Under Australia’s three pillar retirement income system, most people’s retirement income will be funded from a combination of super and the Age Pension as can be seen from Figure 2.2. This is expected to continue to be the case in the future, although the maturing of the system is expected to result in an increase in the proportion of the population who receive a part-rate, as opposed to a full, Age Pension.
Given that a key outcome of the superannuation pillars of our retirement income policy is to supplement retirement incomes and reduce reliance on the Age Pension, a key question is whether the superannuation pillars are cost-effective. That is, does the notional tax expenditure applied to superannuation pillars have an appropriate connection to the expected future reduction in the cost of the Age Pension, improved living standards of older Australians and other identifiable benefits to the economy? Put another way, does the government’s investment in the notional tax expenditure for super represent good value for money? To what extent are the tax concessions used to support inheritances or are dissipated by spending of lump sums? Can this be accurately measured or does the analysis break down under the weight of too many assumptions and sensitivity to changing inputs? The Charter Group believes that questions like this will be central to the work of the Council.
While it might not be possible to provide a definitive answer to these questions, it is nevertheless instructive to weigh the notional cost of the super tax concessions and the actual cost of the non-tax initiatives against the expected offsetting reduction in Age Pension outlays, and other economic benefits, as a result of increased super savings. To do this, it is instructive first to review the concessional tax treatment of super and the methodology used by Treasury to value these concessions.
For the majority of taxpayers, super contributions, and earnings on their investment in super, receive concessional tax treatment compared to tax imposed at personal marginal tax rates. A flat 15 per cent tax rate applies to employer and deductible personal contributions to superannuation, except for those earning over $300,000 per annum. For most employees, this flat tax rate compares favourably with the rates of tax they would pay if their super contributions had instead been paid in the form of salary or wages.
In the accumulation phase, investment earnings on superannuation assets are also taxed at 15 per cent, with certain capital gains taxed at 10 per cent. Again, this compares favourably to the tax rates that apply to most other investment income. In retirement, if superannuation benefits are paid as an income stream, such as a pension or annuity, earnings on the assets supporting that income stream are generally exempt from income tax altogether.
The concessional tax treatment has a number of purposes, including:
- to compensate people for super contributions being compulsorily preserved until retirement, rather than received as wages;
- to encourage people, particularly the self-employed, to save additional amounts through superannuation voluntarily; and
- to provide people with a better standard of living in retirement through larger super payments and correspondingly lower reliance on the Age Pension.
Two estimates of the notional cost to the government of providing the super tax concessions are published annually by Treasury in the Tax Expenditures Statement (TES). Both estimates look at tax revenue implications and neither method looks at long-term pension savings, which are addressed by Treasury’s RIMGROUP model. This process has its own methodology that seeks to assist policy makers trading off tax concessions and actual expenditures to decide what is the best use of government money. It assists this process to know what it would look like if a particular policy were exchanged for another or discontinued altogether.
The revenue forgone method is similar to forward estimates, and assumes the continuation of the concessional taxation treatment of superannuation. The revenue gain method is like a costing — it assumes that contribution and earnings concessions cease on a particular date and examines the cumulative consequences of relatively lower contributions and assets. Table 2.1 shows how this is presented in the 2012 Tax Expenditures Statement.
Table 2.1: Comparison of revenue forgone and revenue gain estimates, 2012-13 to 2015-16 from the 2012 Tax Expenditures Statement
|Concessional taxation of superannuation entity earnings|
|Revenue forgone estimates ($b)||Revenue gain estimates ($b)|
- Reason for difference
- It is assumed current preservation rules remain. In the accumulation phase voluntary concessional contributions are assumed to cease (as in the table below) and most non concessional contributions are also not invested in superannuation after the start date. Over time this reduces the superannuation asset base and thus the revenue gain on withdrawing the earnings tax concession. Additionally, a significant proportion of funds in the retirement phase (not preserved) are withdrawn. Because of other tax concessions for older Australians (particularly the Senior Australians Tax Offset), the funds withdrawn attract minimal tax in the new investments chosen.
|Concessional taxation of employer contributions|
|Revenue forgone estimates ($b)||Revenue gain estimates ($b)|
- Reason for difference
- It is assumed that the Superannuation Guarantee remains and therefore compulsory contributions continue. Voluntary contributions are assumed to be directed to alternative tax preferred investments. Because more voluntary contributions come from those with higher marginal tax rates, the average tax rate for residual compulsory contributions is lower.
Revenue forgone method
The revenue forgone method measures the difference in tax paid by taxpayers who receive a particular concession relative to similar taxpayers who do not receive that concession. It operates on the assumption that, if the super system did not exist, wages and salary currently being contributed to super would be paid directly to employees and taxed at their respective marginal rates. That is, it assumes that if super did not exist, there is no alternative universal saving mechanism where taxpayers could enjoy concessional tax rates of 15 per cent. The money otherwise contributed to super
would either be spent or invested and taxed at marginal rates. The revenue forgone method assumes no behavioural change (that is, it does not take into account the likely use of other ways to reduce tax).
Revenue gain method
Under the revenue gain method, regard is had to the likely behavioural change that would see taxpayers using other strategies to reduce tax, such as negative gearing. This approach measures how much revenue could increase if a particular tax concession were removed. For example, under the revenue gain method, it is assumed that voluntary concessional contributions (that is, non-Superannuation Guarantee concessional contributions) and most non-concessional contributions would not be invested in superannuation. Voluntary contributions are assumed to be directed to alternative tax preferred investments. Because more voluntary contributions come from those with higher marginal tax rates, the average tax rate for residual compulsory contributions would be lower.
For earnings, the smaller contributions and withdrawal of non-preserved assets would reduce the superannuation asset base and thus the revenue gain on withdrawing the earnings tax concession. It is assumed that non-preserved amounts in the retirement phase would be withdrawn from the system, and invested to yield minimal tax because of the tax concessions available to retirees.
Drivers of increased notional tax expenditure
Over the past 10 years, the notional tax expenditures on superannuation, as reported in the TES under the revenue forgone methodology, have risen from an estimated $13.8 billion in 2003-04 to an estimated $31.8 billion in 2012-13. Under the revenue gain method, the notional tax expenditures on employer contributions and earnings (the only superannuation tax expenditure estimates prepared under the revenue gain methodology) were estimated at $23.4 billion in 2012-13.
Under either of the methods Treasury currently uses to measure the notional cost of the superannuation taxation concessions, the cost is rising, and increasing relative to other taxation expenditures. This is a combination of two factors:
- the superannuation system is subject to a robust growth rate, averaging a net compound annual growth rate of approximately 11 per cent.2 It doubles in size roughly every six or seven years; and
- the increase in Superannuation Guarantee contributions to 12 per cent by fiscal year 2020.
Criticisms of the Treasury notional tax expenditure methodologies
The three major criticisms of these methodologies are:
- that they are not costings with assumed behaviour changes in which assets inside the system would reduce year on year;
- the assumption that taxpayers would pay full marginal tax rates ignores likely behavioural changes directed towards the use of tax-effective investments (such as negatively geared housing, shares or investments with deferred capital gains); and
- that the long-term saving in Age Pension outlays should be factored into the cost estimate.
The revenue gain estimates are Treasury’s attempt to address the criticism that the revenue forgone estimates are not costings that take account of likely behavioural change. The revenue gain estimates also have low or negligible taxation for amounts newly invested outside superannuation, but they still use a full marginal tax rate for earnings remaining in the system.
Treasury has published several estimates of the saving in Age Pension from superannuation changes, but has not included these in an alternative version of its tax expenditure estimates. The savings are highest for measures which impact people likely to receive Age Pension. For example, Figure 2.1 shows savings in Age Pension from an increase in the Superannuation Guarantee rate to 12 per cent and the balance between tax losses and Age Pension underlying the analysis.
Figure 2.1: Reduction in taxes and Age Pension outlays from the SG3
Cost of non-tax incentives
In addition to the notional cost of the superannuation tax concessions, the government co-contribution and low-income earner superannuation contribution scheme impose a direct cost on the budget.
In the period since its introduction in 2003-04 up until the end of the 2011-12 financial year, the co-contribution has cost the government $8.3 billion.4 The cost of the low-income earner superannuation contribution scheme is estimated to be just under $1 billion per annum over the forward estimates period commencing in 2013-14, which is the first year the contribution will be paid.5 The cost of the co-contribution is expected to decline following the recent budget changes.
Offsetting reductions in the Age Pension
The TES is designed for a specific purpose — namely the publication of the tax expenditure. The Charter Group believes that a more holistic approach is needed to inform the debate on the cost of superannuation to the budget and the future work of the Council.
As superannuation savings continue to rise, it is expected that there will be an offsetting reduction in reliance on the Age Pension. Currently, around 50 per cent of people of Age Pension age are full-rate pensioners and around 80 per cent receive some pension. The maturation of the super system is expected to result in an increase in the proportion of the population who receive a part-rate pension as opposed to a full Age Pension. Nonetheless, the Age Pension will remain an important contributor to retirement incomes for most Australians.
Figure 2.2 shows the projected change in the proportion of the population of eligible age receiving full, part or no age or service pension. By 2047, it is projected that the proportion of those of eligible age not receiving an age or service pension will remain around 20 per cent, while the proportion receiving a part pension will rise to around 50 per cent and the proportion receiving a full pension will fall to around 30 per cent.6
Figure 2.2: Proportion of people of eligible age receiving full, part or no age or service pension
The above analysis is based on Treasury’s RIMGROUP model, which projects the increasing income and wealth of successive cohorts of retirees. This modelling incorporates the maturing of the Superannuation Guarantee arrangements and other government policies, and other recent changes such as the legislated change to the Age Pension age and the 2012 Budget measure which reduces superannuation concessions for very high income earners. Growth in private incomes and wealth interacts with means tests to constrain future spending on age-related pensions. The impact of higher wealth is shown in the projected decline of full-rate pensioners and projected rise in part-rate pensioners.
The RIMGROUP model is a comprehensive cohort projection model of the Australian population, which starts with population and labour force models, tracks the accumulation of superannuation, estimates non-superannuation savings and calculates pension payments and the generation of other retirement incomes (after all taxes). Thresholds and withdrawal levels associated with income and assets tests are modelled in detail. The model is consistent with current policy and includes known future policy changes.
hese projections indicate that the superannuation pillars are expected to achieve the objective of providing people with a better standard of living in retirement by supplementing the Age Pension, while not necessarily reducing the budget cost of retirement income policy overall.
While it is difficult to be definitive about the net cost of the superannuation incentives, based on Treasury analysis of the notional cost of the superannuation concessions and projections made using Treasury’s RIMGROUP model, it is possible to draw the following conclusions:
- The growth in superannuation assets is projected to result in an increased proportion of the population achieving a higher standard of living in retirement than is possible from the Age Pension alone. This is evident from the RIMGROUP model projection of a decline in full-rate pensioners; and
- The notional cost of the superannuation taxation concessions, according to Treasury’s current methodologies, will continue to grow, given the expected growth of superannuation savings.
There was some useful discussion about the appropriate way to assess the cost of the superannuation tax concessions during the Henry review.
The following is a discussion from section 3 of the Henry review Retirement income consultation paper issued in December 2008:
Box 2.1: Concessionality of the superannuation taxation arrangements(a)
Under a comprehensive income tax benchmark the concession to superannuation is the difference between the tax paid if the superannuation contribution and the earnings were taxed as income at the individual's personal tax rate (plus the Medicare levy) and the tax paid in the fund (generally 15 per cent). Under this benchmark the superannuation concessions have an estimated cost to revenue of over $26 billion in 2007-08 (Australian Treasury 2007).
An alternative way to calculate the value of the tax concession is to use an expenditure tax benchmark. The two types of expenditure tax benchmarks are: a pre-paid expenditure tax based on direct taxation of labour income with an exemption for saving; and a post-paid expenditure tax based on the taxation of a direct measure of expenditure or of goods and services.
Under the pre-paid expenditure tax benchmark, the value of the concession is the difference between the tax paid if the superannuation contribution were taxed as income at the individual's personal tax rate (plus the Medicare levy) and the tax paid in the fund, less the tax paid on earnings in the fund. Benefits are tax exempt under this benchmark, which is consistent with the tax exemption of superannuation benefits in Australia's retirement income system. Under this benchmark, the superannuation tax concessions would have an estimated aggregate cost to revenue of $4.6 billion in 2007-08.
Under the post-paid expenditure tax benchmark, both contributions and earnings would be tax-exempt but benefits would be fully taxable when paid. Under this benchmark the tax concession is expected to be less than under the pre-paid expenditure tax benchmark, as individuals will generally have a lower tax rate on their retirement income than their income while working.
Under all these benchmarks, superannuation is taxed concessionally. However, the concessions are heavily weighted to individuals on higher personal tax rates.
(a) These estimates are not necessarily indicative of the cost of the superannuation concessions over the long term. The tax concessions help to reduce budgetary expenses in future years, particularly Age Pension payments, through the effect of the means tests.
When it comes to assessing future policy proposals, it will be important for the Council to be able to weigh the notional cost of proposed policies against expected future offsetting reductions in expenditure on the Age Pension and other economic benefits. This will involve developing a comprehensive framework of analysis which is able to combine these elements and be improved over time.
The Charter Group is attracted to the idea that the pre-paid tax expenditure method identified in the course of the Henry review is the place to start, but this will be a matter for the Council to determine.
2 APRA data show that the net compound annual growth rate of the superannuation system from June 1994 to June 2012 was 11.2 per cent.
3 Treasury estimates. Treasury uses a model called RIMGROUP to estimate the long term aggregate and distributional impact of superannuation policy changes. RIMGROUP is an actuarial increment and decrement cohort model which breaks each cohort into career earnings deciles and gender. Accumulations are modelled in seven account types within this group structure.
4 Australian Taxation Office, Annual report 2011-12, October 2012, Table 2.22 Administered expenses p. 60.
5 Portfolio Budget Statements 2013-14, Budget-Related Paper No 1.18 Treasury Portfolio, Table 2.16 p. 206.
6 Rothman, G. Modelling the sustainability of Australia’s retirement income system, July 2012 Paper presented to the 20th colloquium of superannuation researchers.