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Why are high marginal tax rates bad for workers but good for retirees?

The 2018 Federal Budget made it clear that the Government believes too many people are moving into higher marginal tax rates. For example, in the Personal Income Tax Plan, it says:

“The plan begins with permanent tax relief to middle and lower income earners, to encourage and reward working Australians and to assist with cost of living pressures. Under Step 2, the plan will help protect incomes earned by Australians from bracket creep. The third step will make personal taxes simpler and flatter to ensure more Australians are paying lower taxes on every extra dollar they earn.”

Sounds like not only a plan, but a set of principles. It appears that the Government regards it as self-evident that marginal tax rates are too high and this is a bad thing.

Centrelink Pension Income Test

After a long campaign the then Government agreed in 2009 to increase the rate of the age and other pensions paid to single people to improve the standard of living for the recipients. However, in order to limit the cost of this increase they also increased the rate of taper (ie the reduction in payments as income increases) under the income test from 40% to 50%. This is effectively a marginal tax rate and it exceeds the highest marginal tax rate on income that has applied for many years. Governments since 2009 have done nothing to change this position.

Apparently, high marginal rates of tax are bad for working people earning an income, but not so for those in retirement or otherwise receiving a Centrelink pension.

Centrelink Pension Asset Test

A 50% effective marginal tax rate under the income test for age and other Centrelink pensions is mild compared with the effect of the increase from $1.50 per fortnight for each $1,000 to $3.00 per fortnight in the taper under the Asset Test which was introduced by the current Government effective 1 July 2017. The taper under the Pension Asset Test is now so steep that the effective marginal rate for a single homeowner with assets between $253,750 and $552,000 and for a homeowner couple between $380,500 and $830,000 exceeds 100%.

Many superannuation funds are now producing estimates of the income (from superannuation, other savings and Centrelink pensions) which a member can expect to receive in retirement. For people whose assets at retirement are expected to lie within the range of the Asset Test taper, the projections indicate that expected income in retirement could be lower if they increase their savings. Their age pension will reduce by more than the income they receive from any increase in their savings (whether within or outside superannuation).

Alternately, in retirement, spending money (on travel, a home or elsewhere or by giving some away within Centrelink limits) within this range of assets will actually increase income. The age pension will increase by more than the income lost on any capital amount spent or gifted.

The impact of deeming rates

For many years, age and other Centrelink pensions have been subject to both income and assets means tests. If a pensioner’s income from other sources or assets, as defined, exceeds specified minimum amounts the rate of pension is reduced.

In the case of the income test, financial assets, as defined, are assumed to earn a deemed rate of return for the income test. Currently the deemed rate of return on financial assets is 1.75% for the first $50,200 for a single pensioner and the first $83,400 for a pensioner couple. Financial assets above these amounts are deemed to earn 3.25%. The lower deeming rate is based on holding this amount in an at-call or cash account at a bank or other financial institution. The higher deeming rate is based on these amounts earning a higher return by being invested on a longer-term basis including shares and property.

This suggests that 3.25% is a reasonable figure to use as the income received by a pensioner on assets within the range of the Asset Test taper. So, an additional $1,000 in assets within the range of the asset test taper will earn 3.25% or $32.50 per year in income and result in a reduction in the pension of $78 per year ($3 per fortnight). This is effectively a marginal tax rate of 240%. The previous taper of $1.50 per fortnight per $1,000 in assets reduced the amount of pension by $39 per year, and this was already an effective tax rate of 120%.

More penal marginal tax rates

Over the years the taper under the Assets Test for Centrelink pensions has always represented a penal effective marginal tax rate. This was recognised in 2007 when the rate of taper was reduced from $3.00 per fortnight for each $1,000 to $1.50. The higher deeming rate at that time was 5.5%. The reduction in the rate of taper reduced the effective marginal tax rate from 142% to 71%. This still exceeded the highest marginal rate of tax on income.

In practice for a short time after, 2007 is the only period in the last 20 years that the taper under the Assets Test represented an effective marginal tax rate that was under 100%. The reduction in interest rates to an unprecedented low level after 2008 has meant that the effective marginal tax rate represented by the taper under the Assets Test was already over 100% even before the increase from $1.50 to $3.00 per fortnight per $1,000.

The assets taper means that a pensioner with assets (savings) within the range of the taper in the Assets Test can increase their total income by spending some of their savings on travel, home renovations or (within Centrelink limits) gifts to their family.

Coming back to Budget 2018

Recapping from the opening quotation in Budget 2018:

“The plan begins with permanent tax relief to middle and lower income earners, to encourage and reward working Australians and to assist with cost of living pressures.”

Must be no need to encourage and reward pensioners and retirees faced with cost of living pressures.


Graham Horrocks is an actuary specialising in financial planning and superannuation, and a former General Manager, Research & Quality Assurance, with Ord Minnett. Since 1999, he has been an independent financial adviser. The article was reviewed by Geoff Walker, former Chief Actuary at the State Bank of New South Wales.

Peter C
June 18, 2018

I vote to keep things as they are, which is pretty much the same as it was in 1999.

This is another example of permanent generosity paid for by the temporary mining boom.

There is a reasonable argument however that something should be done for non-home owners, i.e. pensioners who rent.

They are the real losers in all this, because where can you buy a home, in any of our 5 mainland state capitals, for $203,000 ? (This is the difference between the assets test for home owners and non home owners).

In Sydney and Melbourne, homes for $203,000 are a distant memory.

Gary M
June 17, 2018

To directly answer the question in the heading, it's about incentives. Marginal tax rates are low for workers to encourage them to work more and not lose the extra in taxes. MTRs are high for welfare recipients to encourage them to move off welfare.

Michael 2
June 17, 2018

Hi SMSF Trustee and Michael,

I think pensioners are now being shamed as welfare recipients, this is a development I don't like, to put it mildly.

Retired people in general make enormous contributions to the community as a rule doing work that no one wants or can't afford to pay for, such as baby sitting, raising children, careers for spouses and volunteer work.

Michael 2

June 18, 2018

Hi Michael 2,
Thanks for your message.
Some retirees may contribute to the community. Some may not. I don't see the issue of contribution to the community as relevant to the discussion. Using your spare time to give back to your community isn't particularly noble if you expect to be paid for it.
With regard to shaming - I certainly don't think that people who genuinely need welfare should be shamed for claiming it. I have no problem with elderly people with very limited means from claiming a full pension. I am very happy for my tax dollars to go towards their welfare and I wish them all the best.
However, if I owned my own home outright and had $500,000 in the bank I would personally feel tremendously ashamed about claiming tax payer funded welfare that I clearly don't need.

Tony Rad
June 14, 2018

you can complain all you like about the perceived inequity of our retirement income policies but the fact remains that the fastest growing sector is the over 65s and our future tax payers cannot fund age pensions to millionaires.....

June 14, 2018

Thanks Graham for the thought provoking analysis. So let me get some perspective. Those retirees with assets (super) whose value falls within the taper range of the Assets test represent an unnecessary cost burden for Governments judging by the effective tax rate imposed. Those retirees with superannuation assets in excess of $1.6m represent a new revenue stream for Governments of all persuasions. Like modern day big business, stripping out costs are more significant than new revenue generation to the bottom line. Is it because cost reduction is a simpler path to follow? Finally, those lucky buggers (that's me) who fall into the category of working Australians stand to reap the benefit of tax cuts. The message from Government (whether red or blue) seems clear - bondage is alive and well and it doesn't pay to be emancipated!

Jon Kalkman
June 14, 2018

The taper rate means that for an extra $1000 of assets, the age pensioner will lose $78 per year in income ($3 per fortnight for 26 fortnights). That is a loss of income at the rate of 7.8%. Couples with assets of $800,000 earn less income than those on the full pension unless those assets earn at least 7.8% income, and that is unlikely.

The government expects this couple to make up for this lost income by progressively drawing down on this capital, but this couple has to manage market risk, inflation risk, longevity risk and legislative risk in the context of an uncertain life expectancy and uncertain health care and age care costs. By contrast, the age pension is a world class annuity, indexed to inflation, paid for life and no risk of market failures. For this protected species, there are also no worries about health care costs or age care costs as these are all covered by the taxpayer.

This punitive taper rate creates incentives to maximize entitlement to the age pension especially for those caught in the taper range. The easiest way to do this is to reduce assessable assets, by spending it, gifting it within allowable limits or by investing in the family home by renovations or upsizing. As the family home remains a non-assessable asset, the size of the age pension is not affected by the value of the family home, which also free of capital gains tax when sold.

The government frowns upon the use of tax-advantaged superannuation to be passed through the estate to beneficiaries, but allowing children to inherit the family home free of tax while the taxpayer covers the cost of retirement income, health care and age care is seemingly approved.

June 14, 2018

The whole premise of this article is a bit silly. Equating the taper rate on the age pension to a rate of tax is nonsense.

By that logic we are all paying an effective rate of 100% tax on the unemployment benefit we're all not getting because we choose to have jobs.

The age pension isn't an entitlement. It's a free handout of tax payers money and so it is only to be used as a safety net for people who need it. Your fellow tax payer doesn't owe you free money if you already have enough to be able to provide for yourself.

Joe Hockey told us "the age of entitlement is over" remember?

SMSF Trustee
June 14, 2018

That's appalling, Michael. The age pension is most definitely an entitlement. At least in a modern civilised society it is. I don't think that even Mr Hockey would agree with you that ensuring that our elderly are able to live above the poverty line was in the firing line of his comment. It's never been just a 'safety net for those who need it'. That sort of comment is true for the unemployment benefit and many welfare payments, but the old age pension has always been in a different category.

Though personally I'm fortunate enough that I'll never need to receive it, I don't see my situation as being the 'norm' and I'd never suggest that someone who earned average wages all their life, supported their family and then moved onto the pension was displaying an inappropriate 'sense of entitlement'.

You should be ashamed.

June 14, 2018

I disagree. The age pension is most definitely a safety net.
I too am fortunate enough that I'll never need to receive it yet I earned average wages all my life and supported a family. But then I saved for my retirement and are reading the Cuffelinks news letter.

June 15, 2018

Hi SMSF Trustee,
I fear you misunderstand me. I don't suggest that funding to keep the elderly above the poverty line is inappropriate. I have no problem with the pension being paid to those who need it.

My issue is with those who complain about having their pension reduced because they have too much in retirement savings. I object to those who feel they feel they are 'entitled' to the age pension regardless of their own means.

SMSF Trustee
June 15, 2018

OK Michael, glad to hear it. But that is not the situation that the article is addressing; rather, Graham Horrocks discusses a situation in which there is a financial incentive for someone to be on the pension because to have "their own means" results in a take-back from their pension in excess of the income they earn from investments. These are not wealthy people and for the system to start taking away their basic pension because they have a modest amount of savings to supplement it is ridiculous and wicked. So, perhaps you might rethink your opening remark about the article being based on a silly premise and acknowledge that it is actually talking about a harsh element of the way the system works.

June 15, 2018

Hi SMSF Trustee,
Thanks for your reply. I'm glad we understand each other better now and I no longer need to be ashamed.
I'm afraid we might have to agree to disagree on the validity of the premise of the article.
I don't accept that it is 'ridiculous' to significantly reduce a person's pension welfare payments due to the amount of their savings.
My view is that it is shortsighted and misleading to simply compare the net income position while ignoring the value of the capital itself.
It's far better to have $1000 in the bank plus $25 per year in free money from the government than to have no money in the bank and $50 per year in free money from the government.

But more broadly, I see this argument over taper rates to be irrelevant and silly because I view the age pension purely as a safety net designed for people who are otherwise unable to provide for themselves, not as a free taxpayer funded handout for the elderly.
I don't accept the argument that your fellow tax payer owes you free money, even if you don't need it, simply because you have reached age pension age.
Under the current rules, a person of age pension age who owns their own home outright and has $500,000 in savings is still able to claim a part pension.
As a taxpayer in my 30s I certainly don't own my own home outright and I don't have $500,000 in savings. The fact that I am expected to fund welfare payments to a person who has those assets is, to my mind, the aspect of the system I find 'ridiculous'.

June 17, 2018

Michael, the current retirees were, during their working life, supporting with their taxes, the retirees of that time. Just like previous generations. That’s just how it works but perhaps the “me generation” who unfortunately I am one, wants that to cease. Our turn will come just like it did for generations in the past.

June 18, 2018

Hi Jason,
Thanks for your message.
I've got to say that if "that's just how it works" is the only justification for we can come up with for a policy, that might be a sign that it's time to change that policy.
The first rule you learn in business is that "we do it this way because that's the way we've always done it" is the most dangerous and foolish justification for doing something ever.

And I would argue that a generation of people who argue that they are entitled to free money from the government even though they don't need it during a time when the country is running huge budget deficits are the most deserving of being referred to as the "me generation".

SMSF Trustee
June 20, 2018

I have to make one more comment. I don't think Michael 'gets it'. The annual combined income for a couple on the old age pension in Australia is $32,000. (It can get up to $36k with energy supplement.) That is at least not higher than the poverty line and is probably just below it.
To think that it's fair and proper to take away from this meagre amount immediately upon earning income, as discussed in the article, is - I'll still use the word - shameful. It is an entitlement that our elderly should be cared for and have the opportunity to live out their lives decently. Yes, it's better to have assets that generate income for yourselves and that the pension should cut out once people are in a modestly decent financial position, but to create a situation in which there's a financial inducement to remain entitled to $36k is not acceptable.
I don't see this as a matter of the elderly 'expecting' tax payers to finance them in their old age, it's a matter of taxpayers seeing it as our obligation to do so. It's part of being a civilised, caring community. The principle dates back to biblical times when the first century church would provide for widows who were unable to remarry or earn income from working.
By all means we can have a debate about what level of independent income should take someone off the pension, but a civilised, caring community does not say to these folk, 'sorry, that extra $2k you can earn will now be taken away from you so that you remain stuck at $36k per annum. You'll have to do much better than that before we let you get above the poverty line.'

I congratulate Graham Horrocks for raising this issue.

June 20, 2018

Hi SMSF Trustee,
I'm concerned that we seem to be arguing at crossed purposes as you seem to be basing your argument on a misunderstanding of how the age pension system currently works.
I feel that our debate would be improved by some facts from the Department of Human Services website.
Your assertion that a pensioner's income is reduced "immediately upon earning income" is false.
The homeowner couple you described in your example are able to have up to $380,500 in assets (not including the value of their home) and still receive a full pension. This seems more than reasonable (bordering on generous)
They can invest their money in any way they want and generate as much income as they like with zero impact on their pension. This is because the government doesn't actually measure the amount of investment income they receive - it just assumes a modest 'deeming rate' of 1.75 per cent a year for the first $80,600 of their financial investments and 3.25 per cent above that.
The income test for the age pension allows for a pensioner couple to generate up to $7,800pa in additional income with zero impact on their age pension. Even if they generate income above this amount, their pension is only reduced by 50 cents for every extra dollar they earn. There is therefore no disincentive to seek this income as it is always better to have $1 of your own money plus 50 cents from the government rather than to only have $1 from the government. Again, this seems very reasonable to me.
Given the above, your assertion that this system is somehow 'not acceptable' or 'shameful' seems very peculiar.
While we seem to be unable to agree on how reasonable the current taper rates are, I think we can perhaps find some common ground regarding the amount of the base pension itself. I absolutely agree that the amount of $32,000pa for a homeowner couple if very meagre. I certainly wouldn't want to have to try to live on such a small income. I would support an increase in this basic amount for couples with little to no assets or other income.
Perhaps the increase could be funded by taking away the current entitlement to a part age pension for couples who own their own home and have $1M in the bank...sound reasonable?

June 14, 2018

I don’t know much about tax policy but it seems really weird if this is true:

* "expected income in retirement could be lower if they increase their savings. Their age pension will reduce by more than the income they will get from any increase in their savings (whether within or outside superannuation)."

And - "Alternately, in retirement, spending money (on travel, your home or elsewhere or by giving some away within Centrelink limits) within this range of assets will actually increase your income. The age pension will increase by more than the income lost on any capital amount spent or gifted."

Gary M
June 14, 2018

Who does this affect? Surely only poor people rely on welfare handouts. Oh I forgot – 85% of retirees in Australia are on welfare handouts! (it was 75% in 1990 before compulsory super – so much for the goal of getting people off welfare!). And excludes their family homes from any calculations of need.


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