation Fund over the next decade mean lower spending or higher taxes with possible consequences for economic growth over this period.

With more retirement saving being done by individuals, through KiwiSaver or other means, perhaps some of the revenue going to New Zealand Superannuation could eventually be directed towards early childhood education, or to health spending in general, or to pay down debt.

When public pensions have been changed abroad, governments have announced changes with plenty of lead time to allow people to adjust their private saving patterns.  The Australian government initially gave its citizens a decade to acclimatise to the change.  Last December’s Retirement Income Policy Review followed this principle in recommending graduated changes to the age for taking up New Zealand Superannuation starting in 2020, along with changes in the rate it would grow through time. 

If nothing changes, the future funding of the increased costs of New Zealand Superannuation, health and long-term care will need to come from somewhere.  The challenge for New Zealand is to get an agreement about the trade-offs and phasing that would endure through time. 
In the end, adequacy of income for an older Kiwi means having enough to make ends meet and having enough for unexpected events. 

It’s the same for New Zealand.

ENDS