Brian Fallow: Sums of saving

Inevitably, the $4 billion fiscal pricetag attached to the New Zealand Institute's plan for individual lifetime savings accounts has raised eyebrows, if not laughter.

To the scheme's architect, institute chief executive David Skilling, the sum is commensurate with the magnitude of the challenge.

But Finance Minster Michael Cullen said: "Such a level of support would be totally unaffordable and would lead to the Government moving from being a net saver to a net borrower, which would undermine the whole purpose of the exercise."

Actually, maintaining the Government's status as a net saver is not the purpose of the exercise at all.

Lifting national savings, which is the sum of saving or dis-saving by the household, business and Government sectors, is one of the objectives and an eminently desirable one given the state of our external accounts.

The national savings rate would still go up if any reduction in Government saving was exceeded by an increase in household saving.

But, in any case, the Skilling scheme is also about spreading the benefits of asset ownership and a savings culture more widely within society.

The Government acknowledges the desirability of this. It has signalled that the May 19 Budget will contain measures to boost saving for retirement and help with buying a first home.

But the sums involved will clearly be modest compared with the institute's bold proposal. It will, therefore, only nibble at the problem.

The Skilling scheme rests on the simple intuition that if you make it easier to do something, people will do more of it. During the past 20 years, Skilling argues, we have made it much easier to borrow. Consequently, we have accumulated a lot of debt.

Now we need to make it easier for people to save and accumulate assets.

One of the underlying assumptions behind New Zealand Superannuation is that by the time people retire they at least own the roof over their heads, if often little else. Take rent or a mortgage out of a pension that is only a third of the average wage per head and there would be little left.

But it is an increasingly unsafe assumption. The home ownership rate has declined from 74 per cent of households in 1991 to 68 per cent in 2001. The latest burst of house price inflation will have put home ownership out of reach of even more people.

The Skilling scheme allows withdrawal from the individual accounts for the deposit on a first home. But not for paying the mortgage and not for trading up.

Apart from retirement income, the other member of the trinity of approved purposes for which savings can be withdrawn is tertiary education (tuition only, not living costs).

The institute reckons that with seed payments of $1500 a child from the Government, plus a dollar-for-dollar subsidy for up to $200 a year of parental contributions, plus no tax to erode the rate at which compound interest accumulates, by age 18 people should have around $14,000 in their accounts. That compares with a median student debt of around $10,000.

It would cost about $350 million a year, but Skilling compares that with the $320 million the Government lost last year in forgoing interest on student loans while students are still studying and in writing off bad debts.

To liberal free marketeers, the whole scheme smacks of paternalism and nanny knows best.

If a 2 per cent income tax cut is affordable, they would contend, just give it back to taxpayers and let them decide whether to consume it or invest it as they see fit. They know best.

However, mandatory saving into individual accounts is increasingly popular overseas. The Australians have a system of compulsory workplace superannuation and President George W. Bush's proposed reform of Social Security includes individual accounts.

A defined contribution system of individual accounts is also advocated by Richard Hawke in his book Retirement Income Provision in New Zealand: A Way Forward.

It creates an explicit link between saving now and the ability to consume in retirement, he says. It is not reliant on future politicians not changing the entitlement rules. And it is more appropriate to the modern environment in which labour is mobile, between employers, occupations and countries.

The main problem with individual accounts is administrative costs, he says.

Do you maximise savers' ability to choose among the myriad retail managed funds in the market, accepting that with that competition comes higher administrative overheads and marketing costs, reducing the eventual value of the retirement payout?

Or do you go for the economies of scale of a more centralised model with fewer options for savers?

The institute's scheme skirts around the issue of fund management.

"In a decentralised approach, any financial provider could offer a Kiwi savings account. They could compete on fees and people could choose one, with the Government providing a default," Skilling said.

"The alternative approach would be a centralised provider who would provide a limited range of options. The best model of that probably is what Bush is proposing for Social Security, which is based on the existing plan for federal employees. They have a choice of five investment plans and the scheme administrator contracts out the management of those funds to fund managers, much as the New Zealand Superannuation Fund does at the moment."

The centralised approach was lower-cost, but investors got less choice and there would be less competitive pressure to innovate.

"You could have a centralised approach with an opt-out provision for larger and more sophisticated investors. In practice, there is probably not much difference between having a decentralised scheme with a default fund provided by the Government and having a centralised one with an opt-out."

The administrative and governance arrangement are crucial because what matters in the long term is not so much how much money is saved but the quality of the investment those savings fund.

Having fewer worker/taxpayers supporting more superannuitants in the future won't matter so much if they are more productive, which is partly about increasing the quantity and quality of capital they have to work with.