Terry Baucher wonders if it is time to look again at the funding of superannuation and gathers some of the facts and figures

By Terry Baucher*

In recent weeks both the Retirement Commissioner and Treasury have expressed concerns about the future affordability of New Zealand Superannuation. 

Will the tax system, particularly the present tax treatment of savings, need to change to meet those future demands?

“Unsustainable” is how Retirement Commissioner Diane Maxwell has described the current approach to funding New Zealand Superannuation during recent interviews that can be seen here, here and here.

Treasury’s statement on the Long-Term Fiscal Position wasn’t quite so blunt but observed:

“However, population ageing combined with the retirement of the baby boomer population cohort presents a challenge for governments unlike those faced in the past.”

The Retirement Commissioner has also suggested the Government should either resume contributions to the New Zealand Superannuation Fund (“the NZSF”) or stop taxing the fund:

“See, to me, if you contribute, then tax; if you don’t contribute, don’t tax.” 

(Since the Government’s last contribution in 2009 the NZSF has paid more than $3 billion of income tax).

The NZSF is a “sovereign wealth fund” but virtually uniquely for such a fund, it’s subject to income tax.  (By contrast the Accident Compensation Corporation, the Earthquake Commission and the Reserve Bank of New Zealand are all exempt from income tax on their investment and trading activities). 

The tax rules applicable to the NZSF also apply to KiwiSaver funds and superannuation schemes.  In effect, vehicles designed to fund a future retirement are simultaneously required to contribute to the present through taxation of the very savings intended to provide for the future.  To understand why that happened we must look at the origins of the present retirement savings tax regime.

An overhaul

In the late 1980s, faced with the rising cost of tax breaks (estimated at $660 million for the year to June 1989), the Fourth Labour Government decided to overhaul the tax treatment of superannuation schemes.   The previous tax preferred “Exempt, Exempt, Tax” (EET) treatment was replaced by a “Tax, Tax, Exempt” (TTE) regime. From April 1990 contributions to superannuation schemes are made from after tax income. Employers are required to deduct what is now termed employer superannuation contribution tax (ESCT) from their contributions.  The income of superannuation schemes is taxable but withdrawals from schemes would be exempt from income tax. 

Apart from reducing the fiscal cost, the reforms of the tax system in the 1980s were built on the principle of broadening the tax base to lower tax rates, eliminating tax distortions and treating all forms of savings equally.  Unfortunately, the failure to follow through with comprehensive capital taxation left a huge distortion in the tax system in the form of a preference towards property and housing.

The flat tax rate of 33% applicable to superannuation schemes from 1990 made them less attractive to investors.  Furthermore, members with a personal tax rate below 33% were being over-taxed.  Consequently, the numbers of superannuation schemes and the amounts invested began to fall.   The trend was such the Reserve Bank discussed it in its September 1993 Bulletin.   

Falling scheme numbers

The Government Actuary’s Report on superannuation schemes for the year ended 30 June 2003 reported that between 31 December 1990 and 31 December 2002 the number of superannuation schemes fell from 2,863 to 727. Over the same period the percentage of the workforce who were members of a superannuation scheme dropped from 22.6% to 13.9%.  The Government Actuary described this trend as “quite striking” which is probably code for “that’s not good.”

Meantime the numbers of investors declaring residential property income began to rise.  The total of individuals, trusts, partnerships and companies (including LAQCs) returning residential rental income for the year ended 31 March 1997 was 138,000. By the year ended 31 March 2015 the total (including look-through companies) had doubled to just under 277,000.

The size and potential effect of this shift towards property investment was identified by the OECD in its November 2000 OECD economic survey of New Zealand.   The survey noted the lack of a comprehensive capital gains tax and the favourable tax treatment of owner-occupied housing.  The OECD concluded that New Zealand had a substantial over-investment in housing of maybe 1.5 times that of other major OECD countries.  The 2001 McLeod Tax Review estimated the value of this over-investment as $40 billion (in 2001 dollars).

In September 2004 then Reserve Bank governor Dr Alan Bollard remarked during a speech on the property sector:

“An increasing number of purchases appear to have been by those wishing to let the house on the rental market and expecting to make a capital gain. We lack comprehensive statistics on such activity in New Zealand, but our contacts in the banking sector confirm that a substantial part of the recent growth in housing credit has been for that purpose.”

The Reserve Bank estimated the household sector's net wealth to be about 3 times annual GDP at the end of 2003.   That trend has continued with one ANZ economist recently estimating New Zealand’s housing market to be worth 350% of GDP.

All of this led the Savings Working Group to conclude in paragraph 7.2.3 of its January 2011 final report:

“It is likely, therefore, that the structure of New Zealand’s tax system is more biased against saving than in comparable countries.  Further, with no capital gains tax, the New Zealand tax system is biased towards a large block of economic activity – property investment – that tends to be at the less productive end of the spectrum.”

The effect of the disparity in the tax treatment of property and other savings can be seen when comparing the estimated tax paid by residential property investors relative to the asset base with that paid by investors in KiwiSaver funds and superannuation schemes. 

According to the Financial Markets Authority’s (“FMA”) KiwiSaver annual report for 2015, KiwiSaver funds paid $223 million of tax for the year ended 31^st March 2015.  The closing balance of KiwiSaver scheme assets as at 31^st March 2015 was $28.474 billion.

Surveying the schemes

The FMA’s statistical survey of superannuation schemes as at 31^st December 2014 recorded tax paid of $225 million for the year with a closing funds balance of $22.014 billion. 

(These numbers exclude the $1.14 billion ESCT paid by employers in respect of employer contributions made to KiwiSaver funds and superannuation schemes during the year ended 30^th June 2015.)

Data supplied to me by Inland Revenue estimated the gross residential rental income returned for the year to 31^st March 2015 to be $2,008 million. After deducting the $701 million of rental losses claimed in the period, the net rental income returned and taxed was $1,307 million.  Assuming a 33% rate for individuals and trusts and 28% for companies this implies a tax take of about $425 million, or roughly $33 million less than that relating to KiwiSaver funds and superannuation schemes. 

There aren’t any detailed figures available for the value of residential property investment but Inland Revenue figures supplied to the Victoria University of Wellington Tax Working Group in 2009 (see page 17) estimated its value at $200 billion.

'Unsustainable'

On these figures, KiwiSaver funds and savers paid more than four times as much tax as residential property investors relative to the sums invested.   To borrow a phrase this is “unsustainable”.

As at 30 June 2015 there were almost 2.5 million KiwiSaver members or nearly ten times the number of property investors filing income tax returns.   If a government moves to auto-enrol all employees into KiwiSaver then the pressure to redress the tax distortion in favour of property will increase.  Why should KiwiSaver members be taxed on their locked-in savings whilst property investors’ capital gains remain largely tax-free?

How can that pressure be relieved?

An option

One option would be to reduce or eliminate the tax paid by KiwiSaver and Superannuation schemes (in effect adopt a TEE approach).  The Savings Working Group 2011 report noted:

“The most important tax from the saver’s point of view is tax on investment income…This has a far greater effect on retirement income than a tax on contributions or a tax on retirement income…New Zealand is virtually alone in using TTE in respect to income tax on retirement savings.”

Alternatively, or in conjunction with the above change, the tax base could be broadened to capture previously untaxed capital gains.  (Treasury favours such a change, Inland Revenue does not).

The Government has previously ruled out either increasing the age at which New Zealand Superannuation becomes available or changing the basis of index-linking. Both the Retirement Commissioner and Treasury consider this approach “unsustainable” long-term. The same conclusion applies to the current tax treatment of savings.  At some point, something will give and a far more unpalatable answer such as sharply increased tax rates, lower benefits, or both may result. Moving now to address the systemic issues must surely be the way ahead.

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*Terry Baucher is an Auckland-based tax specialist and head of Baucher Consulting. You can contact him here »