New Zealand has about ten years to adjust retirement and health policies before international financial markets begin to force fiscal reforms, Treasury says

You have to wonder if Treasury ever gets tired of reminding successive governments they will eventually run out of money to pay for pensions and healthcare if they don’t make some policy changes. 

That was the key message of the economic agency’s Long-Term Fiscal Statement released earlier this week — but also of the one it released four years ago, and eight years ago, and 12 years ago, right back to 2006.

It didn't get that much attention this year as we had heard it all before and were quite busy Googling ‘Anna Breman’ and ‘how to pronounce Riksbank’. 

Unsustainable fiscal policy is like putting off doing the dishes. It’s okay for a while, then you’re eating cereal out of a coffee mug and posting a ‘hazardous materials’ sign over the sink.

In a speech on Wednesday, Treasury Secretary Iain Rennie said policymakers don’t have to solve 40 years of forecast problems in “one fell swoop” but the available fixes would get fewer and harder over time.

Policy changes would be forced on governments as overseas investors demanded higher risk premiums on government bonds, pushing up debt costs and slowing the wider economy.

“We're certainly not saying, for 40 years it's going to be fine and then Armageddon … You’d see a set of adjustments essentially being forced on the economy,” Rennie said. 

He couldn’t say exactly when or what would happen but some sort of gradual “adjustment pressures” would emerge over the next ten years if no fiscal policy changes were made.

That’s only two and a half Long-Term Fiscal Statements (LTFS) away. 

Not so distant future

Fiscal pressures are starting to stray into medium-term territory. Already net (of tax) contributions to the Super Fund have stopped and actual withdrawals to pay pensions are set to start around 2030.

The problem, if you don’t remember from previous editions, is that an aging population is pushing up the cost of providing universal superannuation and healthcare. In 1960, there were seven workers per retiree. Now there are four and soon there will be just two. 

If policies are left unchanged, Government spending per person will rise from $18,300 today to $35,900 in 2065 (not counting inflation). Tax revenue would not nearly keep up and debt would explode to 200% of gross domestic product.

Don’t act all surprised, we know all this already. The question is what to do about it? 

There are three main dishes on the menu for policymakers to choose from, and likely we’ll need a mix of all three. Politics is the business of negotiating how much of each to order for the table to share — a fraught decision at the best of times.

Treasury’s à la carte menu includes: superannuation and Kiwisaver reform, broad Crown spending cuts and user-pays healthcare, or (chef’s speciality) increased taxes.

Choosing any single option would be uncomfortable. Paying for it purely out of income taxes would require the average rate to rise from 21% to 32%. Or GST would need to be set at 32%.

Relying only on spending cuts would force expenditure on everything other than healthcare and pensions to be slashed from 13% of GDP to just 5% in 2065, and then continue to fall.

Pensions could be indexed to inflation (like all other welfare benefits) instead of wages, the age of entitlement could be gradually raised to 72, or it could be means-tested at a “relatively low level” of income.

Slow and steady keeps the peace

Treasury modelled a hypothetical scenario in which no corrections were made to policy until 2065, just to demonstrate the costs of drastic policy changes. It found each New Zealander’s average income would be $6,800 lower by 2066, with the gap widening each year. 

Not only is it more expensive, it also changes which generation pays the cost.

“Our modeling suggests if we delay tax increases to 2066, everyone born before 2030 is better off, but people born afterwards end up paying significantly higher taxes over their lifetimes and have lower after-tax pensions,” it wrote.

Treasury didn’t model the economic impact of one million 15-to-36 year-olds rioting in the streets on July 1, 2066 (when their tax rate jumps 70% overnight) but let's assume it would be net negative. 

The economic policy chefs would likely prefer superannuation reform to be the bulk of our fiscal sustainability order. The economic and generational impacts of various options took up more space in the document than taxes or spending cut suggestions.

But it is ultimately up to us voters, and it's still a political stalemate. 

National and Act want to raise the age of eligibility, the Green Party and Te Pāti Māori want to raise taxes to keep it 65 or lower, Labour hopes to come up with an unspecified savings plan, while NZ First seems okay with Armageddon.

Even these proposals are each insufficient on their own, and consensus will likely converge on raising the eligibility age somewhat and transitioning to a partially self-funded retirement. 

The age will surely rise because people are retiring later, anyway. As lifespans lengthen so does the time spent in the labour force. In 1993, just 10% of people aged 65-69 had a job, today it is 49%. Even 27% of those aged 70-74 have jobs these days.

Perhaps not everyone can continue to work (people with physical jobs struggle) but obviously half the population can and chooses to do so. That number should rise further if health and longevity continues to improve.

As for self-funding retirement, that is what Kiwisaver was set up to do. Current settings are a long way from being able to deliver on that, but National and Labour have both signalled they plan to supercharge the scheme. 

The natural end result will be that well-off people will be asked to cover for a larger share of their own retirement income. Perhaps superannuation will remain universal but paid at a lower rate, for example.

Expect this debate to feature heavily in the next few elections, as crunch time is coming.