So, Treasurer Joe Hockey has finally put the aged pension on the block for reform, placing it alongside Newstart and the disability pension. Hockey’s comments late last week that the retirement age of 65 (scheduled to increase to 67 by 2023) is unsustainable in light of increasing life expectancy, and that failure to reform would be akin to intergenerational theft”, is appropriate on a number of levels.

Like many other advanced nations, Australia is facing a demographic tsunami that threatens to cripple government finances. The large-scale retirement of the baby boomer generation means that the ratio of working-age Australians supporting dependents (mostly the aged) will shrink over coming decades, slashing the tax base at the same time as age-related outlays expand …

According to the Grattan Institute, without corrective action, the federal budget deficit could hit $60 billion per year by 2023, or up to 4% of GDP, due mostly to rising health and welfare costs. Grattan also argues that the only part of the tax and welfare system that is not well targeted is that for old people — a view supported by researchers from Curtin University, who recently found that welfare policies across the period 1984 to 2010 overwhelmingly favoured the elderly at the expense of the young.

Judging by the Treasurer’s comments, the government will likely follow the Productivity Commission’s recommendation and seek to raise the eligibility age of the age pension to 70 — a move that is estimated to save around $150 billion over the period 2025-26 to 2059-60 and increase participation rates among older workers by around 3% to 10%.

While such a reform is welcome, on its own it is not enough, and deeper reforms of the retirement system are needed in order to improve intergenerational equity and the long-term sustainability of the budget.

Superannuation is a particularly large problem. While the system was originally designed so that a younger generation could pay for its own retirement, it has instead become a mechanism whereby older people pay less tax given their income than everybody else, with the lion’s share of benefits also overwhelmingly going to richer people.

Under the current system, all employees that contribute compulsorily into super pay a flat 15% contributions tax, which effectively means that the amount of concessions received increases as one moves up the income scale …

For example, someone who earns in excess of $180,000 per year receives a 30% tax concession for each dollar she contributes into super (i.e. 45% marginal tax rate less the 15% flat tax). At the other end of the scale, someone who earns less than $18,200 per year in effect gets penalised 15% for each dollar he contributes into super.

According to Treasury figures, concessions on superannuation contributions were estimated at $16.5 billion in 2012-13, with concessions on superannuation earnings valued at $15.5 billion. Moreover, Treasury estimates that the top 5% of contributors would receive 20.3% of contribution concessions, with higher income earners also receiving the lion’s share of the earnings tax concessions.

Given that the main rationale behind superannuation is to both adequately provide for retirement and take pressure off the aged pension, the 15% flat tax system is inherently flawed and designed to fail. By providing massive taxation concessions to those on the highest incomes, the budget loses billions of dollars of forgone revenue. At the same time, the super system is unlikely to relieve pressure on the aged pension, since those that are most likely to need it — lower- and middle-income earners — receive minimal (if any) concessions, which both hinders their ability to build up a retirement nest egg and discourages them from making additional contributions.

A simple reform that would greatly improve the equity and sustainability of the retirement system would be to abolish the flat 15% tax on superannuation contributions and replace it with a flat concession (e.g. 15%) that is the same for all income earners. A reform of this nature would not only improve equity, since all taxpayers would receive the same taxation concession, but also boost lower-income earners’ super savings, thereby reducing reliance on the aged pension and relieving pressures on the budget.

Other inherent flaws in Australia’s retirement system include the exclusion of the family home from the assets test for the aged pension, combined with the ability to withdraw one’s super as a lump sum (instead of an annuity). Both loopholes create an incentive for households to borrow to purchase an expensive home in the lead-up to retirement, retire at 60, withdraw their super tax-free as a lump sum, use the money to pay off their mortgage or to fund consumption, and then go on the aged pension from 65 years of age. In such instances, the taxpayer is left wearing the cost of superannuation concessions throughout the individual’s working life, and then again once that same individual goes on the aged pension.

In fact, the latest Retirement and Retirement Intentions survey by the Australian Bureau of Statistics found that “of those who had made contributions, 55% had received all or part of their superannuation funds as a lump sum payment”. It also found that “many of those who received a lump sum payment used it to pay off or improve their existing home or purchase a new home … or to buy or pay off a motor vehicle”.

Obvious reforms that would improve the integrity, fairness and sustainability of the retirement system, therefore, also include:

  • Increasing the access age to superannuation (from 60 years currently) so that it more closely matches the pension access age;
  • Reducing the ability to draw super as a lump sum; and
  • Including one’s owner-occupied home (or part thereof) in the assets test for the aged pension, so that taxpayer assistance flows more to those in genuine need.

Hockey’s acknowledgement that the aged pension system is both unsustainable and inequitable is a welcome start. However, if the government’s “ending the age of entitlement” is to be equitable and consistent, it will need to place the retirement system front and centre, incorporating the growing army of wealthier, older Australians drawing unreasonable tax concessions and benefits.

To not target this group would indeed be “intergenerational theft”, and would place the budget in an increasingly precarious position as Australia’s population ages. It would also mean that the working-age population is left wearing the brunt of budget expenditure cuts at the same time as it incurs the cost of supporting its relatively well-off parents.

Peter Fray

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