Manuscript untitled: Retirement income, tax, and NZ

As many of you know, I have done a lot of work on New Zealand’s retirement and tax systems in the last decade. I have been attracted to this issue because New Zealand has tax and retirement income systems which are now substantially different from those in most high income countries. 

Standard economic theory suggests many of the choices New Zealand has made impose disproportionately large costs on current and future young generations. Of course standard economic theory may be wrong. Nonetheless, when a country adopts a path that is different from standard economic theory and normal international practice, it suggests that the path should be carefully investigated to ensure it is in an appropriate direction.

To this end I am planning to write a monograph, serial fashion. Over the next few weeks i propose to write the thing a few pages at time (in between a very busy lecturing schedule in which I am teaching four courses) and post them on this blog. My thanks to Matt and Gulnara for giving me this opportunity. I am not sure how far I shall get, but all feedback is welcome.

Feedback from younger readers is especially welcome, for reasons that will soon be obvious.

Here is page 1 – the good bits version – or, at the moment, the only bits version.

The heart of the problem

The message of this book is very simple.

Over the last sixty years, New Zealand has adopted a set of retirement income and tax policies that are very different to those used in almost all other rich countries.

New Zealand’s policies tend to be very simple and easy to understand. While ‘simple’ is often a good thing, in this case, it has a downside: it imposes high costs on current and future generations of young people. 

These costs come in various disguises. For example, young people will pay much more in taxes to fund government pensions than their parents or grandparent because the retirement income system disproportionately pushes the costs forward onto young generations. Moreover, the simple way New Zealand taxes retirement savings creates incentives that lead to higher house prices and rents.

Because these costs are much higher than the costs faced by current middle-aged and older cohorts, most young New Zealanders could be a lot better off if New Zealand had a different set of retirement income policies. Many people recognize the disadvantages young people face from New Zealand’s unique retirement income policies and taxes.

So why does the system continue? Largely because it is very hard to change the system without disadvantaging some older people. Politicians have been reluctant to introduce reforms because of their concern for those older people who cannot easily adjust to changes, and because of their recognition of hard political realities. 

Fortunately, there is an opportunity for reform. The trick is to let young people redesign the system they want for themselves without changing the basic features of the system for older people. A retirement system designed in the twentieth century may be suitable for people my age and older. But there is no need to impose a retirement income system designed in the twentieth century on people who will live most of their lives in the twenty-first century. Rather, young people who are dealing with very different circumstances to their parents and grandparents should be allowed to choose a different system – a system, which meets their demands and aspirations even as it leaves the current system in place for older generations. 

Of course, it is not costless for young people to opt out from the current system – the system is designed in a manner that means the costs disproportionately fall on younger generations. But the current allocation of costs across generations is largely arbitrary and unplanned. As a country, New Zealand has a great opportunity to deliberately choose how the costs are spread across generations while giving young people the option of choosing a better system, one they want. A reallocation of costs would be part of any “exit” strategy. Yes, costs may go up on middle aged people like myself. But it should be possible to work out a way to redistribute these costs in a manner that most people find fair. The taxes we pay to fund the New Zealand Superannuation Fund are already a step in this direction.

Is it likely that young New Zealanders want a different set of retirement income policies and taxes? Who knows – it should be their decision. Since New Zealand’s current system is so different from those adopted in other countries there should be no presumption that it is what young people want, even if it is what older people want. Fortunately, there are many different retirement income schemes and tax systems in use around the world, so there are lots of examples of what works and what may not work. These schemes have many features that young New Zealanders may find attractive.

Some changes could be easily made, without affecting the retirement incomes of older New Zealanders. Other changes may require more difficult choices if they affect the transfers flowing between generations. Either way, New Zealanders have a fantastic opportunity to allow younger cohorts to design the retirement income policies that they want, aligned with their interests and suitable for the century they live in. We should not squander it.

This book is all about the possibility of change. It describes the main features of New Zealand’s retirement income and tax policies, and how they are different to those in place in most rich countries. It explains why young people may want change – why the current system is so bad for young people – but it does not advocate change to the current system for older generations or advocate any particular solution for young generations.  Those choices are for young people to make, to enable them to have a system designed by themselves for themselves for the twenty-first century.