The ghost of the 'greedy geezers' hovers over our super debate

In 1988, Henry Fairlie famously wrote an article in The New Republic accompanied by a cover entitled “Greedy Geezers”. The article suggested that the elderly were living too well at the expense of the young.

More recently, some commentators have taken issue with this characterisation, arguing that the elderly and young have both suffered from the global financial crisis and its aftermath in the United States and around the world.

In Australia, as elsewhere, some retirees remain very well off. It is sobering that the Government’s modest proposals to make wealthy retirees pay some income tax on superannuation savings have led to a storm of protest, with misplaced allegations of retrospectivity.

The government proposals include a $1.6 million cap on tax-free retirement savings, with a 15% tax on earnings on amounts above that capital sum. But wealthy superannuants will still pay much less income tax than wage earners with the same level of income.

A generous and unsustainable policy

Super fund withdrawals and investment income in pension phase became entirely tax-free in 2006 under changes made by Treasurer Peter Costello. It is widely recognised that this was a high water mark in the generosity of the superannuation tax system, unsustainable except for the mining boom with the “rivers of gold" flowing into Government coffers at the time.

The table below shows how extraordinarily generous the superannuation tax system will remain for better-off retirees, even after the imposition of the government’s proposed tax.

For example, a wage earner with a taxable income of $200,000 a year pays tax and Medicare levy totalling $67,947. Under the proposed reforms, a retiree with $200,000 income from super (implying capital of $4 million in the fund, at a 5% return), will pay $18,000 in tax. The retiree is still $49,947 ahead (see Table, column 5). Cries of double taxation cannot be sustained because the whole of the draw-down of the lump sum continues to be tax free – only the future investment income is taxed.

The ALP proposal to tax investment income over $75,000 per annum at a 15% rate is not shown but its effect is quite similar to the Government proposal.

More superannuation tax reform needed

The current Government proposals do not go far enough in producing a coherent, fair system for taxing retirement savings. Ideally, we would apply an expenditure tax treatment to superannuation savings. Given where we start in the current system, this is most easily done on a “pre-paid” basis, by levying tax in full on contributions at marginal rates, and then exempting earnings and payouts. This is sometimes called a TEE (Tax contributions, Exempt earnings, Exempt payouts) system.

To achieve transition to this TEE system, we have suggested in a recent research paper that the 15% tax on superannuation funds be retained for existing (prior) accumulations and extended to earnings on existing superannuation accounts when in pension mode. This 15% tax is only transitional, on the way to our preferred TEE system under which earnings from new savings would be tax-free.

We estimate that expenditure tax treatment of retirement saving, including taxing contributions at marginal rates (but not taxing earnings) could raise around $12 billion a year, plus $8 billion from the 15% transition tax on earnings for existing accumulations, including in pension phase.

A 15% tax in retirement phase is also proposed by the Grattan Institute, which suggests that this tax could raise $2.7 billion a year. The Government’s proposal raises much less: $2.2 billion over three years.

Administrative simplicity and effects on superannuants

The Government’s proposal will require new rules for segregating retirement accounts above and below the $1.6 million threshold. The ALP proposal may be administratively easier than the government proposal, which has been criticised as too complex by financial planners. However, for both proposals administrative difficulties will arise, particularly for those who have multiple superannuation accounts.

Our proposed flat transition 15% tax would be much simpler than either proposal. The dollar impact of a flat 15% tax is shown in the Table above (columns 6 and 7). This approach would still be highly concessional, except for those with only $20,000 per year in income from superannuation (implying capital of $400,000 in the fund). Those superannuants may wish to consider taking their monies out of the superannuation environment and simply investing normally. This may not be welcomed by the superannuation industry.

Another approach would be to apply the 15% tax above an exempt threshold, but this need not be as high as the $75,000 proposed by the ALP – for example, it might be $20,000.

Fixing savings incentives and fairness across the whole retirement system

Some of the revenue raised under our proposal could be used to reform the age pension means test, which under current policy is to become much harsher. For those affected by the new asset test from mid-2017, the pension means test has an implicit deeming rate of 15.6%. The ALP originally opposed this asset test tightening but have now agreed to support it. We suggest that a 6% deeming rate would be about right, implying, say, a 3% real return on saving and a gradual run-down of assets.

This proposal would push incentives to save from the income tax system into the age pension system, ensuring that net incentives to save are not diminished (except perhaps at the top end) and in some cases may even be strengthened.

We don’t want to punish the “greedy geezers”. But the current campaign against the Government changes has little basis in reality and undermines fairness and fiscal sustainability goals of superannuation reform.