A Lesson in Fairness for a Retirement Savings System

Australia is engaged in an ongoing debate about the fairness of the superannuation system. Those on the highest incomes are extracting the greatest and an unfair advantage from tax benefits currently available. This problem of perception is inevitable in a system where contributions come out of our pre-tax income.

Australia is engaged in an ongoing debate about the fairness of the superannuation system. Those on the highest incomes are extracting the greatest and an unfair advantage from tax benefits currently available. This problem of perception is inevitable in a system where contributions come out of our pre-tax income.

To try to lessen the concern, the basic approach people have taken is to argue for restrictions on how much can be put into the system each year (on a pre-tax basis). There are also proponents of the view that there should be lifetime limits rather than annual limits. In a sense all, these proposals are trying to make taxation of the savings system more progressive, driven by a desire for greater fairness. They all make the system more complicated.

Deloitte Access Economics is the most recent contributor. Its recommendation is a little different. It proposes we use the progressivity of the income tax system as our anchor point. This actually seems like a good starting point. The design of the progressive income tax system is so that people with higher incomes make a greater contribution to funding society’s needs. It meets the basic requirement of fair acceptance.

What is interesting with the Deloitte proposal however is that it suggests we all should have an equal discount off our marginal tax rates for our superannuation contributions.

While this too seems fair, it is not clear why we need to have any discount at all.

The common rationale is that we all need an incentive to compensate us because our savings lock away for a long time. This is rather like a compensation for being compelled to do something. It is a bit odd though because the government compels us to do many things without any incentive payments. There is no incentive payment for driving on the left, or for paying one’s taxes. There is no obvious reason for the government to provide incentives for compulsory payments into superannuation. If you have compulsion, you do not need incentives. It complicates the system unnecessarily.

A more subtle explanation for the incentive would be always lightly taxing savings (as argued in the Henry review). This is to provide equity between savers and consumers – if I consume all my income today, but you save and then pay tax on your savings, you are paying higher taxes than I am. While this makes sense for voluntary savings, it is not relevant in the context of compulsory savings.

In a paper, Stephen King and I wrote for CEDA we argued the sensible and fair approach is to require all payments to compulsory superannuation be made out of people’s after-tax income and there should be no discount at all. The progressive income tax system solves the fairness problem. Eliminating the incentives gets rid of an unnecessary complication and it simplifies the system significantly.

The administrative savings would be substantial. Everybody simply pays x% of their after tax income into a compulsory superannuation fund. Get rid of all the limits and caps: get rid of the administrative complexity for once and for all. Compliance would be easy to monitor through the tax system.

People would probably save outside the compulsory system and these would be the same as outside savings are now: no news rules would be required.

Once the savings are in the compulsory sector, they would not need further taxation. Again, this would simplify the system and reduce administrative complexity.

These changes would bring compulsory superannuation into a similar tax regime as people’s primary residence. In both cases assets build up over one’s life, based on after-tax contributions, and not subsequently taxed. This might have other advantages of bringing the two systems into closer alignment since housing and superannuation are the two basic forms in which most Australian’s save.

Logic and fairness suggest superannuation and primary residences should both be included in assessing a retiree’s right to access government support in later life. This is an important issue but separate from the issue of providing fairness in the accumulation phase.

What ‘fair’ superannuation would look like is republished with permission from The Conversation