Littlewood: Retirement Promises are Claims on the Future

Ten Pension Reform Principles by NZ’s Michael Littlewood

Michael Littlewood at Cato’s Social Security Symposium (May 2024)

Debates over Social Security reform in the United States are often framed around financing tweaks rather than first principles. Proposals to lift or eliminate the payroll tax cap, for example, are frequently presented as a way to secure the system by tapping higher earners, as if rising retirement obligations could be effectively met without confronting deeper questions about what the system is meant to do, how benefits are structured, and what future taxpayers can realistically be asked to support.

The contribution below approaches the pension promise issue from a different national context—New Zealand—but with broader relevance on stripping away comforting myths. Its ten principles question the idea that prefunding changes real costs, that compulsory saving meaningfully alters national saving, or that pension shortfalls present a narrow revenue problem rather than as a question of benefit design, economic growth, and long-run fiscal constraints.

In Reimagining Social Security, my co-author and I also draw on New Zealand as an example for a more predictable government retirement design that provides a flat, universal benefit to alleviate old age poverty, while empowering Kiwis to save for their own financial security. Rather than treating Social Security’s financing gap as a narrow revenue problem, the book asks more fundamental questions about the program’s purpose, its distributional design, and the political incentives that shape reform proposals.

Focusing on who can be taxed more diverts attention from harder choices about benefit growth, work incentives, and the long-run economic effects of an aging population. Growth also depends on how retirement promises are financed, since highly distortionary taxes can undermine the very economic expansion needed to sustain an aging society. You can view this video to see Michael Littlewood (Retirement Policy and Research Centre, University of Auckland) discuss “Lessons from the Canadian and New Zealand Pension Systems” with Chris Edwards (Cato Institute) and Philipp Cross (Fraser Institute) at our Social Security Symposium (May 2024).

I do not present this essay because I endorse every conclusion. I publish it because it focuses the debate on fundamentals—economic substance over accounting form, incentives over rhetoric, and tradeoffs over illusions—at a moment when calls to “fix” Social Security increasingly rest on the assumption that ‘someone else’ can be forced to pay for politician’s unsustainable promises.

Ten principles relating to pension reform

By Michael Littlewood

New Zealand has an aging population. We need to talk about that but we can’t yet because we don’t know enough about what New Zealanders are doing.

There are some things that we can get straight in preparation for that debate. The following ten principles may help.

1. The cost of any retirement income scheme is the benefits paid

It doesn’t matter how a retirement income scheme is organised (public or private; defined benefit or defined contribution; pension or lump sum; workplace-based or personal; fully (or partially) pre-funded or PAYG, the cost of the scheme is the benefits actually paid.

The only way to reduce the future cost of any scheme is to reduce benefits.

2. Pre-funding pensions doesn’t change their cost

It doesn’t materially matter when (or if) money is set aside to meet the benefits (as with the New Zealand Superannuation Fund or any private pension). Pre-funding changes the incidence of the pension’s cost but does not, of itself, change that cost.

Government pensions should be ‘pay as you go’, in line with all other government spending (education, police, defence, health, etc.). A private pension should be pre-funded as the employer probably won’t be there to meet all the pension payments.

3. Private provision is no more secure than public provision

Private (pre-funded) saving schemes seem superficially more secure than future claims on taxpayers through unfunded public provision. Economically, there is in fact little to distinguish them. Each arrangement represents a set of claims on the contemporary economy that must be converted into real resources to meet the living standards of the elderly. Regardless of how those claims are framed, it is the economy’s contemporary strength, during the saving or accumulation period and then as they are consumed in retirement, that will determine their real ultimate value.

4. Preventing poverty in old age

The only reliable way to eliminate (or reduce) poverty in old age is for the government to provide a universal, taxable pension, regardless of income or means, where the annual amount payable is linked to an inflation-related measure (such as average wages or an estimated poverty threshold). The pension should be paid to everyone above the ‘state pension age’, regardless of work status and should be taxed as ‘ordinary’ income.

Means-tests are superficially logical but are complex, expensive to administer and generate unintended consequences (the Australian experience). Paying a pension to someone who doesn’t ‘need’ it may seem wasteful but the virtues of universality tend to outweigh the purities of targeting.

5. Governments are relatively powerless

Generally, governments cannot force, or encourage, citizens to save more for retirement than citizens want to save. Policies that either require or encourage people to save in a particular way will affect the make-up of their savings but probably won’t change the overall picture.

Governments may be able to control tax-advantaged or compulsory retirement saving accounts but have no control over how citizens behave with respect to the rest of their financial decisions. They will take account of their regulated accounts and will probably reduce unregulated savings (or increase debt). That is the Australian experience.

6. Governments should concentrate on things that only governments can do

Governments should focus their policy decisions on those things that only governments can do. This is a quite short list and includes:

• providing a universal age pension (item 4 above);

• maintaining a level tax playing field (so that all ‘income’ is taxed at the appropriate rate);

• regulating securities’ offerings;

• producing high-quality data on what citizens are doing about their financial security (present and future) and

• developing high-quality information/education programs that help citizens make appropriate decisions.

Everything else should be left to citizens, their employers and financial service providers.

Twenty years ago (before KiwiSaver), the government discovered that New Zealanders were probably over-saving for retirement. Might that still be the case? We need to find out.

7. Citizens will act rationally

We must assume that citizens will act in their own best interests. That includes making decisions about whether, when, where and how to save for retirement; and then what to do with those savings. For many, not saving for retirement will be perfectly rational. Reducing debt may be more important than setting aside money in saving accounts.

8. Employer-subsidized schemes are flawed

Employers must decide how much and how to pay their employees. The state should have no direct role in that, other than to facilitate the enforcement of employment contracts. However, the state should at least raise questions about schemes that subsidize employee contributions for retirement benefits. Matching or subsidizing retirement contributions is still pay—and should be treated (and taxed) as part of total compensation. An employee should not receive higher total or net compensation simply because part of their pay is routed through a subsidized retirement scheme rather than paid as wages.

9. Economic growth is the only thing that really matters

Underpinning all discussions about the future costs of an ageing population should be ‘how do we grow the economy by more than currently expected?’ A bigger pie means there will be more to share for all parts of society, including the retired. It also allows the country more choices about that future.

More savings does not automatically mean more growth. More savings means different economic claims.

10. We need to talk about it

We need to talk about these things. Before we can do that, we must gather and disseminate high quality data, currently missing. The questions that need answering will become clear once the evidence is available. The answers to those questions will probably be obvious and uncontroversial.

An earlier version of this article was published in August 2025 on Kiwiblog here.