Letter to Mr Andrew Gee, M.P., Chairman and Mr Scott Buchholz, M.P., Secretary from Terrence O’Brien – dated 7 September 2016

7 September 2016

Mr Andrew Gee, M.P., Chairman

Mr Scott Buchholz, M.P., Secretary

Coalition Backbench Committee on Economics and Finance

Parliament House, Canberra, ACT

Dear Sirs

Examination of proposed superannuation changes

I am writing to you in your capacities as leaders of the Coalition Backbench Committee on Economics and Finance, tasked (according to recent media reports) with reviewing the Government’s Budget proposals to change the taxation treatment of various aspects of superannuation. 

To assist your Committee in its work, I wish to draw your attention to four recent studies bearing on the superannuation changes and the broader challenge of retirement income policy reform.  The studies are to form part of the forthcoming edition of the Centre for Independent Studies’ quarterly magazine, Policy.  They are attached to this letter for your convenience, and have been released electronically on the Centre’s website (https://www.cis.org.au/commentary/articles/four-solutions-to-the-big-problems-with-superannuation-policy ).

I am the author of the first of the four studies, which I hope might clarify from the last 40 years of history why so many super savers feel betrayed by the Government’s Budget measures; unconvinced by the alleged need for them; and unpersuaded by the Prime Minister’s and Treasurer’s attempted defence of them.  Moreover, they fear that if retrospective measures are approved, more will follow in the unprincipled political competition to raise revenue from super savers that was revealed over the election campaign.

Previous significant increases in super tax have been designed to gradually raise revenue over time, but were grandfathered to avoid reducing the living standards of those already retired and living on lifetime savings legally amassed under the previous rules.  Similarly, those near retirement (usually, those over 50 years of age, as a rule of thumb) have traditionally been spared the adverse impact on their lifetime savings of tax increases that they were too close to retirement age to adjust to. These traditional practices conform to the grandfathering principles codified in 1975 by the Asprey review of taxation, and successfully applied to tax increases in the 40 years since.

In contrast, the Turnbull/Morrison measures take the opposite approach, instantly penalizing those who trusted in, and acted on, the deliberate, well-researched incentives of the previous law.

The four studies and their main messages for your Committee are:

Grandfathering super tax increases – Terrence O’Brien:  The Government’s tax increases would do less damage to trust in super if they were grandfathered, as has been done over at least the last 40 years for other changes adverse to those already retired or near retirement.

How should super be taxed? – Robert Carling:  The common claims that super tax concessions are very expensive are wrong, and claims that their cost is unfairly distributed are based on an indefensibly narrow, one-dimensional conception of fairness.

Building a better super system – Simon Cowan:  The main problem with the super tax concessions is that they are not reducing reliance on the age pension as much as they could do if better designed.

Don’t increase the super guarantee – Michael Potter:  Scheduled increases in the SG from 9.5% to 12% would worsen the budget outcome for many years (because they move income from relatively highly taxed to lower taxed forms); bear inequitably on women and the low-paid; expose households more to the risk of adverse regulatory change; and reduce pre-retirement welfare of the less-well off without much improving their post-retirement income or reducing their dependence on the age pension.

On my reading of the studies, an implicit message emerging across all four is that reforming Australia’s retirement income system will require future well-researched, well-explained, gradual changes that can only be successful if governments retain the trust of the retired and those near retirement.

In my view, the largest cost of the Budget measures to raise tax on super is that, for want of grandfathering, they have destroyed trust in superannuation law-making in a way that will severely damage future prospects of better-considered retirement income reforms to superannuation, the age pension and their important interactions. To be clear: the Budget measures are not about stopping egregious tax avoidance (such as was done through retrospective measures deployed in the 1970s against contrived ‘bottom of the harbour’ schemes); rather, they attack law abiding savers who responded as previous governments wished to the intended purpose of well-deliberated incentives passed into law.  They have merely lawfully saved enough money to retire on, after properly paying tax on it in the contributions and accumulation phase.  This hardly warrants an attack on their living standards near or after retirement.

Reported Coalition reflection on the measures

I was concerned to read media reports that the Coalition’s focus in reviewing the measures is mainly on the proposed $500,000 lifetime cap on non-concessional contributions to super. Protest against that measure rightly focusses on its retrospectivity, narrowly defined. But as I argue in the first study above, all the Government Budget measures are “effectively retrospective”, in the useful phrase coined by Treasurer Morrison in his  address of 18 February 2016.  The measures all serve to invalidate retirement decisions and late-career savings plans for self-funded retirement by imposing disadvantageous new rules or tax rates where irrevocable decisions and plans have been induced by, and legally based on, previous rules.

Equally worrying, the reported adjustments being considered to the $500,000 cap are mainly increases to the cap, which misses the central problem: retrospectivity itself, rather the amount to which the retrospective cap is applied.  A higher cap backdated the same way is still retrospective and still destroys everybody’s confidence in law-making for super saving.

Recent developments

The four CIS studies were completed shortly after the election. Two subsequent developments should be very worrying to the Coalition, and to all concerned to maintain confidence in superannuation, limit growth in reliance on the age pension, and improve or at least maintain the efficiency with which scarce capital is allocated in the Australian economy.

Firstly, APRA quarterly superannuation performance statistics for the June quarter 2016 are showing marked declines in personal contributions (e.g.the concessional and non-concessional contributions to be further restricted under the Budget measures) as shown in the following table.  (Since personal contributions are by far the largest source of overall member contributions, the latter have also declined by about the same percentages as shown in the table.)

Such a dramatic decline after normal growth in previous quarters is easily understood: the Greens and Labor have been promising significantly to increase tax on super since March and April 2015, respectively.   The Liberals proposed in effect tripling the Labor tax increases in the 3 May 2016 Budget, providing cover for Labor to triple its original tax grab.  So super savers and self-funded retirees knew by May that their retirement living standards from super savings were sure to decline whatever the election result in early July, and through chaotic policy processes likely to lead to further tax raids in future.  So they commenced rebalancing their lifetime savings away from super in the June quarter 2016. I suspect the current quarter’s data, capturing a full three months of savers’ reaction to the new super landscape and the election outcome, will confirm and extend the adjustment apparent in the last quarter.

Source: APRA Quarterly superannuation performance,  June 2016  http://www.apra.gov.au/super/publications/pages/quarterly-superannuation-performance.aspx 

Second, the super policy decision-making process continues to degenerate. The election result confirmed that the attack on lifetime savings would be compounded by protracted political and legislative uncertainty and unpredictable horse trading — a new low in bad policy processes in the area demanding the highest standards of clarity and predictability. In late August, Labor made its third super tax policy iteration in less than 18 months. (Remarkably, Labor still claims to support removing super rule changes from the election cycle and budget night surprises by the creation of a superannuation charter and a new, objective analytical process for evaluating proposed policy change.)

Labor’s first policy announcement in April 2015 was promised to be its last.  Its second policy change in June 2016 (tripling its tax grab) was promised to be its last for five years.  Labor’s third but doubtless not final change of 24 August 2016 proposes both higher taxes on contributions to super, plus the desirable elimination of the government’s $3 billion in new but largely forgotten and unloved increases in tax expenditures on super.  Essentially, this bargaining approach promises Labor’s support to the Coalition, conditional on the Coalition eliminating all ‘winners’ from its Budget measures, and further increasing the tax burden on those aspiring to be self-funded retirees.

I anticipate there will be a further late twist to Labor’s support for the Coalition’s tax increases on self-funded retirement.  After Labor has ensured all ‘winners’ from new tax expenditures have been eliminated and all losers multiplied to maximize the damage to Coalition support, its emphasis will turn to its historical championing of grandfathering (such as in the Keating-Hawke reforms of 1983 and 1988 described in my study).  It will support the Coalition’s tax increases, but only conditional on the Government accepting Labor’s ideas on grandfathering.  This will deny the Coalition the revenue from the tax increases in the forward estimates period that encompasses the life of the current Parliament. 

It is easy to script this next stage in the rout of the Government’s super measures:  Labor will claim it has been ‘both fair and fiscally responsible’, by ‘securing increased tax on super through sound structural reforms’ for it to spend in its own future terms of government, but ‘only prospectively and not to the disadvantage of two generations of savers who have built their plans on the current rules’.  (Those two generations are the current self-funded retirees (say the 60-80 year olds); and those in mid-to-late career savings efforts to become self-funded (say the 40-60 year olds).) 

The economic consequences

Why might the trends and possible resolutions above matter (apart from permanently destroying big swathes of voter support among super savers of the 40-60 and 60-80 generations)? 

Funds not contributed into super will be used somewhere else:  spent, or saved or invested in other ways.  Looking to the absolute numbers behind the percentage declines shown in the table above, nearly $1 billion that was flowing into super funds in the June quarter 2015 was flowing somewhere else in the June quarter 2016. Treasury assumes in its revenue estimates for the Budget measures that those alternative destinations will be more highly taxed than superannuation, but that seems unrealistic to me. 

More likely, the long-term savings previously destined for super will now mostly flow to the only other forms of long-term saving not heavily penalised by the progressive taxation of nominal income: negatively-geared rental property, and the principal residence. The latter option has the considerable additional advantage of being outside the age pension means test.  For those formerly planning to be self-funded in retirement, rearranging their affairs to preserve access to the pension offers three advantages that super-funded retirement lacks: it removes longevity risk (the risk that savers will outlive their savings); it is safe from current and prospective very high market risk of zero or low returns (because pensions are indexed); and it is safer than super (for the moment) from regulation risk – for example, that tomorrow’s governments might restrict negative gearing, or reduce capital gains or pension asset test protection for the principal residence.

For the Australian economy, the costs of these likely reallocations of long-term savings from super into one form or another of property investment ought be obvious: instead of super savings being allocated through reasonably efficient capital markets to finance diversified productive assets such as infrastructure investment, equities, or corporate or government bonds, they will instead increase the demand for property. The supply of property is restricted and prices are inflated by restrictions on land release and other obstructive regulations.  Much of any revenue from increased demand for real estate will accrue to State and Territory governments. Real estate may not be able to be confiscated by the Commonwealth in the way lifetime superannuation savings can be, but the potential of such property investments to support increased future national living standards is much lower than from the mix of productive investments financed through superannuation.

The corollary of the adjustments hypothesized above is of course increased future reliance on the aged pension – a real fiscal sustainability threat, unlike the bogus sustainability threat often asserted to arise from the well-researched and carefully implemented Costello Simplified Super reforms of 2006-2007.  In effect, every dollar the Government’s measures discourage from going into super will morph to some degree into an increase in the future cost of the age pension.

The budget consequences

Compared to the seriously adverse consequences of the Budget measures for the economy and for confidence in super, the fiscal impact is small and easily made good. As noted in my study, grandfathering will of course delay the buildup of revenue from tax increases, because (depending on details of design) the increases would only apply to those some distance from retirement, and with time to adjust their savings strategies to the new tax regime. That is a fair adjustment of tax parameters that change lifetime savings strategies, in the tradition of previous tax increases on super savings in retirement, such as those implemented in 1983 by the Hawke-Keating government.

For reasons noted above, I doubt the Budget measures would raise anything like the revenue forecast.  But let’s accept for argument’s sake that $6 billion over the period to 2019-2020 is the notional target for the urgent priority of fiscal consolidation.  I need hardly argue to Coalition members that  a better strategy to sustainably improve the budget with improvement to the efficiency with which resources are used is to reduce government spending.  Based on a calculation by Mikayla Novak, the required expenditure reduction to make good the revenue forgone by grandfathering the superannuation tax increases would  be a cut in the expenditure of each government department of about two-fifths of one percent. (Departments usually live with efficiency dividends of 1-2%, and sometimes as high as 4%.) Can it seriously be argued that any voter would even notice the difference in government services from a 0.4% loading on the efficiency dividend?

In conclusion, I suggest the Coalition should go back to the drawing board on its super tax increases.  If it feels it must persist with them, it should comprehensively grandfather them, as was done by the Hawke-Keating Government with its super tax increases of the 1980s. Better that the course of good superannuation policy rule-making be embraced by the Coalition than that it be forced on it by Labor.

Should it be helpful to you or your Committee, I am of course happy to speak with you on the themes of this note.

I am unaware of the membership of your Committee, and so have copied this letter to all Government members.

Yours sincerely

Terrence O’Brien

Declaration of interest: I am a retired public servant who worked for some 40 years in the Commonwealth Treasury, the Office of National Assessments, the Productivity Commission, and at the OECD and the World Bank.  I receive a superannuation pension from a fund I joined at age 19. My pension would be more heavily taxed by one of the changes proposed by both Liberal and Labor.

(Address and contact number supplied)