Address to Superannuation and Investment Conference, Intercontinental Hotel, Grey St, Wellington
Governments and the superannuation industry have a number of things in common. One of them is the perennial problem of getting people to plan for the long term, and then to remain focused on those objectives. In this regard, we both face the challenge of what might be called 'prudence fatigue'.
Prudence fatigue is the condition that sets in five or six years into a sensible plan for achieving financial security, once a few initial milestones have been passed. It is the temptation to splurge, or to take an extended savings holiday, as soon as one starts to feel that financial security could be within one's grasp.
I am sure individual savers enter these danger zones from time to time. It is particularly tempting after a period in which investments have shown good returns for Mom and Pop investors to cash in their gains, on the assumption that good times are here to stay and they can always resume their savings habits later on. That leaves professional advisors having to remind them of what they would rather forget: that the economy is subject to cyclical changes, and that if one spends all the gains on the upswing one will be left with limited options on the downswing.
It is a hard discipline to leave windfall gains where they lie, and to realise that markets and economies go through predictable cycles. And it is a hard discipline to appreciate that if a long term plan is abandoned it is ver difficult to regain the lost ground.
The same problem exists at a national level. Six years of sustained economic growth have increased the size of our economy by around 20 per cent, and enabled us to achieve some important milestones in terms of the stability of our public finances.
We have succeeded in reducing gross sovereign-issued debt from 35 per cent of GDP in 1999, to slightly over 20 per cent today. Added to that, shortly before this year's Budget the Crown achieved a positive net financial asset position for the first time since the 1850s.
An important element in this has been the strong performance of the Crown Financial Institutions, such as the Earthquake Commission and the New Zealand Superannuation Fund. These institutions made investment gains (unrealised, of course) that contributed $2.5 billion towards this year's operating balance, notably the 19.5 per cent return on assets achieved by the New Zealand Superannuation Fund, which netted $1.1 billion for the Crown's balance sheet during the nine months to March this year.
The Fund now holds assets of around $10 billion, and that is forecast to rise to $23 billion by the end of the decade.
What is also clear from the Budget forecasts, is that conditions will not be so propitious for the Crown’s accounts for the next few years. Treasury is forecasting that GDP growth will fall from 3.7 percent in the year to March 2005 to 2.1 per cent in the year to March 2006, and will bottom out at 1.0 per cent in the year to March 2007.
This will impact on the government's finances starting from next year. The current year will be the last for some time to see a cash surplus. Instead, cash deficits are forecast totalling $7.4 billion for the forecast period. The deficit will be $1.5 billion for 2006/07, rising to a peak of $2.7 billion in 2008/09, before falling back to $1.1 billion in 2009/10.
What that means is that for that period it will be difficult to maintain our programme of investing in infrastructure, and difficult to maintain the health, education, policing, and other services that New Zealanders expect as an essential part of their quality of life. Difficult, but not impossible, as the Budget demonstrated.
One might have thought that, given the state of the Crown's finances going forward, we might not have had the chorus of cries for immediate tax cuts. The outlook for the next few years shows that, whatever position one takes on the question of tax cuts, one cannot pretend that there are no trade offs involved. To cut tax at a point when the country is heading into a deficit situation surely means cuts to expenditure are the inevitable tradeoff. Less tax means less health care, fewer roads, fewer tertiary education places and so on.
Similarly, with an economy running to full capacity, with a tight labour market and a large current account deficit, tax cuts involve tradeoffs in terms of economic stability. One has to be prepared for tax cuts to flow on to higher inflation and pressure to tighten monetary policy.
There is no free lunch, either in fiscal or in economic terms. And it is certainly frustrating that some portions of the media happily dumb down their coverage of the issue to give the impression that tradeoffs do not exist.
This is the context in which I would like to discuss the government's overall superannuation and investment strategy. The truth is that long term savings, like prudent fiscal management, can be a hard sell. The end point sounds attractive, but the short term sacrifices required are not.
The overall objectives of the government's strategy are things that I believe have almost universal support.
- We want to increase the overall rate of domestic savings.
- We want to see a larger proportion of ordinary New Zealand families making realistic savings plans for their retirement.
- As much as is possible, we want a level playing field for different types of investment and for different types of investor.
- And we want a regime where investment decisions are made on the basis of the merits of the investment proposal, rather than extraneous questions such as taxation.
These are objectives the government has pursued for the last six years, with some success.
We are forming a platform of long term stability for New Zealand Superannuation. This platform comprises two elements. First, a strong political consensus around New Zealand Superannuation as a guaranteed basic income for those in retirement. The days when superannuation was a political football are over, and any differences between the major parties are nuances rather than matters of great substance.
The second element is the Superannuation Fund, which now has multi party support and is showing good returns from its investment strategy. The additional stability that the fund gives to the long term financing of New Zealand Superannuation will increasingly become a source of competitive advantage for the country, as other developed nations with similar issues around population ageing are forced to make hard fiscal choices in the next few decades.
We are moving to foster a stronger savings culture through the establishment of the KiwiSaver scheme. As you will be aware, the Bill which gives effect to the scheme has been examined by Select Committee. As I understand the general tenor of the submissions was one of cautious optimism.
Only a few submissions were opposed to the concept; and most were broadly supportive with concerns about particular design features and about whether the incentives in the scheme would in fact be sufficient to create a shift in the savings culture of ordinary Kiwis.
I can only say at this point that I look forward to seeing what the Select Committee recommends. I believe the scheme has many basic strengths, and provides ample scope for fine tuning at a later date, should that become desirable.
The development of KiwiSaver turned a spotlight on a number of taxation issues which needed addressing. Chief among these was the fact that investment through New Zealand collective investment vehicles is generally overtaxed relative to direct investment.
Under the current rules, effective tax planning has a significant impact on investment returns for direct investors. Collective investment vehicles, however, while having the greatest mainstream appeal, often suffer the worst tax result. As a result, many less sophisticated investors have been discouraged from investing, or have invested primarily in property. On the one hand, they see collective investment vehicles as being less tax efficient than other options; but on the other hand, they do not back themselves to choose and understand the most tax efficient method of making financial investments.
This is an inequitable result and has arguably caused a bias against financial intermediation, which is a key part of the KiwiSaver initiative.
The new rules seek to remedy these problems, with one of the key improvements being that lower income investors, whose investment income is currently over-taxed at 33 per cent, will be taxed at their correct rate.
Managed funds will no longer be taxed on their share gains from New Zealand and Australian companies, which puts them on an equal tax footing with direct investors.
The other major change will impact upon offshore investment.
I think it is important to focus on the harm we are trying to fix. It is currently quite easy to achieve a low tax or no tax result for direct portfolio investment in shares outside New Zealand. Overseas tax regimes generally discourage companies in their jurisdiction from paying dividends, while the New Zealand tax rules currently rely on dividend payment for taxing most such investments.
Additionally, dividend paying and non-paying offshore investments are often substitutable. This has three harmful effects:
- First, it can leave higher income or more sophisticated taxpayers with significant ability to minimise their tax burden by investing offshore. That is unfair on other taxpayers, and goes against the principle that if you live in New Zealand you are expected to contribute to New Zealand by paying New Zealand tax on all your income, whether it comes from New Zealand or overseas.
- Second, it discourages investment in New Zealand companies. As New Zealand cannot rely on a limitless supply of foreign capital, nor can such capital always replace domestic capital, the current system has the potential to artificially lower the amount of capital available to New Zealand businesses.
- And third, investment in some high growth and lower tax countries including trading partners in Asia and Latin America can currently be over-taxed relative to investment in countries such as the United States and the United Kingdom. In particular, direct investors currently face tax barriers to overseas investment as a result of currency fluctuation and share price volatility outside a few countries in the so-called "grey list" (Australia, Canada, Germany, Japan, Norway, the United Kingdom and United States).
Hence, the current tax rules steer New Zealand investors towards investing directly in offshore shares in the eight "grey list" countries, so that they pay little or no tax in New Zealand on their investment income, since companies in those countries often pay low or no taxable dividends.
However, investors in shares in other countries – such as Singapore and Korea – are fully taxed in New Zealand on their income. As a result, the current rules can steer New Zealand investors away from newer investment destinations., such as Asia and Latin America where most economists see ongoing high rates of growth.
Because New Zealand cannot adopt dividend-only taxation for direct offshore portfolio investment in shares, without the risk of undermining its domestic tax base, a more coherent and comprehensive set of tax rules is needed. We need to ensure that historical investment destinations do not continue to receive undue benefit relative to new destinations, and effectively lock New Zealand investors out of some of the more promising new opportunities.
This issue has long been something of a Gordian Knot and any way that one might attempt to cut through it is bound to create winners and losers. As is always the case, the winners are a broad group including low income earners and people who invest through managed funds; and the losers are a clearly defined group of high net worth individuals and their sharebrokers, who are easily spurred into action and ready to take out full page advertisements in the major dailies.
However, I would point out that the major loser in the current changes is the government, which will forgo about $110 million a year in tax revenue with this reform. Nevertheless, we believe it is important to remove distortions in investment decision making and we are willing to bear that loss.
To sum up, I think if one takes a longer view it is clear that we are part way through a process of building a sustainable institutional structure to support and promote savings and investment in New Zealand. We are eliminating the confusion and uncertainty regarding state provision, which made it difficult for a generation of New Zealanders to be sure exactly what was the basis of their planning.
We are establishing a vehicle which enables the savings industry and the government to work in partnership to bring a new generation of savers on board. And we are clearing away anomalies in the investment tax regime that skewed decisions and limited options for New Zealand investors.
The job is not done, by any means. All of these instruments need to be implemented, tested, and refined over the next decade. And most importantly both the government and the savings industry need to work to keep New Zealanders focussed on the long game.