Means Tested NZ Super

A speculative post by PaulL, sometime poster and regular commenter.

There are many on here who point out that NZ Super recipients are NZ’s largest class of beneficiary, and the only one that isn’t means tested. And furthermore, that NZ Super is becoming increasingly unaffordable with current settings. These things are true.

There are those on the other side who claim that NZ Super should be an entitlement because current retirees have paid in for decades, and are now getting back what they funded. This is demonstrably false, because those same retirees haven’t bequeathed current generations a large savings pool. It is true that current retirees voted themselves income in retirement, but at the same time they voted to spend all the money on the way through, so effectively they’ve voted that other people (current generations) should pay for their retirement. I can see why they might do such a thing, but it’s not a principled “we paid into a savings scheme, now we want our savings out.”

There is, however, some truth that current retirees bequeathed future generations a large set of assets – roads, institutions, power generators etc etc – all the current assets of NZ that each citizen enjoys a one in five millionth share of. I haven’t done the maths, but it’s certainly arguable that this asset base that is gifted to each new citizen is more than is being asked for in retirement income.

I’m ignoring all that in this post. Instead, I’m asking the question of whether it’s economically defensible for NZ Super to remain universal.

NZ doesn’t have a substantial tax advantaged retirement savings scheme, as compared to, for example, Australia. The Australian system provides tax breaks for retirement savings up to a cap, with contributions concessionally taxed and complex thresholds and maximums throughout to limit benefits for the wealthy. All eligible savings must be through an approved savings vehicle that locks the savings in until retirement, to avoid people pocketing the tax credit then spending the savings pre-retirement.

The justification for this regime is that people who save for their own retirement reduce the expenditure by the state in retirement, and the tax credit provides encouragement for that to occur.

I don’t love the Australian system. It has some advantages compared to NZ, but many of the commercial super scheme providers are outrageously useless, providing poor returns and very high management fees. The union backed schemes are in some ways worse – they provide higher returns, but they also launder money that is fed into the union movement in the form of sinecures for grossly unqualified directors who are union-tied. Employers find it easy to give unions a monopoly on super schemes through award negotiations (costs the employer nothing), and this is parlayed into kickbacks and corruption of various sorts.

All of this is ultimately due to the compulsory nature of the savings, and the lock in to a small number of schemes that are administratively compliant. The administration is an industry in itself on both the government and industry side.

I want to propose a different structure. Rather than lock-in and tax credits on entry, I suggest that those are largely equivalent to allowing people to save however they want, and providing tax credits on exit. Your savings grow more slowly (by the amount of tax on entry), but your payments are increased (by the amount of the credit on exit). To illustrate, I’ve created a simplified example with only a single contribution:

	Credit on Entry Option	Credit on Exit Option
Gross Savings	$50,000	$50,000
After Tax Savings (assume 40% marginal rate)	$50,000	$30,000
Compound returns for 30 years @ 8%	$503,000	$302,000
Gross income in retirement @8%	$40,251	$24,150
After tax income in retirement (assume 40% marginal tax rate)	$24,150	$24,150

One difference is that your marginal tax rate when you pay in is likely higher than your marginal tax rate when you draw out, and for that reason tax credits on entry may be more attractive. I’m ignoring this for the purposes of this post.

What if we restructure NZ Super so it’s no longer universal, and provide a tax credit for those with retirement income? We’d have:

• An income tested NZ Super, with a 50% abatement rate kicking in on the first dollar of retirement income. Note that “retirement income” would explicitly exclude salary and wages, to avoid discouraging part time work
• A tax credit on any “retirement income” earned by someone over 65, to reflect that that income is saving the taxpayer money. This tax credit would be set at 41.25% (based on a marginal tax rate for most taxpayers of 17.5%, 100-17.5=82.5, divided by 2 = 41.25%), which would exactly match the 50% abatement rate. The tax credit would be capped at the current value of NZ Super, ~$29K per annum for an individual, matching the current NZ Super value

Similar arrangements would be made for couples, with more complex tax treatment.

I think this structure is economically defensible. An income tested retirement benefit is justifiable the same way the unemployment benefit is defensible – someone without any retirement savings should not have to live in penury. Income testing that with an appropriate abatement rate to encourage people to save for their retirement is also defensible.

Providing a tax credit for those who save for their retirement is also defensible. As I noted earlier, it’s essentially the same thing as concessionally taxing savings, but it has the benefit that we don’t need any administration on the super savings schemes. You save or you don’t, you pay down your mortgage, or you invest in your business, or you save in a sharemarket account – all these are now your own choice. You can choose the best savings product for your own situation. If you have savings in retirement that generate income, we give you a tax credit to say thank you. This tax credit may be a little less generous than if we’d had a tax credit on entry (for reasons of the marginal tax rate as discussed above), but it is better than what you currently get in Kiwisaver.

I’ve carefully constructed this structure to give the exact same outcome as a universal NZ Super. Whilst this new arrangement is somewhat more economically and politically defensible, the reality is that universal NZ Super is a superior scheme. My new scheme does the same thing, but at the cost of involving two separate agencies (IRD and WINZ), and with a lot of complex administration as to what counts as retirement income and what doesn’t, whether someone drawing down assets counts as retirement income, and whether someone working counts as retirement income.

In some sense NZ Super is a very elegant way of achieving exactly the same outcome with very low administrative cost.

An entirely separate point is whether it will be necessary to raise the age of eligibility for NZ Super over time, which I absolutely think will be necessary, but won’t be possible so long as NZ First remains holding the balance of power.

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