Some Possible Effects of the Proposed Retirement Saving Scheme

By Professor Chris Moore

(A copy of this article was sent for publication to the New Zealand Herald.)

Whether or not you support Winston Peters' proposed Retirements Savings Scheme (RSS), it's served at least one useful purpose - it's forced us to think a little more deeply about our own future financial position and more generally about the complexities of funding retirement in an aging population.

Naturally, our first reaction will be based on how it affects us personally compared with the present voluntary income-tested (which becomes universal from 1 April 1998 with the surcharge gone) pay-as-you-go scheme. This isn't a bad frame of reference to use for it's far from clear that the present scheme, with income-testing, isn't as fiscally unsustainable as Winston would have us believe. If that's the case then Winston will have to call on his oratory skills to convince the public to vote for RSS with its high administrative overhead and compliance costs. After all the promised tax cuts don't disappear. They will be available to save for retirement under the present voluntary scheme. We'll know more on this issue when Jeff Todd's committee reports on its review of the present scheme at the end on the month.

An interesting question concerns the likely impact RSS will have on the level and pattern of savings. From a national perspective it's unlikely to lift the overall level of savings given that most of RSS contributions are likely to funded from tax cuts. Although it's unclear that this is the case for high income earners ie those paying the top marginal tax rate of 33 cents in the dollar on most of their income. If high income earners are to have their RSS contributions funded from tax cuts then a significant reduction in the top marginal tax rate is needed. This point needs clarification for the proponents are being coy on this issue. Nevertheless, any increase in household savings resulting from RSS will generally be matched by government dissaving, leaving the national saving rate unchanged.

The impact of RSS on households' saving patterns will be more dramatic in that any equity gain in housing - a major source of household savings - from paying off the mortgage won't count as RSS savings unless it's specifically arranged through some rather convoluted arm's length arrangement with a RSS fund manager. To the extent that RSS contributions inhibit paying off the mortgage at a faster rate, RSS not only forces households to hold higher than desirable levels of debt but also limits their access to the best low risk-high return investment they can make ie reducing debt. This, I'm sure, is great news for financial institutions who will earn an interest margin on higher levels of household debt as well as fees for managing RSS investment funds.

Another interesting outcome of RSS is its likely impact on domestic investment markets ie equities, fixed interest securities such as bonds and commercial property. Let's assume that household taxable income in 1998 from salaries and wages, dividends, interest and rents (estimated from NZIER's March 1997 Quarterly Predictions) is around $77 billion, then the annual flow of RSS investment funds will start at $2.3 billion (3%) and rise, if fiscal surpluses allow, to $6.2 billion (8%) in 1998 dollars. These are large numbers compared to recent investment flows into managed funds reported by the Reserve Bank in their June 1997 Bulletin. They show that managed funds, including overseas investments, grew from $32.68 billion in the quarter ended 30 June 1996 to $34.13 billion in the quarter ended 31 March 1997 ie New Zealanders invested $1.45 billion in managed funds over the year.

The question is then what impact will the large RSS investment flows have on domestic equities, bonds, commercial property? In the first instance the markets are likely to price the effect of the additional funds in before an actual dollars flows. So expect share values to rise, interest rates on bonds to fall (higher bond prices), and yields on commercial property to fall leading to higher property values.

So what will stop our markets from overheating and becoming too volatile as RSS funds search for a domestic home? Ironically, it's Winston's bete noire - foreign investment. First, fund managers will place the majority of RSS funds in off-shore equities, bonds and property in order to diversify investment risk. Our domestic markets are too small and too thin and besides a natural disaster eg a major earthquake could collapse the markets, taking RSS funds with them! Second, if the funds flowing into domestic assets cause markets to become overvalued, then it's likely to be foreign investors - they currently own over 60 percent of the sharemarket and bond market - who are likely to sell first. Under this scenario, New Zealanders will become majority investors in our domestic markets. Either way, it's the ability of foreigners to invest in New Zealand and our ability to invest overseas that ultimately lowers the risk profile of invested RSS funds that drive Winston's RSS.

Professor Chris Moore

Director, Centre for Banking Studies, Massey University

Email: C.I.Moore@massey.ac.nz

Prepared for the WWW, 18 July 1997