The debate over the Government’s plan to limit tax breaks for earnings on superannuation balances larger than $3 million was loud, disjointed, and unsophisticated. This was hardly a surprise for seasoned super policy stakeholders.

The discourse on superannuation policy lacks solid anchors. In this regard, there are at least two areas to straighten out in order to progress with the super tax policy debate.

First, we should be clearer about the policy rationale for super tax breaks. Understanding first what they are for provides a much clearer framework for assessing how they should be reformed.

Second, we should separate questions of how best to tax savings from questions of how to appropriately measure tax breaks. Debate over what tax breaks should exist shouldn’t be confused with debate as to how to measure their cost.

Our latest report, Super Savings: Practical Policies for fairer superannuation and a stronger budget, aims to clarify these issues and shows how super tax breaks should be reformed.

What are super tax breaks for?

Super tax breaks mean less tax is paid on super savings than on other forms of income.

Three rationales for these tax breaks are typically put forward, however, reform is justified against all three.

First, many argue tax rates on the return from savings, especially long-term savings such as super, should be lower than tax rates on income from working. The impact of taxes on savings compounds over time, so the impact on future consumption can be much larger than the headline rate of tax, the longer savings are held. It’s like compound interest, but in reverse.

For this reason, some argue that all savings should be exempt from tax, and view super tax breaks a necessary first step. Indeed, many retirement income systems are taxed in this way.

Yet the UK’s Mirrlees tax review concluded that to avoid bias against savings, only the risk-free component of investment returns need be tax free. And Nobel Prize winning economist Peter Diamond and James Banks argue that even the risk-free return on savings should be taxed, albeit at a lower rate than other income. The ANU Tax and Transfer Policy Institute has reached a similar conclusion.

In any case, super is already taxed much more concessionally than other savings vehicles. Tax breaks on both superannuation contributions and on earnings combine for a negative marginal effective tax rate for most income earners, compared to pre-paid expenditure tax treatment whereby tax is paid on income when earned, and then both earnings and withdrawals of savings are tax-free.

Estimates by Treasury suggest that Australia’s superannuation tax breaks cost $9 billion more in forgone tax revenue in 2017 (and would cost more today) than if they were subject to pre-paid expenditure tax treatment.

Second, and relatedly, many argue super tax breaks are supposed to encourage additional savings, over and above compulsory contributions. However, the evidence suggests that tax breaks for retirement savings have little impact on the total amount saved. Instead, it’s compulsory superannuation that lifts savings. As the 2020 Retirement Income Review concluded, “tax concessions appear to have a weak influence on overall savings behaviour”. Rather, people with higher incomes, and older savers, tend to switch their existing savings into whichever investment vehicle pays the least tax.

The implication being that we should move to harmonise the tax treatment of savings at the same rate, as ANU Tax and Transfer Policy Institute Director Robert Breunig recently proposed. Making super tax breaks less generous is a necessary first step towards broader reforms to taxing savings.

Third, superannuation tax breaks also arguably compensate people for being compelled to lock up their savings until retirement. However, low-income earners are more likely than higher-income earners to be hurt by this compulsion. They are under more financial stress while working, and live shorter lives on average so have less time in retirement to spend their superannuation.

It follows that the tax break offered on each dollar of superannuation savings should be higher for lower-income earners than high-income earners, whereas, Australia’s current system does the opposite.

Separating measurement and design

A recurring issue with tax expenditures is the choice of benchmark. A benchmark is the standard tax treatment or “tax norms” against which the cost of tax concessions can be assessed.

Writing in The Conversation, Professor Andrew Podger of the ANU objected to our and Treasury’s use of an income tax benchmark (where super contributions and earnings are both taxed at marginal rates – TTE) to measure the cost of super tax breaks. Professor Podger argued for an expenditure tax benchmark where savings are taxed only once at marginal rates, upon either entering or leaving the system (an EET or TEE system), with no tax on earnings.

But arguments in favour of tax concessions on savings are separate from the question of how the costs of these concessions are measured. The point of tax expenditures is to allow comparison of all such tax-advantaged vehicles so that the policy outcomes can be compared with their costs. In this regard, the income benchmark remains the best measure of the revenue costs of providing these concessions.

There are good reasons to tax savings income concessionally. But the income tax benchmark allows the community to understand the costs of these concessions and to assess whether they provide “value for money” in meeting those policy goals.

How should super tax be reformed?

Our recent report, Super Savings: Practical Policies for fairer superannuation and a stronger budget suggests how super tax breaks should be reformed.

First, contributions tax breaks should offer smaller tax breaks, per dollar contributed, for high-income earners.

The pre-tax contributions of people earning more than $220,000 a year should be taxed at 35 per cent, instead of the 30 per cent charged to those earning more than $250,000 currently, saving the budget $1.1 billion a year.

Further, we suggest that, as large pre-tax super contributions generally represent tax minimisation by wealthier, older Australians, rather than genuine retirement saving, the cap on pre-tax super contributions should be lowered, from $27,500 to $20,000 a year, saving $1.6 billion a year.

Second, earnings in retirement – currently tax free – should be taxed at 15 per cent, the same as superannuation earnings before retirement. This would save the budget at least $5.3 billion a year, and much more in future, while simplifying tax administration for super funds.

The top 10 per cent of retirees would pay an extra $7000 to $7500 a year on average, whereas the poorest half of all retirees would pay no more than an extra $200 each and would stand to benefit much more from the increase in health and aged care spending these revenues could fund.

Taxing super earnings in retirement isn’t retrospective because it applies only to future earnings, which is no different to if we change the personal income tax rates applying to investment held outside of super.

Third, earnings on super accounts larger than $2 million – rather than $3 million as proposed by the government – should be taxed at 30 per cent. This would save about $3 billion a year, compared to about $2 billion a year under the government’s plan.

In total, our proposals would save the budget more than $11.5 billion a year.

Super tax breaks would still cost the budget more than $30 billion a year if our recommendations were implemented. But those tax breaks that remain would deserve to stay.

Joey Moloney

Economic Policy Deputy Program Director
Joey Moloney the Deputy Program Director of Grattan Institute’s Economic Policy program. He has worked at the Productivity Commission and the Commonwealth Treasury, with a focus on the superannuation system and retirement income policy.

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