3
Mar
2015

IGR will show how we are robbing the young to pay the old

by John Daley and Danielle Wood


Published by The Australian Financial Review, Wednesday 4 March

Treasurer Joe Hockey releases the fourth Intergenerational Report on Thursday. In theory, the five-yearly study of the impact of demographic change on economic growth and the budget will tell us about the country’s future over the next 40 years. In practice, its forecasts depend on the highly uncertain assumptions of today.

What we can say is that budget deficits for the last few and next few years are substantial. The Commonwealth’s current deficit of $40 billion a year is already imposing big costs on future generations. And current tax and spending policies are transferring much more income and wealth from younger to older generations than in the past.

Long-term budget projections are always speculative, but current age-based tax and welfare policies – particularly superannuation tax concessions and the poor targeting of eligibility for the age pension – are hurting the budget position now.

Providing one generation with generous benefits that the next cannot afford is a potent intergenerational transfer. Grattan Institute’s 2014 report, The Wealth of Generations, shows that without policy change there is a real risk that today’s young Australians will not achieve the same standard of living as their parents.

Government cash payments for older households have risen strongly in recent decades. Cash payments per household – including the age pension and other benefits – increased by more than 30 per cent in real terms over the past 20 years. The Age Pension now costs $42 billion a year – about 10 per cent of all government expenditure.

A broadening of the eligibility for pension payments as well as several “top ups” to the base rate have contributed to this increase. Half of the government’s spending on age pensions goes to people with more than $500,000 in assets. Of those with $1 million in assets on top of their own dwelling, 80 per cent collect a part pension.

At the same time, tax contributions from older Australians are falling. Despite healthy growth in their incomes and workforce participation, households headed by someone aged 65 or older now pay less income tax on average than 20 years ago.

This is mainly because of the generous tax treatment of superannuation for older Australians. In 2007 the Howard government made superannuation earnings tax free for people over 60, as long as the account-holder is making some withdrawals. Superannuation accounts held by under-60s, by contrast, pay 15 per cent tax on all income. Most of these superannuation tax concessions for people over 60 go to the richest 20 per cent of households.

The cost of these growing tax and welfare transfers to older households is substantial. As The Wealth of Generations report shows, in 2010 governments spent about $32,000 on each household over 65 more than they received in tax from them — up from $23,000 per household in 2004.

These higher payments to older households cost the budget about $22 billion a year, and contribute substantially to Commonwealth budget deficits. By contrast, in 2010 an average 25-34 year old household paid $7600 more tax than it received in benefits – about the same as the contribution of households of this age in 2004.

Some older Australians argue that they have paid their taxes and so are entitled to these benefits. But they are taking more out of the pot than previous generations did. Government borrowing is paying for the growth in these benefits, and imposing the cost on future taxpayers.

As the population ages, the cost of these generous tax and welfare policies will continue to grow. Whatever the IGR assumes about the future bottom line, better targeting of these benefits is essential to put the budget on a sustainable footing and ensure intergenerational fairness.

Reintroducing the 15 per cent tax on the earnings of superannuation accounts for people over 60 could raise about $4 billion a year for the Commonwealth government. Including owner-occupied housing in the pension assets test above a $200,000 threshold, could improve the budget position by about $8 billion a year.

Changing retirement policy settings will affect those who are already retired and have arranged their affairs to maximise their entitlements. But the solution is not to grandfather existing arrangements. That will exacerbate intergenerational concerns as young people on the wrong side of the drawbridge continue to foot the bill for benefits they will never receive.

Other transition mechanisms – such as gradually increasing the value of owner-occupied housing that is included in the pension assets test – could be adopted to minimise negative shocks to retirees while ensuring that all age groups contribute to budget repair.

The government has argued that budget deficits constitute “intergenerational theft”. It will presumably use the IGR to make the case for its budget repair. But if we are serious about tackling intergenerational theft, we must consider tough reforms to the generous retirement income policies that are some of the key causes of today’s deficits.