We almost never discuss superannuation in terms of its fundamental rationale: encouraging individuals to achieve their optimal consumption pattern over their lifetime. Superannuation exists to provide for consumption during the years when individuals no longer have a regular income. The case for mandatory superannuation is that, left to their own devices, individuals may not save enough to meet their consumption needs in retirement.
Over 30 years ago, we established a superannuation scheme with ever-increasing mandatory contributions, and with both contributions and earnings being taxed at preferred rates. It is interesting to contemplate why such tax subsidies were deemed necessary when individuals had no option but to contribute. Those involved in the establishment of the scheme have indicated that these subsidies were a carryover from what existed at the time and their continuation was regarded as necessary to gain support for the legislation.
How has superannuation fared?
Now, 30+ years on, how has this worked out? It is pointless to answer this question in the context of the average individual, as the impact of superannuation varies for each of us. Let's start with the wealthy (say the top third), for whom superannuation has provided a tax haven to invest as much of their savings as possible. These discretionary contributions, on top of the already substantial mandatory contributions, have resulted in the wealthy accumulating superannuation balances well beyond what is required to meet their consumption needs in retirement. Consequently, these individuals are not depleting their superannuation balances in retirement, leading to ever-increasing large estates being passed on to the next generation.
From a policy perspective, how has mandatory superannuation with significant tax incentives fared? It has failed miserably. Modelling shows that for our wealthy group, mandatory superannuation was never necessary to provide for their retirement, much less to provide them with huge tax incentives to do something they would have done anyway.
Are these needless tax subsidies significant enough to be concerned about? Yes, they currently cost taxpayers about $50 billion each year. Recognising that left unabated, these tax subsidies will grow to 2.5% of GDP by the early 2060s. At the same time, the aged pension is forecasted to represent 2% of GDP, down from 3% when mandatory superannuation was introduced. This suggests the current net annual cost of the tax subsidies is around $40 billion, growing to over $110 billion by 2060.
The tax subsidies provided in superannuation have always been bad policy, representing a waste of taxpayers' money. However, they also play another important role as a reverse Robin Hood. The poorest group (say the bottom third by wealth) is potentially disadvantaged from a tax perspective by being required to contribute to superannuation. This is recognised by providing those with annual earnings of less than $37,000 with a $500 government contribution to their superannuation to negate any tax burden caused by compulsory contributions. Incidentally, our modelling shows that this $500 is inadequate to offset the tax burden in many cases, leading us to conclude that our poor group effectively receives none of the tax subsidies.
Hence, we conclude that there are two significant issues with our superannuation scheme from a policy perspective. First, it is a waste of taxpayers’ money as it encourages excessive contributions to retirement savings. Second, almost all of the tax subsidies flow to the wealthy, further distorting our income distribution.
What's the solution?
The question then becomes, what can the government do about this situation? The answer seems obvious: reduce or eliminate the tax subsidies and/or redirect them to those in greater need. However, there is a problem with the government attempting to do this—it will hurt them at the ballot box. To see this, we need look no further than the 2019 elections, which Bill Shorten lost largely due to proposed tax changes that were viewed as negatively impacting superannuation.
Of course, the negative impact of any proposed tax changes on the popularity of a government depends not only on the legislation itself but also on the existence of a group that will actively lobby against it. We have created such a group with superannuation, where an ever-expanding industry’s revenue stream (and personal earnings) is linked to further expansion of superannuation. This is evident in the current debate on the Div 296 tax, which represents a small step by the government to reduce the tax subsidies flowing to those with excessive superannuation balances. The group targeted by the Div 296 tax represents a major source of income to the industry, whose incentives to kill the legislation are further fuelled by the possibility it will be the precursor for further changes that will negatively impact the industry.
Is the Div 296 tax a good starting point for targeting these tax subsidies? Probably not, as it is far too convoluted, although it does target those who benefit most from the needless subsidies and who least need the wealth for its intended purpose (funding consumption). The fact that it has features such as a ceiling that is not indexed and that it captures unrealized capital gains provides the industry with targets to attack the legislation and divert attention away from the key issue: the great waste of taxpayers' money attributable to the tax subsidies.
Where does this leave us? With a superannuation scheme that fails us in many ways, one of which is the needless waste of taxpayer funds. This point is not lost on the government, which sporadically proposes legislation aimed at achieving small improvements. When it does so, the legislation is subjected to much criticism from the industry, generating sufficient unrest among voters that the government backs off. We are just stuck with bad policy.
Emeritus Professor Ron Bird (ANU) is a finance and economics academic and former fund manager.