Pensions move a super-sized mistake

BY ROD ORAM

For better or worse, superannuation is back with a vengeance on the political agenda. National will regret the Budget that put it there.

Prime Minister John Key has done himself irreparable political damage, just as Muldoon and Bolger did before him. What is it about National that makes it so inept on the issue?

Yet, deciding what to promise and how to pay for it is, at heart, not too difficult an issue. Only the politics make it so.

We can make accurate demographic projections. They show the ratio of pensioners to taxpayers is climbing rapidly as our population profile ages. And we can make reasonable but less precise long-term assumptions about investment returns.

It is harder, though, to make assumptions about the economy. If we grow the economy robustly, it will be easier to pay for super in future decades out of taxation of the day. But that doesn't let us off the hook. Higher wages mean higher pensions and we're still stuck with the demographics.

Thus, superannuation policy has to do two things at an absolute minimum. It has to be very long term so people know decades before retirement what pension they can expect from the government and what retirement income they need to provide themselves through savings.

The policy must also be subject to regular review not so politicians can change the framework on a whim but so we can see how we're tracking. The financial analysis will have better and worse years. If adverse trends emerge, we can consider long-term changes.

Abrupt changes, as in the Budget, only discourage savers and damage political credibility.

Apparently oblivious to these basic truths of superannuation, Key has made three big blunders.

First, he has promised he would resign as prime minister if he ever changed the superannuation age. That is an easy pledge to make for short-term political gain. Even if he becomes one of our most long-lasting leaders, he will be long gone by the time his successors have to plug the future pension hole his promise has created.

In other countries, politicians are more sensible. In the recent Australian Budget, Prime Minister Kevin Rudd set the country on a 14-year journey to raise the entitlement age to 67. Similarly the US, which has a younger demographic than we do, is heading to 67 and the UK to 68.

Second, in the Budget, Key locked National in to paying a pension of 66% of the average weekly wage. Again, that's easy to promise. But future governments might need more financial flexibility. If it is a National government, it will have once again broken a pension promise.

Third, Key approved Finance Minister Bill English's decision to suspend contributions to the Superannuation Fund for at least 11 years. They argue it would be silly to borrow in times of budget deficits to keep contributing. Moreover, the Fund was designed to allow such flexibility.

They are wrong on both points. This is a once-in-a-generation time to be investing, particularly if you are an entity with low debt, secure cashflow and a long-term strategy. The great global economic contraction has savaged prices of shares, property, businesses and other assets. Buyers might have to ride out some short-term corrections but they can reasonably expect handsome long-term gains.

Even Treasury says so. The day after the Budget it released its projections for the Fund in light of the government's decision. It expects the Fund to be worth $13.275 billion at the end of this month. If contributions continued, it would be worth $124b in June 2031, the year it would likely start helping to pay for pensions.

With an 11-year holiday, the Fund will be worth $86.5b at the same date, a shortfall of $37.5b. That's a gross number. Interest costs on money borrowed for the contribution would deliver a lower net. But the Fund's return would still comfortably exceed the cost of borrowing.

National painted the worst possible picture about borrowing to invest. It said no sensible household would. But it isn't a household. It is a government. It should be making the inter-generational decisions we need.

Beneficiaries of future pensions should be making some contribution to them now through taxation. We should not leave the entire burden to future taxpayers.

Moreover, National argued it would have to borrow the whole contribution of $1.75b this year, rising to $2b in coming years. But it wouldn't have to. It could have made more savings in current spending than the derisory $500m a year it has.

And it could explore other borrowing mechanisms such as infrastructure bonds that the Fund and public could buy. They would be far preferable to burdening the taxpayers with long-term payments to the private sector through public private partnerships.

The prime minister and finance minister were also wrong to say the Super Fund legislation did not require the government of the day to contribute if it was in deficit.

Under the spirit and letter of the legislation, the contribution is meant to be as much a part of government spending as health, welfare or other big commitments. The calculation of deficit or surplus should come after the payment. It is not a discretionary sum paid only if the books are in surplus.

It was designed this way for a very practical reason. Our public finances are more volatile than other developed countries'. They more abruptly out-perform the economic cycle on the upside and under-perform on the down side. So, the Fund was designed to stop finance ministers over-spending when tax revenues were strong and under-spending when they were weak.

There is a mechanism for the government to suspend payments. But only if it offers a plausible plan for getting back on track. The government says it has with larger payments in the next decade and delaying payouts from the Fund 20 years from now.

The day after the Budget, Treasury gave some updated projections for the Fund out to 2021 to lend weight to the government's argument. To do so, Treasury changed two assumptions from the last modelling in 2000. They lifted the pre-tax investment return to 8.65% from 7% and cut the tax rate to 24% from 33%. These gave a new net return of 6.57% versus 4.69% in 2000.

Treasury has also used updated demographic projections from Statistics New Zealand. Taken together, the changes mean that the total cost of superannuation will be only 5.43% of GDP in 2021, down from 6.75% projected in 2000.

Even if these new assumptions are more realistic, we still need a lot more about analysis of later decades. Thankfully, that is due to come at the end of this month. The government is due to answer 27 big questions the Retirement Commissioner posed in 2007 in her statutory triennial review of superannuation.

The answers will be crucial because there is much more to the entire pension system than just the Fund. It was only meant to be part of a sustainable framework. There are lots of other big issues to wrestle with, such as entitlement age.

Hopefully the answers will help us have the full, constructive debate that's necessary. But we won't have it unless the government can park the politics its three big blunders have stirred up.

- © Fairfax NZ News