KiwiSaver: Just another money-go-round

by Trinh Le

By 30 April 2008, over 600,000 people had joined KiwiSaver. Every month we get an update on KiwiSaver enrolments as a reminder of how successful KiwiSaver has been. But does more members mean more savings?

Research shows that KiwiSaver is merely a money-go-round. Over half of the savings are funded by taxpayers, in the form of the $1000 kick-start subsidy, matching contributions of up to $1040 per year and foregone tax revenue from ESCT (employer superannuation contribution tax) exemption. Most of the remaining savings are employers’ contributions and money that members would have saved in other forms.

Only 9-19 per cent of KiwiSaver balances are estimated to be from reduction in consumption.

That much “new” saving is hardly enough to cover the administration and compliance costs of implementing the scheme, and the deadweight loss due to taxation.

Deadweight losses arise because taxes increase costs to producers and lower benefits to consumers/workers, reducing the incentives for them to engage in economic activity, thus less output is produced. Treasury uses a conservative deadweight cost estimate of 20 per cent for public sector cost-benefit-analysis. That is, every $1 of public money spent needs to return a benefit of $1.20 to “break even”.

When these costs are taken into account, the impact of KiwiSaver on national savings is most likely negative.

In the short run, household savings rise. Business savings will fall because employers are now required to contribute to employees’ KiwiSaver accounts, a cost that is not fully offset by the employer tax credit of up to $1040 per year per employee.

Government savings will drop markedly due to the costs of the kick-start subsidy, matching contributions, employer tax credit, fee subsidy, first home subsidy, and the revenue forgone due to the fact that most of employer’s contributions are tax exempt and that investment earnings are taxed at a preferential rate under the PIE regime.

These findings are broadly in line with evidence from countries with long established tax-favoured saving schemes. Most US studies have found that IRAs and 401(k) schemes tend to raise savings by 0-30 per cent, insufficient to meet deadweight losses and administration and compliance costs.

Even Treasury (Budget Economic & Fiscal Update 2007, page 79) estimates that the fiscal costs of KiwiSaver will exceed the increase in household savings by 10%. It is ironic that Treasury endorses KiwiSaver while forecasting KiwiSaver will reduce national savings.

In the long run, most of the cost will fall on households. The money the government spends to meet the huge fiscal costs of KiwiSaver comes from taxes paid by businesses and households. With higher taxes and non-wage costs (contributions to employees’ KiwiSaver accounts), businesses will charge consumers more or pay workers less to maintain profitability. Workers will pay more taxes, have lower take-home income while facing higher prices for goods and services as consumers, so household savings will decline.

Savings in KiwiSaver are households’ money. Households would be much better off keeping their income in the first place, so that their savings are not lost in the money-go-round.

Every day, more and more people will sign up for KiwiSaver. Given the scheme exists, it is in everyone’s individual interest to join, as financial columnist Mary Holm rightly advises. This does not mean the existence of the scheme is in our collective interest. Quite the contrary.

The more people are in KiwiSaver, the higher are the fiscal costs of the scheme, and the more taxes Kiwis will have to pay. The economy will be worse off because taxes reduce incentives to invest, produce and work.

The fund management industry can expect to benefit from this policy, but few else. Is helping investment bankers increase their wealth at the expense of everyone else what KiwiSaver was really intended to do?

Dr Trinh Le is an economist at the New Zealand Institute of Economic Research