The distributional impact of KiwiSaver incentives.

• Author: Gibson, John
• Position: Report

Abstract

New Zealand's approach to retirement incomes profoundly changed with the recent introduction of KiwiSaver and its associated tax incentives. Previous policy reduced lifetime inequality, but KiwiSaver and its tax incentives will increase future inequality and lead to diverging living standards for the elderly. In this paper we evaluate the distributional effects of these tax incentives along with other impacts of KiwiSaver. Using data from a nationwide survey carried out by the authors, we estimate the value of the equivalent income transfer provided to individuals by the tax incentives for KiwiSaver participation. Concentration curves and inequality decompositions are used to compare the distributive impact of these tax incentives with those for New Zealand Superannuation. Estimates are reported for both initial and lifetime impacts, with the greatest effect on inequality apparent in the lifetime impacts.

INTRODUCTION

New Zealand's distinctive approach to retirement saving profoundly changed on 1 July 2007 with the introduction of KiwiSaver and its associated tax incentives. The previous approach, in place since 1990, provided a non-contributory flat pension to anyone who qualified by virtue of age and residency and then let people supplement that as they saw fit without favouring one particular savings vehicle over another (St John and Willmore 2001). In contrast, many countries also promote a contributory (and often mandatory) savings scheme to supplement the basic pension and voluntary provision. Because the flat pension, NZ Superannuation, is paid to everyone at a standard amount unrelated to previous earnings, it helps to equalise lifetime incomes. (2) Scobie et al. (2005) show that NZ Superannuation places a floor under the income of retirees, so that even when some fall below a relative poverty line (60% of the median) the poverty gap is negligible. Also, Ginn et al. (2001) describe it as a "women-friendly" pension because there are no earnings-related contributions, so women receive the same payments as men even though their average incomes are lower and they participate in the labour force for fewer years.

These same features are not present in KiwiSaver, which will lead to diverging living standards for the elderly. Since KiwiSaver is a workplace saving scheme, it will amplify gender, ethnic, educational and other inequalities reflected in earnings and employment variations. Not only will wealth (and retirement income) gaps emerge between members and non-members, the differing levels of member and employer contributions and variation in the performance of KiwiSaver funds will also introduce inequality. While such inequalities might be considered an inherent feature of any saving scheme, they are likely to be compounded by the generous taxpayer incentives provided to KiwiSaver members (Crossan 2007).

The main incentives for KiwiSaver participation are the $1,000 tax-free contribution on first joining (the "kick-start"), the matching contribution of up to $20 per week ($1,043 per year) from the government for members aged over 18, (3) and the exemption from Employer Superannuation Contribution Tax (ESCT) for employer contributions up to a maximum of 4% of the employee's gross pay. (4) In addition, there is a subsidy for the purchase of a first home of up to $5,000 (subject to income and house price limits), and a fee subsidy of $40 per year. From 1 April 2008 employers received a tax credit of up to $20 per week to (partially) offset the cost of compulsory employer contributions into the accounts of employed KiwiSaver members. These compulsory employer contributions are set to rise one percentage point per year, from 1% of gross pay in 2008 to 4% by 2011. Existing superannuation schemes that become KiwiSaver-compliant can access many of these benefits, including the exemption from ESCT for employer contributions and the matching government contribution of up to $1,043 per year. The investment income earned within KiwiSaver schemes is also favoured by comparison with equivalent earned income. The highest-paid members had tax on fund earnings capped at 30% from 1 April 2008, which is lower than either of the two higher marginal rates of tax on earned income (33% for pay between $38,000 and $60,000 and 39% for pay above $60,000). (5)

Although KiwiSaver began in July 2007, the various incentives were proposed in two distinct groups, which are often called KiwiSaver I and KiwiSaver II (Crossan 2007). The KiwiSaver I incentives were announced in the May 2005 Budget, and were the $1,000 kick-start and the fee subsidy. There was also a design feature, rather than a tax incentive, that all employees beginning a new job were auto-enrolled in KiwiSaver and then could opt out, rather than having the default of not being enrolled and having to opt in. The remaining incentives were announced in the Budget of May 2007 just before the beginning of the scheme, except for the ESCT exemption, which was announced in late 2006.

The original arguments for the KiwiSaver scheme were to: "Encourage a long-term saving habit and asset accumulation by individuals who are not in a position to enjoy standards of living in retirement similar to those in pre-retirement" (Section 3, KiwiSaver Act 2006). Proponents of this intervention appear concerned that many New Zealanders are not saving sufficiently for their own retirement, although this issue remains unsettled. (6) A related concern that was often highlighted by the Minister of Finance who introduced KiwiSaver is that New Zealand appears to have one of the lowest household savings rates among the developed countries (Cullen 2007), although the evidence for this claim is also controversial. (7)

These tax incentives will have varying impacts on inequality. The effect of the kick-start incentive for joining KiwiSaver and the $1,043 matching contribution depend on patterns of KiwiSaver membership. If it is mainly the rich who join, then despite the equal and capped nature of these payments, they will raise inequality. Regardless of membership patterns, the exemption from ESCT for employer contributions will increase inequality; because this is capped as a percentage of salary rather than a dollar amount, higher earners benefit more from this incentive than lower earners (while non-earners and the self-employed do not benefit at all). Over time the ESCT exemption will become the most important source of inequality, since it provides open-ended benefits every year until retirement, while the kickstart benefit is a one-off and the matching government contribution is capped. Finally, growing KiwiSaver balances for the more highly paid will be favoured by the concessionary tax treatment of investment income. Hence, any tendency for KiwiSaver incentives to contribute to inequality can be expected to increase over time as compulsory employer contributions increase each year from 1% of pay in 2008 to 4% in 2011. (8)

These likely effects on inequality should not be surprising. New Zealand experimented with tax-favoured saving schemes over two decades ago. These were found wanting because they encouraged shifts from non-tax-favoured saving into tax-favoured saving, with little evidence that saving actually improved overall, but with a large hidden cost to the Government in tax forgone that reduced public saving (St John 2006). Moreover, Treasury at the time found that tax incentives largely favoured the better off, who can use tax-favoured schemes to avoid higher tax rates and who save the most anyway. Consequently, this previous experiment with tax breaks for saving schemes was ended in 1987.

Although a comprehensive evaluation of KiwiSaver is planned, it may be several years before standard data sources show impacts on inequality. The Survey of Family, Income and Employment (SoFIE) would be a natural source for such analysis, given that it collects information on financial assets like retirement savings schemes every second year (the even-numbered waves), and also allows for a wide variety of distributional analyses based on demographic and economic characteristics. However, wave 6 of SoFIE went into the field in October 2007 without any questions on KiwiSaver, so it will not be until wave 8 in 2009/10 when the necessary data are collected. (9) The processing lags in accessing SoFIE data make it likely that independent analyses will have to wait until after 2011. By that year, the annual fiscal costs of KiwiSaver are forecast to be almost $3 billion (Gibson 2008), which is a very large amount of public expenditure not to be scrutinised, considering that the entire annual cost of NZ Superannuation is just $8 billion. (10)

Therefore, to provide more immediate data to help inform ongoing appraisals of KiwiSaver and its associated tax incentives, we initiated a nationwide KiwiSaver survey in December 2007, which ran until February 2008. Almost 400,000 people had joined KiwiSaver at the time of the survey, and enrolment continued to grow strongly throughout 2008, reaching 716,000 after 12 months and 827,000 by October 2008. Even within the first year, government expenditure of $1.1 billion was required for KiwiSaver (New Zealand Treasury 2008:116). The unexpectedly high expenses on KiwiSaver were also a contributor to the replacement of government surpluses with forecast deficits in late 2008. (11) Hence an evaluation even at this early stage is desirable. A major objective of the survey was to provide information that could be used to estimate the value of the equivalent income transfer provided to individuals by the tax incentives for KiwiSaver participation. In this paper we report on the results of this survey, using tools such as concentration curves and inequality decompositions to compare the distributive impact of these tax incentives with those for NZ Superannuation.

This comparison is not meant to imply that KiwiSaver is necessarily an alternative to NZ...