In my previous article, I derived break-even super tax rates required to allow for the cost of not being able to access super savings for up to decades. These rates increase with marginal income tax rates, yielding tax concessions adjusted for illiquidity, that rise with marginal rates. This analysis comes at a time when the proposed Division 296 superannuation tax is being hotly debated, particularly the unrealised capital gains tax component and non-indexation of the $3 million threshold.
Extrapolating from that article, if we must have an increase in superannuation tax - and more fiscal discipline would be preferable - then rather than introducing a Div 296 style tax for revenue raising purposes, it would seem more logical to implement a progressive scale of super tax rates, linked to marginal income tax rates. That is, replace the flat 15% tax rate on contributions and earnings with a scale of rates.
Such a structure would represent a discount to marginal tax rates, allowing for both the illiquid nature of compulsory super and the smoothing of real tax concessions across income levels.
Here's how it could work
Super tax rates could be determined by extensive data analysis and modelling, but for illustrative purposes, might look like this:
Marginal tax rate | Super tax rate
30% | 15%
37% | 17.5%
45% | 20%
Note: while a super tax rate of 15% might align well with a 30% marginal rate, 15% would also need to apply to marginal rates of 0% and 16% to maintain parity with the current system and to prevent gaming. A 15% floor on the super tax rate would ensure individuals cannot exploit periods of none or low non-super income, deliberate or otherwise, to reduce super tax. And though a super tax rate of the order of 10% might be fair for a 16% marginal rate, the current Low Income Superannuation Tax Offset could remain in place to address that.
A progressive super tax arrangement would essentially be an income-based approach, reflecting the idea that super is really a deferred income stream or deferred salary, taxed consistently with other income.
As opposed to a Div 296 tax that is basically a quasi-wealth tax, taxing amounts above an arbitrary threshold, and not respecting how super balances have been accumulated to date. It would potentially tax compound growth built up over decades under accepted current tax settings and disincentivise longevity in the workforce.
This alternate approach would be administratively possible because infrastructure is already in place to handle the Division 293 tax, being the extra 15% tax on voluntary contributions made on income levels in excess of $250,000. The ATO links personal income tax data with super contributions.
Part of the motivation for Div 296 was for it to deal with ultra-high super balances that use the super system as a tax-preferred environment to shield wealth. A progressive system would therefore need a backstop of some sort, like a hard cap attached such that accounts cannot exceed a certain balance of say, $5 million.
An example
To gain a feel for some numbers, consider the following example.
An individual aged 27 who has just crossed into the 37% marginal tax rate bracket has $50,000 super accumulated to date and has 12% SGC contributions going into super, with no other contributions. Wages growth is 2.5% p.a., and the fund earns 6% p.a. before tax. Assuming ad-hoc government increases in tax thresholds over time, he doesn’t push into the next tax bracket until age 47. According to the above scale, his super tax rate on earnings and contributions is 17.5% until age 47, and 20% thereafter.
At age 67, his super will have accumulated to $2.83 million. Had his super tax rate been a constant 15%, the fund would have grown to $3.13 million, and it would have reached the $3 million Div 296 threshold at age 66. Higher super tax rates have cost him $300,000, or about 9.5%, over the 40 years.
Some observations:
- On a tax rate of 15%, the worker would be liable for Div 296 tax before retirement age. That is, even young workers on modest salaries today can eventually be hit with this tax due to the non-indexation of the $3 million threshold.
- Yes, the individual would pay more tax throughout his working life under the progressive super tax scale but it would be consistent and predictable. Crucially, he would avoid the shadow of a Div 296 tax hanging over him in his retirement years, which could potentially erode more savings if his super balance continued to compound post retirement.
- This would be a moderate increase in tax to retirement in exchange for long term certainty and simplicity. There is no logic in placing a back-ended Div 296 tax on retiree funds at a time when unfettered access to savings is needed more than ever in retirement years.
- A progressive super tax system would avoid future shocks, with known rules around tax captured during a working life. It would essentially be pre-retirement reform as opposed to post, and it would align with existing tax structures.
- The system wouldn’t penalise individuals who may end up with a balance of more than $3 million through working longer and/or having achieved superior investment returns.
- High income earners would still pay more tax but transparently and proportionally.
As an aside. A system that maintained a flat earnings rate tax of 15% with just the contribution tax rate varying according to marginal tax rate could also be possible. For example, the above case would yield a similar tax take over the 40 years, if the 37% marginal rate mapped to a contribution tax rate of 22%, and 45% to 30%. However, such a system would not be as clean as one with the same tax rate applied to both earnings and contributions.
From a revenue raising perspective, the Div 296 tax is projected to collect around $2 billion in the first year of operation across some 80,000 super accounts with balances in excess of $3 million. Being a more lump sum-based tax, the average tax take per person would be considerably higher from year to year than an income-based tax. But under my proposal, there would be a much broader base, with the extra super tax take commencing at income levels a little over average earnings across potentially millions of workers.
And there would be less chance of any behavioural erosion of the base under my approach as it would be more understandable and palatable to the electorate than the incoherent Div 296 tax.
Again, the ultimate position would be determined by modelling though a progressive tax system should raise moderate and consistent revenue per account over time from not just the wealthy but also average earning workers. A lower burden per person but with a far broader base could still see the required revenue raised.
In summary, the Div 296 tax penalises time and compounding. It is a new tax on existing savings, a retrospective, balance-based tax. And it is complex and unpredictable at a time when retirees need clarity and certainty of cashflow.
However, a progressive tax model, across income levels at a discounted marginal tax rate, wouldn’t materially affect the retirement nest egg for middle to high income earners. A fairer, simpler, more ordered system, it would respect the accumulated value of savings built up in good faith under existing rules. And importantly, there would be no ill-considered tax on unrealised capital gains.
Tony Dillon is a freelance writer and former actuary.