OPINION: Australia is lauded for its retirement income structure. We are in an enviable position compared with the implicit pension debt being racked up among our counterparts in the Organisation for Economic Co-operation and Development. As a paradigm, it has everything going for it – income protection for the less well off, cost containment and minimal levels of mandatory self-provision for those who can afford it.
But successive governments put the whole structure at risk by tinkering with superannuation taxes. No country has borne more capricious changes to the taxation of its private pensions than Australia.
It’s worth taking a step back from the current controversy to reflect on three questions. First, what should a pension tax system look like? Second, why should our pension tax system be subject to so many more changes than its counterparts elsewhere? And, finally, why does it matter if Canberra fiddles?
Almost all countries offer tax concessions for pension saving. The implicit deal is, preserve your savings until you retire, and get a tax break. The most common break is exempting the investment earnings of the pension fund. Then either contributions are deductible under the personal income tax or benefits are tax-free.
On the whole, taxing benefits is the better way to go. This avoids complexities around employer deductions for pension contributions, and bad investment outcomes are cushioned through lower taxes while investment outcomes above the norm pay some extra tax. The government shares the risk. The timing of tax collections is better too – tax revenues will increase when an expanding older population cohort is driving up public expenditure.
But whether contributions or benefits are taxed, as long as investment earnings are exempted, economic efficiency is well served. You have a system that closely aligns the tax treatment of superannuation with the tax treatment meted out to the other major life-cycle asset – owner-occupied housing. This is a critically important aspect of the policy design. In their roles as retirement saving vehicles, these two assets should be treated similarly under the tax system. And by exempting earnings, the price distortion between consumption during working life and during retirement is largely eliminated.
Australia’s superannuation tax departs from both these standard paradigms. Instead, it separates superannuation taxes from personal income tax altogether. Contributions are income tax exempt, but taxable at a flat rate in the pension fund; earnings on those contributions are also taxed. Benefits used to be taxed as well, until the 2007 Better Super reforms exempted benefits paid to those over 60.
The result is that there is no link with the progressivity inherent in the personal income tax.
Separating superannuation taxes from personal income tax makes tinkering with pension tax tempting for governments. Changes can be made without their showing up in a pay packet the next week.
This has happened several times since the superannuation guarantee was introduced, and it looks like it’s about to happen again. What is proposed may be a small step in the direction taken by the Henry review, which accepted contributions taxes were here to stay, but recommended the rebate be linked to the personal rate schedule. It also recommended a reduced earnings tax to help the power of compound interest generate more accumulations.
If that’s the direction of change, then it would be better to take the proposal in its entirety, rather than just apply it to the top 1 per cent, as news reports suggest is likely. And this should be well thought out, with discussion and consultation, not a last-minute cash grab.
Why does the tinkering matter? Two important reasons. First, this is a whole-of-life issue, and long-term planning is part of it. Although some rules are bound to change with time, surprises are bad. Arbitrary policy surprises destroy credibility in the system. The top 1 per cent today, the top 5 per cent tomorrow, who knows the day after?
People are likely to reduce their non-mandatory contributions, saving will fall, eventual reliance on the age pension will be higher than it would otherwise have been.
Second, change increases administrative costs and charges. More records have to be kept, checked and transferred when the worker changes funds.
Australia’s pension costs are already on the high side. Through a full career, lifting charges by just half a percentage point can cut the eventual accumulation by more than 10 per cent. That affects everyone’s super, not just the top one per cent.
John Piggott is director of the ARC Centre of Excellence in Population Ageing Research at UNSW.
This opinion piece first appeared in The Australian Financial Review