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The Decline of the Middle Class

decline-of-the-middle-classThe Decline of the Middle Class

This year has had its share of surprises. Brexit and Trump have both caught the world unawares and, although both the Brexit referendum and the US elections were separated by time and place, there is a common theme which provides an explanation for the results; the decline of the middle class.

It has been eight years since the global financial crisis. Economies have been characterised since then by low growth, low inflation, low interest rates and high unemployment. It has been a hard slog for the working class, particularly those in older age brackets who have found it more difficult to get work or who have seen their retirement savings impacted by low investment returns. There is an increasing level of disparity between the rich and the poor, which has led to an angry, disaffected working class looking for a different solution to their economic problems.

A research report from McKinsey Global Institute, published in July, 2016, called “Poorer than their Parents: Flat or Falling Incomes in Global Economies” found that the trend for stagnating or declining incomes in the middle class is not just occurring in the US – it is a global phenomenon. The report found that as many as 70% of the households in 25 advanced economies saw their earnings drop in the last decade. This compares to just 2% of households who had declining incomes in the previous twelve years. The middle class, who have had the expectation of their fortunes increasing over their lifetimes, have been hugely disappointed; hence their vulnerability to influence by radical politicians touting new solutions. We have seen evidence of this in the UK and the US, and other economies may yet have a similar experience. Increased polarity between rich and poor leads to unrest and pressure for political and economic change.

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Save the Nation

Save the Nation

New Zealand is on the brink of a financial crisis unless national savings increases, according to the final report of the Savings Working Group (SWG). Government, households and businesses are all guilty of overspending and borrowing too much money, leaving our economy in a vulnerable state. The SWG has recommended policies to increase the quality, quantity and rewards of saving. These include reducing serious tax distortions, and improving the disclosure for financial products, especially for fees and performance as well as improving their efficiency and returns.

In the area of retirement saving, the SWG has recommended that all employees over the age of 18 be automatically enrolled in KiwiSaver with the ability to opt out. At present, automatic enrolment applies only for new employees. Also recommended is that the enrolment age be lowered to 16 and that the default employee contribution be set at 4% with the option to drop it to 2%. Of course, one of the most obvious solutions to our savings problem is to increase the retirement age. Despite this being a good economic solution it is still politically unacceptable, at least until after the next election.

The proposal for the Government to help make annuities available to retirees is an excellent one. Many retirees prefer to have a regular monthly payment to supplement income rather than a lump sum to invest. It has been suggested that payouts from KiwiSaver could be part lump sum and part annuity.

While much progress has been made to introduce financial literacy into the school curriculum, the SWG has gone one step further and suggested that financial education be compulsory in schools. This is to be applauded. Increasing the level of knowledge of financial matters is critical for changing attitudes towards saving and thereby securing the financial future of our nation.

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Budget Winners and Losers

The latest Government budget had something for everyone but while most households will be a few dollars a week better off, there are some clear winners and losers. In the winners’ corner are businesses, those on high incomes, and savers. The biggest losers are property investors who have built large portfolios financed partly by tax rebates.

Owners of investment property have been able to deduct depreciation from their rental income, thus reducing the amount of tax they pay on rental income and in many cases resulting in large tax rebates. These rebates were used to repay money borrowed for the purchase of the property. From April 2011, investors will no longer be able to claim depreciation on most properties. Some investors with large portfolios will find it difficult to make debt repayments without this tax break and may be forced to offload properties. Investors who tough it out and keep their properties will find they need to increase rents to get a decent return. There will be a shortage of rental properties which will ultimately put even more pressure on rents.

The other group of losers from this budget will therefore be those who are renting. On the plus side, the sell-off of investment properties will keep prices low for first-home buyers and it will become more attractive to buy rather than pay high rent.

While income tax rates have been lowered, GST has been increased and this creates an incentive for people to save so as to get the maximum benefit from tax cuts. Over 60% of eligible people have not yet joined KiwiSaver, and this should be a priority for savings. The minimum contribution for KiwiSaver is 2% of pay and tax cuts will be around 1.5%. The message is clear; save and you win, spend and you lose.

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