Retirement beckons for Cullen fund
Fri 11 Jul 2008 by Infometrics Ltd.

The vanishing surpluses in Michael Cullen’s 2008 Budget have not only scuttled his reputation for fiscal conservatism, but also sounded the death knell for one of Cullen’s key policy legacies – the New Zealand Superannuation Fund.

Remember, the rationale for running large surpluses was that the money was needed to seed the NZSF (or Cullen fund).   But the surpluses are gone, and the government now needs to borrow to meet its contribution targets over the next four years (and Treasury has already warned us that their economic forecasts are subject to downside risk).

It is a dubious proposition to assume that rebuilding those surpluses will be a priority for a National (or any) government, or that future governments are likely to see a repeat of the fortuitous economic conditions that produced such big surpluses in the first place.

So what use is a Cullen fund that is being supported through government debt?   Borrowing to invest is just a shell game with little impact on national savings.   The only way the government could make money out of it is be exchanging its low-risk debt for higher-risk (and hopefully higher-yielding) assets.

If a financial advisor told you to take outa mortgage to invest in share markets, you would rightfully regard this as madness.   This kind of activity is only slightly more defensible for a government.     Firstly, the government pays a lower rate of interest on their debt.   Secondly, the government is better placed to bear this kind of leveraged risk – after all, even if markets collapse, the government still has the fall-back plan of off-loading the losses onto future generations.

But we usually consider the proper role of government to protect us to risk, not to take on more risk on our behalf.   Is the government seriously arguing that public policy intervention is required because New Zealand investors are too risk-averse?

A further caveat for those who seen this gamble as a sure thing comes from the recent credit crunch.   The major global investment banks have recently managed to lose the equivalent of the Cullen fund many times over using precisely this strategy – using their excellent credit rating to borrow cheaply and make risky loans, hoping to pick-up a margin along the way.

There is little serious dispute that something needs to be done about the looming increase in New Zealand superannuation costs, which are projected to rise by over 4% of GDP over the next 30 years (at a time when government expenditure will also be under extreme stress from rising health-care costs).

Meeting this rising cost from income tax alone would require around a 32% increase across the board, or a tax-hike roughly four times as big as the tax cut coming in October.

But it is far from clear that the Cullen fund is much of a solution to this problem, even if a future government does find the capacity to fund it properly again.

There is a common misperception that the Cullen fund provides a fix to the shortfall in super funding.   However, all the Cullen fund is intended to do is ease the transition costs as the population ages and the ratio of retirees to workers rises, which will lead to a permanent increase in the expense of New Zealand superannuation (not just a baby-boomer hump).   The Cullen fund doesn’t change the fact that taxes will ultimately have to rise (or benefits be cut) to the tune of 4% of GDP, it simply delays the day of reckoning.         

Even a Cullen fund that is being fully-seeded from fiscal surpluses only has two real advantages, the main one being that it is more equitable to extract some more tax from current workers as they are the prime beneficiaries of a super scheme that will pay them out more than they paid in.

The other benefit is just realpolitik.   The compromise solution for superannuation will involve both tax increases and reductions in pay-outs.   But introducing the Cullen fund was equivalent to bringing forward that tax increase.   In other words, the current Labour government is attempting to bind future governments to a superannuation compromise that is more heavily tilted towards raising taxes.

Of course neither of those benefits occurs when the money being put into the Cullen fund is borrowed rather than paid for out of taxation.

Although both major political parties have claimed that New Zealand Super will not be reduced in the future, this claim is incompatible with their current policy of lowering tax rates.   This contradiction (to put it politely) is actually worsening the problem, because a false belief in the viability of superannuation discourages private retirement savings.

Ironically, KiwiSaver in its current form is actually making the fiscal burden of superannuation worse.   KiwiSaver acts as a further sinkhole for taxation but provides no mechanism via which the money being accumulated in KiwiSaver accounts will offset the government obligations to provide superannuation.   Realists should be suspicious that such a claw-back is inevitable.

The Cullen fund was never much more than a palliative measure to calm public fears about the patent mendacity of current superannuation promises.   Now that it is no longer properly funded, it fails at even that task.   Nevertheless, this zombie fund seems destined to linger on indefinitely while our current politicians lack the conviction to tackle the superannuation problem head-on.

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