Inflation indexing: Time to do everything, everywhere all at once

The Oscar-winning film Everything, Everywhere All At Once. There’s a message in that title for our political policymakers.

Among the most controversial aspects of the government’s new plans for super is a decision to ignore inflation.

At any given time over the past 30 years when inflation was laid flat, a plan that did not “index” or continually adjust for inflation might have been acceptable.

But in 2023 ignoring inflation is a dangerous game; the super debate is just the tip of the iceberg.

With inflation running at nearly 7 per cent, indexation – or the lack of it – can create instant winners and losers across investment markets.

It’s a key reason the new plans for super matter to many more people than it might appear at first glance.

In fact, inflation and its cousin “indexing” is suddenly going to matter to everyone – from retirees to newly minted university graduates.

This week the government outlined a detailed plan for the new changes to super. The core proposal is that anyone who has funds of more than $3m in the system will enter a new tax channel where a 30 per cent rate will be applied to earnings.

Very wealthy investors with fortunes in super were always going to be a political target. If we are to believe the government’s figures, there are only about 80,000 people involved. Nobody will be marching in the street for the rights of very wealthy super investors.

A Treasury consultation paper this week outlined how the new scheme might work and it even called for ideas around the mechanics of applying the tax.

But the paper suggests no flexibility on two highly controversial points: The new tax would not be indexed – it would have a $3m threshold forever!

Additionally, the tax would include realised and unrealised gains. Taxing unrealised gains is a breach with all tax practice in Australia.

In deciding to not index the super tax change against a background of high inflation, the reality is that many more people than estimated would be pulled into the tax net.

Already industry analysts forecast that more than 800,000 people coming into the super system today would ultimately get caught in the net.

In the long term, this move is going to push people away from superannuation, and it is going to drive even more people into ploughing more money back into the family home or other tax shelters.

But the immediate issue is discrimination. Again, putting the absolute dollar threshold number of $3m to one side, consider how super can now work in different ways within the broader system.

Once the new super tax system gets rolling we will have a split situation. Those on the pension will have an income which is indexed for inflation. In fact, anyone on a pension already gets their income indexed twice a year – and the outstanding issue among lobby groups for the sector is to have it indexed more regularly.

In contrast, one segment of the self-funded retiree population will not get the benefits of indexation.

It gets worse. If the government does not allow for inflation in the new tax it will quickly face a bizarre outcome where the current “tax-free cap” of $1.7m in superannuation – which is indexed – will enlarge to the point it could swamp the system.

Keep in mind that our current elevated level of inflation is going to push the tax-free cap up by $200,000 on July 1 to $1.9m. If the tax-free cap keeps getting indexed like that it is entirely possible the $3m threshold for the 30 per cent tax is ultimately outpaced.

This is daft. In fact, by itself, it is an argument to index the new 30 per cent tax.

As you can see, indexing cuts both ways. It’s an almost invisible friend or foe.

For most investors it is very difficult to get a grip on it. Who keeps track of all this indexing and non-indexing? It’s not like you can go to the Department of Indexing and find out what they’ve been up to on their website.

Rather, indexing has become a tool for how the government can manipulate the tax system.

With variations everywhere, we are getting to the point where if you are on the wrong side of indexation it’s going to hurt.

Just now the Greens are pushing a bill to abolish indexation when it comes to all education and training loans. A range of student groups, including the National Union of Students, are pushing for change.

When we had an average rate of 2.5 per cent inflation for three decades nobody cared; Inflation indexing was barely on the radar.

Many people put student loans on the “never, never” – even with the tightening of terms under the Coalition where more students had to pay back more of their loan, the attitude to HECS-HELP debt is often indifferent.

But last year the average student loan of $25,000 went up by 3.9 per cent and this year the increase will be a lot bigger.

Over the past few weeks our podcast, The Money Cafe, has been awash with questions from anxious adults over the increases in HECS debt and how they will deal with their inflation-fuelled loan obligations.

It’s always the same when governments get selective about who might take the pressure – in this case the pressure of rising inflation.

The extra super tax for higher earners – Division 293 – is not indexed. But across the tax system perhaps the most absurd case of something not being indexed is in the so-called “Sophisticated Investor” regime. This is where you can only access certain financial products if you qualify as a sophisticated investor and in doing so, you also lose a range of consumer protections.

Under the terms of this arrangement you must either have $2.5m in assets or earn more than $250,000 over the past two years in a row.

Here’s the thing: When they launched the scheme in 2002, they never indexed it.

Even with the recent history of low inflation, the number of sophisticated investors has mushroomed.

An ANU study found that only 1.9 per cent of the population on commencement of the scheme were eligible. “However, this figure had risen to 16 per cent in 2021 … and if unchanged could rise to 29.1 per cent of the population by 2031 and by 2041 to 43.6 per cent of the population,” the study said.

Yep, keep going with that scheme and one in two Australians could be classified as sophisticated investors at which point the entire scheme will be a meaningless farce.

Which brings up back to super and the government’s new plan to not just change the rate of tax for wealthy super investors but to change the very nature of how they will be taxed.

Inflation is high and it could remain high for a long time.

Indexing one thing and not indexing another is very bad policy. It creates inequities across the system. At its worst, it presents the sort of shambles we have with the sophisticated investor rules.

There is only one way to solve the problem: Index everything, everywhere, all at once – and start with the new changes planned for super.