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• Under a PAYGO system, there is no accumulation of funds to pay future benefits.
• Rather, the PAYGO system simply transfers income from workers to retirees.
• When today's workers retire, they in turn rely on the taxes of the next generation of workers to pay their benefits.
• The system can survive as long as there is a larger number of workers and a small number of retirees.
• Benefits from a PAYGO system are normally relatively low.

• The number of workers to retirees is shrinking rapidly.
• In some countries, the ratio of workers to retirees is already below 2:1 (Austria, Belgium).
• By 2025, most developed countries will have fewer than 2 workers to 1 retiree. Some including Germany will be 1:1
• Result - A PAYGO system is not sustainable.

• Taxes for superannuation, and healthcare already exceed 50 percent of direct personal taxes.
• Unless changes are made to current health and benefit programmes they will have to increase by 6 - 8% of GDP over the next 25 years.
• Unfunded benefits already exceed 100% of GDP.
• Successful Reform must move away from the PAYGO model towards a funded system.

• To ensure that all New Zealanders can enjoy a reasonable level of income and healthcare in retirement (current living-alone benefit).
• To improve incentives for employment, assist and reward effort and, in a broader sense, self-help, participation and dignity.
• To ensure that income transfers are made efficiently so that any welfare losses are minimised, economic growth is improved not inhibited and the changes contribute to jobs.
• To ensure the system is fiscally sound, that is, sustainable.
• To ensure that income distribution between generations is fair and equitable.
• To help create a structure of incentives that encourages self-sufficiency.
• To minimise transitional costs as much as possible.
• To ensure the new system is as simple and transparent as possible.

One of the biggest issues in moving from a PAYGO pension system to one based on saving and investment is whether private capital investment can yield a satisfactory rate of return.

Retirement Benefit to be70% last years after tax income

With Benefits adjusted for inflation

Real interest rates required to deliver above benefits:

• As Table 1 shows, all equity markets except Italy, Portugal and Spain earned a Real Equity rate of more than 6%.

• Table 2 covers the entire 20^th century. All show a Real Return of more than 6%.

• Table 3 shows an average annual return of 7.9% during the last three quarters of the 20^th century (70% stock and 30% bonds).

Table 3

Source: Ibbotson Associates, Stocks, Bonds, Bills, and Inflation: Classic Edition Yearbook 2001, Tables C-1, C-2, C-3, C-4.

Note: Assumes a portfolio comprised of 70 percent stocks (90 percent large cap, 10 percent small cap) and 30 percent bonds (50 percent corporate, 50 percent government).

Advocates of PAYGO claim:

• The PAYGO system redistributes income though the benefit formula.
• Because benefits are a flat amount for all retirees, irrespective of their wage history, the system therefore pays proportionally more, relative to wages, to low-income workers.

• Actual redistribution is often different from what was intended.

• Low-income workers often have less education than high-income workers, therefore -
• They tend to enter the labour force at an earlier age and pay taxes for a longer period than do high-income workers. (Impact of compound interest.)
• Upon retirement, life expectancy for low-income workers is less than for their high-income counterparts. Maori and Pacific Island people in particular have a lower life expectancy.
• Indeed, it is possible, redistribution may go in the other direction from low-income workers to high-income workers.
• Market-based financing does not promote or preclude redistribution.

• All of us grow old.
• Serious ill health, inability to earn an income, a risk rather than a certainty for most of the population, becomes almost inevitable in old age.
• Earning power often drops to zero. While some costs drop away, bills for healthcare escalate. Many elderly people may even need full-time residential health care.
• That is exactly the time when we all stand most in need of absolute assurance that care will be there and our dignity will be maintained.
• Premiums cost money. Higher in the case of health than for other people. Many elderly haven't got it. In any new system what safeguards old people from the scrap heap?

• Quite simply, people, if they want to, keep a share of the tax that currently goes to fund the healthcare and pension of people over the retirement age and save it, approximately $4,000 a year (subject to any claw back provided for under welfare and education). Table 4
• At age 18 everyone opens an individual savings account. They save the $4,000 (their share of money currently going to retired population).
• They continue to save until their fund holds at least enough to cover the average healthcare costs and prescribed minimum pension required in retirement.
• Every person in the country (not impacted by the social welfare claw back provisions would have, in their own name, the money required to guarantee income and health care in retirement).
• A safety net provision would apply to those who were subject to claw back for most of their working life.
• Where people died before retirement age, savings including interest, would become part of their estate and pass to their beneficiaries.
• From retirement age they would use that fund to pay:
  • Their catastrophic healthcare insurance premium and buy any healthcare not covered by that policy i.e. up to 5% of their annual post-retirement income.
  • Buy an annuity or simply live off the income from the fund (if it is large enough to allow this to happen) or part one and part the other.
• Government would continue to play an important role in the new system as a regulator rather than provider.
• Those who object to the compulsory nature of the savings scheme should remember this. Money currently is going into a compulsory tax based pay as you go scheme.

• A transition of at least 35 years is likely to be necessary.
• People who retire during these 35 years would receive a set percentage of what the government tax paid scheme would have provided plus their own savings. (Table 5)

PAYGO benefit subject to inflation adjustment of +2% a year.

Funded System income would erode in real terms by 2% a year.

If you lived to 100, relative income would be:

• Sense of ownership and economic participation that will come to 2 million New Zealanders who currently have no capital or hope of obtaining any.
• Change in social attitudes that will follow this sense of economic participation.
• Ability to use Super Fund holdings to change incentives in areas such as Welfare and tertiary education (spending own money not taxpayers).
• Increase in GDP that will flow from:
  • move back into the workforce by welfare beneficiaries
  • increased savings
• Increased productivity/elimination of waste in our Health system.
• A general increase in New Zealanders feeling of economic security and therefore their willingness to be entrepreneurial.

ACT Caucus get off fence and start advocating a funded system.

Paid for by

Issue

Tax Cuts vs Super Fund

Tax cuts $3B available

Advantages

• Puts the money in the hands of individuals to spend as they see fit.

Disadvantages

• Does nothing to fix other big issues - Super, Welfare, health and education.

Other issues

How much room does $3B give you?

Not much

Outcome

Virtually nothing for 77% of taxpayers.

Super Fund

Advantages

• $4,000 real a year saved for 47 years = approximately $1 m real capital savings in retirement.
• Married couple = approximately $2 m real capital savings in retirement.
• Alters the incentives faced by those on benefits - 200,000+ back into workforce over 3 years
• Allows you to package changes to Education and Health to reduce spending over time to no more that the annual increase in the cost of living not the 3½ and 6½ a year real (last 10 years) increase in these respective costs.
• Enables you to get to a 15c flat company and personal tax rate within 10 years.
• Change the way people think about themselves.