Retirement savings and tax: Why are we disincentivising green alternatives?

In an earlier post I noted that a partial solution to the climate crisis is large scale investments in capital-intensive green energy projects, particularly in developing countries. This provides an opportunity for middle-aged savers in high income countries, so long as their savings are productively invested.

This is where New Zealand has an issue. 

New Zealand has a two-pronged retirement policy. The first is New Zealand Superannuation, which is largely funded on a pay-as-you-go basis and so generates zero savings (this is discussed here). The $14 billion in tax largely paid by working age people (or the companies they own) is directly transferred to older people and nothing is saved.  No green energy plants are going to be financed here. 

The second is private savings, either through KiwiSaver or other private saving instruments. This has potential.  But in order to take advantage of the increase in savings that occurs as the population ages, savings need to be productively invested

Productive investment relies on information and incentives. With respect to tax policy settings this means the tax system shouldn’t artificially encourage investment in one sector or another (unless it is to solve some externality problem such as pollution). Investment opportunities should be equally taxed – or equally not taxed. 

Unfortunately, NZ does this poorly. 

In contrast to the rest of the OECD, New Zealand has a tax regime for retirement savings that encourages investment in housing and property rather than other assets. Unlike most other countries, New Zealand taxes retirement savings on a “taxed-taxed-exempt” basis under which income is taxed when it is earned, the profits, dividends and interest on these investments are taxed as they accumulate, and the accumulated sum is exempt when it is paid out. 

When this system was introduced in 1989, the plan was to even up the tax on different classes of investment, a noble goal, but when it was implemented it was introduced without a capital gains tax and with an exemption for owner-occupied housing, New Zealand’s largest asset class. This provides an artificial tax incentive to save for retirement by investing in large houses or by buying property in the best possible suburbs. 

Other countries tax retirement savings on an “exempt-exempt-taxed” basis. This provides a tax regime which is broadly neutral between housing and assets held in retirement savings accounts , although it taxes other assets more harshly. This system is largely regarded in the literature as less distortionary than the New Zealand system. 

This means that in other countries private savings accumulated for retirement can be invested in green technologies without facing the tax disadvantage they face in New Zealand.

Unfortunately, for older New Zealanders there may be no practical way to change New Zealand’s current retirement income policies – except to raise taxes now to prefund a larger fraction of future New Zealand Superannuation payments, by placing the money in the New Zealand Superannuation fund. There is evidence that this is a popular policy.

In general, once a previous generation has adopted a pay-as-you-go retirement income scheme, it cannot be undone without some groups being made worse off than they otherwise would have been (although with the benefit that the large opportunity costs placed on future generations by a pay-as-you-go system will be reduced). For older people, it may also be impractical to change the distortionary TTE tax scheme. 

But, as I noted earlier, this does not mean young cohorts who are yet to accumulate much savings (say those born after 1985 or 1989) could not redesign a retirement saving scheme for themselves that does not prevent or discourage green energy investments. 

Given that they will be living in the 21st century for much longer than older cohorts, perhaps they should be given the opportunity to do this. So far there has been little analysis as to whether it is possible for young people to adopt different tax or retirement policies than older people. There is no inherent reason why it may not be possible. 

Perhaps, then, the time is right to allow younger cohorts to design savings institutions and retirement income polices that will simultaneously enable them to address three of the biggest problems the world is likely to face in the next fifty years.