The economics of PAYGO and SAYGO retirement schemes in New Zealand

Transcription

1 The economics of PAYGO and SAYGO retirement schemes in New Zealand Andrew Coleman University of Otago and Motu Economic and Public Policy Research March 2012

2 Peter Diamond (MIT, Nobel prize 2010) 1. If r < g, it is efficient to immediately adopt a PAYGO system as there is too much capital 2. Empirically r>g, and in long run SAYGO is more efficient than PAYGO because compounding returns mean you can have lower contributions for same pension 3. If you start with PAYGO, the transition is difficult as one generation has to double pay.

3 More recent research 4. The transition is not as difficult as once thought 5. Risk considerations mean that a mixed PAYGO- SAYGO system is best. 6. But how much SAYGO, and what form?

4 Martin Feldstein (Harvard University, CEA under Reagan) 1984: The transition is too hard to manage

5 Martin Feldstein 2005 AEA Presidential address I now know I was wrong When returns are high, the transition can be managed using private accounts.

6 Basic issues (1) PAYGO (2) SAYGO Productivity growth Population growth Assets accumulated Provides capital returns (3)Important issues (i)divergent capital paths (ii) Labeling (iii)intergenerational costs

7 Basic issues (1) PAYGO Productivity growth Population growth

8 Basic issues (1) PAYGO (2) SAYGO Assets accumulated Provides capital returns

9 Basic issues (1) PAYGO (2) SAYGO (3)Important issues (i)divergent capital paths (ii) Labeling (iii)intergenerational costs

10 (i) Divergent capital paths When a PAYGO scheme starts (US, 1938), Retired people get more resources and increase consumption Working age people pay taxes, and because they are promised a future pension they accumulate less capital but maintain consumption Total consumption increases Capital accumulation reduces, reducing future size of the economy

11 Consumption SAYGO SAYGO Capital time time

12 (ii) Labelling The same result occurs if Government adopts a PAYGO system old people get resources now, working age pay taxes now, get pension later Government borrows from working age people to give a pension to the old, and repays them with interest when retired Capital accumulation falls as government crowds out private sector asset accumulation Different labels but same result..the distinction with a SAYGO system is that no capital is accumulated.

13 (iii) Intergenerational costs. When r>g, a PAYGO scheme imposes costs on all subsequent generations as their taxes could have earned more invested in capital. The consumption gain to the initial generation is offset by consumption losses to all subsequent generations. The sum of these costs, discounted at the return to capital equals the initial transfer A near meaningless result, as it is true whether r = 5% or r = 15%.

14 (iii) Intergenerational costs. The main issue is that adopting a PAYGO imposes costs on some generations to transfer to others. The costs on subsequent generations is higher the higher is the gap between r and g When the population growth rate slows, later generations have higher costs than earlier ones. Increasing the SAYGO component imposes costs on the transition generation to lower subsequent costs.

15 The Main Argument The cost of the current scheme will rise, imposing larger costs on future generations Reducing the size of the PAYGO scheme and increasing the SAYGO component will partially shift these costs from the future to the present The transition can be managed to increase capital accumulation Several different SAYGO options can be considered

16 So.what are the numbers like for NZ?

17 tax rates Transition Paths Projected pension expenditure due to demographic change 12% 8% 4% PAYGO regime 0%

18 PAYGO Public flat rate X Public earnings related Mandatory private Voluntary private SAYGO X X X X

19 Relative efficiency Long term relative efficiency of SAYGO and PAYGO Mimic economy and population in 2050 Real return = 4% Productivity growth = 1.5%, wage = $ year working life, 19 year pension

20 Relative efficiency Results r = 4% T N R g W g R S t Total assets SAYGO tax rate PAYGO tax rate SAYGO /PAYGO % 1.5% 1.5% $419,310 $557b 3.2% 7.2% 44% % 1.5% 0.0% $366,437 $475b 2.8% 6.2% 45% % 1.5% 1.5% $383,732 $457b 2.9% 6.2% 47% % 1.5% 0.0% $339,422 $396b 2.4% 5.4% 44%

21 Relative efficiency SAYGO requires approximately half the contributions as PAYGO A very large quantity of assets (nearly 2xGDP) is required to make full transition

22 Transition Paths Finding Transition Paths Find paths that end at long rate SAYGO rate after N years. Over the transition period, the fund must accumulate the required level of assets. Infinite variety of paths: look for ones with smooth transition.

23 Transition Paths tax rates SAYGO transitions - 1 Transition tax rates 50 year transition to full SAYGO regime 12% SAYGO regimes increase 2012 taxes by 2.2% GDP 8% 4% PAYGO tax path 0% years SAYGO regime ends at 3.2 % GDP

24 Transition Paths tax rates SAYGO transitions - 3 Transition tax rates 60 year transition to 0.72 SAYGO regime 12% SAYGO regime increase 2012 taxes by 2.8% GDP 8% 4% PAYGO regime 0% years SAYGO regime ends at 4.3 % GDP

25 Transition Paths tax rates SAYGO transitions - 4 Transition tax rates 60 year transition to 0.50 SAYGO regime 12% SAYGO regime increase 2012 taxes by 2.2% GDP 8% 4% PAYGO regime 0% years SAYGO regime ends at 5.2 % GDP

26 A partial transition can be obtained keeping taxes below long term PAYGO rate, and reductions possible sooner.

27 Double Pay Double Pay To make the transition, some cohorts will need to pay more. Is this fair? We can calculate how much each cohort has paid, and how much each cohort can expect to receive

28 Double Pay I look at a cohort turning 60 in 1981 or 2011 or 2041 etc I calculate the number of person years the cohort lives from 20 pension age, and after the number after pension age The ratio provides an estimate of the number of years someone is supported for each year they are working age

29 Double Pay Dependency ratio I then calculate in each year the ratio of the number of people receiving a benefit to the number of people aged This is the number of people you provide support to in a particular year When averaged over 45 years, this is the average number of people you support each year you are working age

30 Double Pay Table 3 Cohort eligibility ratios and average dependency ratios by birth cohort Year turning 60 Years < eligible age Years? eligible age Cohort eligibility ratio Average dependency ratio prior 40 years Ratio ,111, ,496 47% 26% 179% ,124, ,055 49% 27% 184% ,226, ,385 51% 27% 191% ,243, ,807 54% 27% 198% ,189, ,175 55% 27% 201% ,446, ,094 49% 27% 183% ,701, ,470 48% 26% 185% ,154,185 1,017,020 47% 26% 184% ,273,236 1,133,960 50% 25% 196% ,574,276 1,315,530 51% 26% 200% ,701,133 1,359,790 50% 26% 192% ,672,785 1,387,180 52% 27% 190% ,499,531 1,284,343 51% 29% 176% ,480,164 1,305,355 53% 32% 166% ,772,250 1,432,382 52% 34% 151% Statistics New Zealand data and Long Term Fiscal Projection forecasts; author s calculations

31 Double Pay Dependency ratio I then calculate in each year the ratio of the number of people receiving a benefit to the number of people aged This is the number of people you provide support to in a particular year When averaged over 45 years, this is the average number of people you support each year you are working age

32 Double Pay Table 3 Cohort eligibility ratios and average dependency ratios by birth cohort Year turning 60 Years < eligible age Years? eligible age Cohort eligibility ratio Average dependency ratio prior 40 years Ratio ,111, ,496 47% 26% 179% ,124, ,055 49% 27% 184% ,226, ,385 51% 27% 191% ,243, ,807 54% 27% 198% ,189, ,175 55% 27% 201% ,446, ,094 49% 27% 183% ,701, ,470 48% 26% 185% ,154,185 1,017,020 47% 26% 184% ,273,236 1,133,960 50% 25% 196% ,574,276 1,315,530 51% 26% 200% ,701,133 1,359,790 50% 26% 192% ,672,785 1,387,180 52% 27% 190% ,499,531 1,284,343 51% 29% 176% ,480,164 1,305,355 53% 32% 166% ,772,250 1,432,382 52% 34% 151% Statistics New Zealand data and Long Term Fiscal Projection forecasts; author s calculations

33 Double Pay Average Dependency ratio and Cohort Eligibility ratio, cohorts turning % 50% 40% Cohort eligibility Fraction of life spent over age of eligibility for cohort turning 60 in year 30% 20% 10% Average Dependency ratio average dependency ratio in preceeding 40 years

34 Double Pay For all cohorts turning 60 between , people get a pension for at least 80% more person years than they provided a pension to others. The cohort turning 60 in 2046, still gets a pension for at least 50% more person years than they provided a pension to others.

35 Double Pay This is somewhat crude. We need to take into account the size of the pension Taxes are paid for all of your life, not just when you are 20-65

36 Double Pay Average pension tax contributions and receipts by cohort 25.0% Receipts adjusted for size of cohort 20.0% 15.0% 10.0% 5.0% Payments adjusted for post-retirement tax contributions 0.0% Cohort turning 60 in particular year

37 Double Pay Bottom line Almost all cohorts can expect to get twice as much in pension benefits as they paid in taxes to provide benefits to others.

38 Will savings rise during the transition? Suppose the government increases taxes now to prefund NZ Superannuation/ operate private accounts system. Will this raise capital accumulation? It won t if the private sector reduces its other saving It probably will if the contribution increase comes by restraining consumption increases as income rises This worked in Australia

39 SAYGO options PAYGO Public flat rate X Public earnings related Mandatory private Voluntary private SAYGO X X X X

40 Private accounts are only one option Private accounts link benefits to contributions and reduce the disincentives of high marginal taxes. They can be arranged so that most people are better off (Feldstein &Samwick, Feldstein & Liebman) FSC proposal provides a plan to run down savings in retirement

41 If we cut PAYGO, we use voluntary SAYGO Suppose the government raised the age of eligibility. This reduces the size of the PAYGO component If households save more, this is an unstructured SAYGO response. This is perfectly coherent..and there are costs to tell people when and how to save.

42 If we cut PAYGO, we use voluntary SAYGO This is the option favoured by people to the right of Feldstein in many countries. But most countries prefer structured saving arrangements NZ already has smallest structured retirement saving arrangements in OECD.do we want to shrink it further?

43 Australia Australia Since 1992, Australia has adopted a mixed SAYGO-PAYGO system Means tested Government pension ($A19500 currently) at age 65 (rising to 67) Mandatory individual account with 9% contributions (rising to 12%)

44 Australia Australia NZ retirement income for median person Australia New Zealand 2035 $A41000 $NZ $A60800 $NZ33100

45 Australia Australians currently pay more in and get much more out. However, the amount they pay in will rise by little between now and 2050 In NZ, the amount we pay in will nearly double between now and 2050

46 Australia By 2050, Australians will pay in 9.7% of GDP versus 7.4% of GDP in NZ They will get a pension out that is 52% of per capita GDP versus 34% of per capita GDP

47 Saving Habits Spending Halfbits

48 Conclusions 1. SAYGO is more efficient 2. Transition to a partial scheme is feasible 3. Making current cohorts pay more is fair 4. If we don t change, we will have much less efficient scheme than Australia

49 Waiting for Highlanders to bridge the gap