Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 58

Age pension reform: income taper change is unlikely

I have previously suggested that reform of the age pension is likely at some point in the future and investigated one area of reform (the approach to pension indexation, see Cuffelinks 21 March 2014). I now look at another reform candidate, the income test taper rate. Once again we can identify how complex and sensitive an area of reform this would be – the Government needs to tread carefully!

Background on age pension income testing

Currently the full age pension fortnightly base payment for a single is $751.70, which can increase to $827.10 once supplement payments are included. Combined couple base payments are $1,133.20 ($1,246.80 with supplements).

To be eligible for the age pension you must meet age and residency requirements. The amount you receive is dependent on two tests, one based on the income and the other on the level of assessable assets. In this article we focus on the income test.

The income test consists of a threshold level; beneath this level the age pension entitlement is unchanged. For singles this level is a fortnightly income of $156 and for couples $276 combined. For each dollar earned beyond this level of fortnightly income the age pension fortnightly rate is reduced by 50 cents. So a single age pensioner would receive no age pension payments once fortnightly income reaches $1,841.60 (or a combined income of $2,817.20 in the case of couples).

In 2009 the Rudd government introduced the Work Bonus programme. Under this programme, a level of employment income is excluded from the income means tests ($250 per fortnight per individual regardless of whether one is single or part of a couple).

What did the Harmer Review say on income testing?

The ‘Harmer’ Pension Review, released in 2009, looked at income means testing in detail. It was a balanced exploration of the issues. Some key issues were:

  • to ensure that those with a moderate reliance on the age pension were not receiving inadequate government support
  • a focus on sustainability, meaning that there should exist sufficient incentives for those past retirement age to work 
  • treating different segments of the population equitably (by income and age).

With regard to the first dot point, the Harmer Review found that that “there is no evidence that the means test as a whole is operating to provide an inadequate level of support to pensioners with low to moderate reliance on the pension.”

The second dot point questioned whether high taper rates were sustainable given the backdrop of an aging population. The taper rate could be thought of as an effective tax rate. Once a single person (or a couple) earns more than the relevant minimum level of income, then for every additional dollar, even though it is (usually) not taxed, they receive a lower age payment. This has the same net effect on disposable income as a tax on earnings. To this extent, a taper rate of 40% (as it was at the time of the Harmer Review) represents an effective marginal tax rate of 40% - very high for low income earners. This could be viewed as a major deterrent to working beyond pension eligibility age. This taper rate is now 50% making working pensioners effectively the highest taxed (from a marginal perspective) of all working Australians.

From an equity consideration (the third dot point) the Harmer Review considered that those on low income were given appropriate assistance and that the poor required more additional support. The Harmer Review also identified large inequalities between the outcomes of workers below working age versus those who are eligible for the age pension. For instance, at the time of the Harmer Review, an age pensioner who is in employment and is paid the equivalent of the Federal Minimum Wage would have had a disposable income of $627.84 a week. Compared to the outcome of a non-pensioner ($494.44 a week), it is easy to identify the inequality that exists based on age.

Following this review, the Rudd Government announced major reforms to age pensions in 2009. The pension rate was increased and the income test taper rate was also increased, from 40c in the dollar to 50c in the dollar. The previously mentioned Work Bonus scheme was also introduced. This all appears to be reasonable policy: for those not looking to work the changes represented a redistribution of government age pension capital to the poor and away from those with other income sources (supported by the Harmer Review), while those looking to work are less penalised by high effective tax rates.

The effect on an individual of these changes is illustrated in Chart 1 below. The effect of the changes on couples is similar.

Chart 1: Impact of 2009 Rudd government changes to age pension

The changes make a small amount of work a more financially attractive proposition for those past retirement age. This fits nicely with Harmer Review focus groups where people were most people said they were not looking for full time or stressful work. The benefits of the Rudd Government changes gradually disappear as employment income increases and for those earning $2,000 per fortnight the changes have little or no impact.

Where is the potential for age pension reform with respect to income test taper rates?

I see little potential for a direct change to income test taper rates. Decreasing taper rates would be expensive for the government. And if taper rates increase then this will increase the financial disincentives to work and more people will cease to participate in the workforce and collect a higher age pension. It is worth noting that amongst the many (137 to be exact) reform recommendations of the Henry Review, it was recommended that no change be made to the way that employment income is treated versus investment income: the Work Bonus appears supported by those who have undertaken the major reviews.

I suspect that income test taper rates are not prominent on the Coalition budget radar. Issues such as pension rate indexation, asset testing (specifically the assessment of your home), and the age pensioner concession card appear more obvious candidates for reform.

 

David Bell’s independent advisory business is St Davids Rd Advisory. In July 2014, David will cease consulting and become the Chief Investment Officer at AUSCOAL Super. He is also working towards a PhD at University of NSW.

 

RELATED ARTICLES

Mind the (expectations) gap: demographic trends and GDP

banner

Most viewed in recent weeks

10 reasons wealthy homeowners shouldn't receive welfare

The RBA Governor says rising house prices are due to "the design of our taxation and social security systems". The OECD says "the prolonged boom in house prices has inflated the wealth of many pensioners without impacting their pension eligibility." What's your view?

House prices surge but falls are common and coming

We tend to forget that house prices often fall. Direct lending controls are more effective than rate rises because macroprudential limits affect the volume of money for housing leaving business rates untouched.

Survey responses on pension eligibility for wealthy homeowners

The survey drew a fantastic 2,000 responses with over 1,000 comments and polar opposite views on what is good policy. Do most people believe the home should be in the age pension asset test, and what do they say?

100 Aussies: five charts on who earns, pays and owns

Any policy decision needs to recognise who is affected by a change. It pays to check the data on who pays taxes, who owns assets and who earns the income to ensure an equitable and efficient outcome.

Three good comments from the pension asset test article

With articles on the pensions assets test read about 40,000 times, 3,500 survey responses and thousands of comments, there was a lot of great reader participation. A few comments added extra insights.

The sorry saga of housing affordability and ownership

It is hard to think of any area of widespread public concern where the same policies have been pursued for so long, in the face of such incontrovertible evidence that they have failed to achieve their objectives.

Latest Updates

Superannuation

The 'Contrast Principle' used by super fund test failures

Rather than compare results against APRA's benchmark, large super funds which failed the YFYS performance test are using another measure such as a CPI+ target, with more favourable results to show their members.

Property

RBA switched rate priority on house prices versus jobs

RBA Governor, Philip Lowe, says that surging house prices are not as important as full employment, but a previous Governor, Glenn Stevens, had other priorities, putting the "elevated level of house prices" first.

Investment strategies

Disruptive innovation and the Tesla valuation debate

Two prominent fund managers with strongly opposing views and techniques. Cathie Wood thinks Tesla is going to US$3,000, Rob Arnott says it's already a bubble at US$750. They debate valuing growth and disruption.

Shares

4 key materials for batteries and 9 companies that will benefit

Four key materials are required for battery production as we head towards 30X the number of electric cars. It opens exciting opportunities for Australian companies as the country aims to become a regional hub.

Shares

Why valuation multiples fail in an exponential world

Estimating the value of a company based on a multiple of earnings is a common investment analysis technique, but it is often useless. Multiples do a poor job of valuing the best growth businesses, like Microsoft.

Shares

Five value chains driving the ‘transition winners’

The ability to adapt to change makes a company more likely to sustain today’s profitability. There are five value chains plus a focus on cashflow and asset growth that the 'transition winners' are adopting.

Superannuation

Halving super drawdowns helps wealthy retirees most

At the start of COVID, the Government allowed early access to super, but in a strange twist, others were permitted to leave money in tax-advantaged super for another year. It helped the wealthy and should not be repeated.

Sponsors

Alliances

© 2021 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.

Website Development by Master Publisher.