Robbing the elderly is the fool’s way to tackle ‘intergenerational inequality’
It is scarcely plausible that 40-year-olds would envy 70-year-olds, much less want to trade places. Think past generations had it easier? Look at the numbers.
Responding to Ken Henry’s claim about “intergenerational bastardry” and similar comments at the recent economic reform roundtable, the Albanese government has announced that it will apply an “intergenerational lens” to policy developments.
What that implies is no mystery: more taxes on the elderly, who deserve to be punished for their alleged transgressions: saving too much; owning residential property that has risen in price; paying too little in superannuation taxes; costing government too much for health interventions and for aged care. The goal, we are assured, is that of advancing “intergenerational equity”.
There is, however, a striking fact: as best one can tell from reports on the roundtable, none of the participants even attempted to define what “intergenerational equity” means. That is unsurprising because “intergenerational equity”, as economists use the term, would hardly support the contentions that have dominated the headlines.
Now, “equity” generally refers to treating like alike. But what that involves when comparisons are being made across cohorts whose lives span quite different periods is far from obvious. Typically, economists have cut through those conceptual difficulties by thinking of a fair bargain between successive generations.
For example, ever since a Labor government introduced the age pension in 1909, each generation, during its working life, has borne the fiscal cost of the previous generation’s age pensions, on the assumption that it too will be supported when its time comes. That system has involved a fair bargain because those who cover its costs could reasonably expect to benefit from the insurance the pension provides against poverty in their own old age.
In exactly the same way, aged care benefits are largely paid for by current taxpayers who, while shouldering that cost, secure an insurance that will protect them from a crippling, if not entirely unaffordable, burden should they develop dementia or other debilitating conditions in later years.
In both these cases, the generation currently bearing the costs can reasonably expect to be no worse off (and may in fact be better off) from the complex of intergenerational taxes and transfers. The result is that it has no reason to resent those currently receiving the benefits, which it too will eventually receive.
Put in economic terms, the arrangements are therefore “envy free”, in the sense that the payers do not wish they were in the earlier generation rather than their own.
That concept of an “envy free” bargain is directly relevant to the current debate – and nowhere more so than to the implications that can, and cannot, be properly drawn from a recent study by Peter Varela, Robert Breunig and Matthew Smith at the ANU’s Tax and Transfer Policy Institute that estimates the distribution of net income and of its main components by age over the past 25 years.
In particular, much has been made of the study’s finding that the average net income of the elderly is now some 75 to 80 per cent that of the average 40-year-old – a finding that has been greeted with considerable shock. But as well as not being particularly startling, that finding says nothing whatsoever about equity.
It is, to begin with, scarcely plausible that the hypothetical 40-year-olds would envy the 70-year-olds, much less want to trade places. To take just one important factor, “income”, as defined in the study, includes a substantial apportionment to the elderly of the cost of a broad range of social welfare benefits, including those, such as health and aged care services, that are provided in kind. But lack of data meant the study could not apportion the outlays associated with the NDIS, almost all of whose recipients are well under 65.
It therefore imputes a large share of social welfare outlays to older age groups, with those outlays accounting for more than 40 per cent of the total income (as defined by the study) of 70-year-olds. However, what is crucial, but seems to have been almost entirely overlooked in the debate, is that those benefits are conditional on the recipient suffering an adverse condition – such as low income in the case of the pension, or sickness and disability in the case of health and aged care services.
And no one could sensibly believe that a rational 40-year-old would prefer to be stricken with (say) dementia, thus qualifying for substantial funding through the aged care system, than to be young and reasonably healthy.
It would be every bit as absurd to think that those who are currently of working age – and who may, if epidemiologists are to be believed, incur an even higher risk of requiring age care services than the elderly now do – would be better off were the insurance our aged care system provides unavailable. They would, in that event, be forced either to save enough to cover the cost of debilitating conditions or run the risk of finding themselves bereft of services they desperately need, with both options slashing their lifetime wellbeing.
Equally, there is no reason to believe today’s 40-year-olds would rather have been 40 when today’s elderly were – which is the other leg of the “envy free” test.
On the contrary: had they been 40 in the late 1980s and early ’90s they would have just come out of a severe and prolonged recession, with net incomes (that is, incomes taking account of taxes and benefits) just half those of today’s 40-year-olds. Adding to the pressure, out of those lower earnings, and often with only a single breadwinner, they would have been supporting more children, while staggering under the weight of mortgage interest rates that peaked at 18 per cent in 1990.
To make things worse, the life expectancy of the 1950 birth cohort was far lower than their own. Fully 9 per cent of its males died before the age of 50, as compared to half that for the cohort that is now 40. And the men born in 1950 had only a 60 per cent chance of making it to age 80, as compared to an 85 per chance for the men born in 1985.
Adopting even a very low estimate of the value Australians place on additional years of life, that postponement and compression of mortality is equivalent to a gift of up to $1 million that accrues to younger Australians but not to those in old age.
It is consequently hard to find in that data much evidence of generational inequity: on any sensible measure, the current generation has it good compared to its predecessor. What then do the claims of inequity reflect, above and beyond deeply muddled thinking?
Insofar as they have an empirical basis, the claims seem to centre on what could be called “asset envy” – that is, resentment at the assets owned by the older population.
There is, however, nothing inherently wrong with older generations owning more tangible assets than their younger counterparts. After all, by far the largest asset 40-year-olds possess is their human capital: the skills and know-how, which will generate income for another 30 years or more. Like earlier generations, they will, as they age, convert that human capital into other assets, such as housing and superannuation, that will carry them through retirement, when their human capital is of little remaining use.
It follows that in a properly functioning economy the old will have more net tangible assets, and a higher income from those assets, than the young, allowing them to retain a reasonable standard of living. Indeed, ensuring that would be the case was the fundamental aim of the superannuation system, that was intended to, and has, helped shift the burden of financing retirement from the aged pension, which is paid for by those currently of working age, on to the private savings of the retirees themselves.
Nor is there any substance to the contention that superannuation is lightly taxed. Australia is unusual in taxing contributions to, and annual earnings on, compulsory savings, rather than only taxing the savings when they are eventually consumed. And our effective tax rate on those savings is anything but trivial.
Thus, a medium income earner will, over the course of only 25 years of saving, have typically paid about $25 in taxes on contributions and earnings for each $100 of superannuation savings at the time of retirement, while the effective tax rate on a higher income earner will be about double, or 50 per cent. For mandatory savings that are held in the accumulation phase for more than 25 years, and for voluntary superannuation, the effective tax rates are even greater.
Those rates are well above the average tax rates that apply in most advanced economies. Indeed, Treasury’s own calculations show that they are higher than would be income taxes levied at full standard rates on the incomes superannuants eventually secure – which is the way retirement savings are primarily taxed in our peers.
Moreover, taking account, as one should, of the benefits self-funded retirees forego would show that the actual tax rates are even higher than those estimates suggest, with the ever more stringent means testing of the pension and of aged care benefits compounding the extent of the increase.
In short, the notion that superannuation is scarcely or even untaxed is a furphy. There has nonetheless been considerable focus on a relatively small number of high superannuation balances. The scope to accumulate large balances has been substantially narrowed in recent years; but even putting that aside, the focus on those balances misses a crucial point.
Unlike contributory social insurance schemes – which provide a capped and predictable income stream in retirement – our superannuation system intentionally shifted on to superannuants the risk associated with post-retirement income.
As those risks played themselves out, a few investors did very well, amassing eye-watering balances, while many others did much less well, in some cases incurring losses. It is absurd to suggest equity is advanced when good luck is punished without bad luck being compensated. A tax system which did so would be a case of “heads I win, tails you lose” – a wager which may be attractive to a tax-hungry government that can force it on to taxpayers but has nothing to do with equity, intergenerational or otherwise.
All that leaves what some regard as the elephant in the room, namely housing. It is certainly true that housing prices have risen, as immigration pushes up demand while regulations restrict supply. As a result, current owners have accrued capital gains, which, for owner-occupied housing, are untaxed. And since homeownership rates rise with age, a higher share of those gains has gone to older than to younger age groups.
It is, however, incorrect to treat unrealised capital gains on housing, which is a relatively illiquid asset, as if they were cash in hand – which is what the Varela, Breunig and Smith study does. Short of actually selling a house, very high costs are involved in converting those gains into cash, for instance by securing a reverse mortgage.
As for selling a house, that not only incurs costs of its own but also requires obtaining alternative accommodation – whose price will have risen too. The same applies, with even greater force, to imputed rent: that is, the entirely hypothetical amount homeowners would secure in rent were they to rent out their home, which accounts for nearly 20 per cent of the study’s estimate of the income of 80-year-olds.
The actual income gains from changes in property values are consequently significantly smaller than the study suggests. Should those gains be taxed? That is a complex question, whose costs and benefits ought to be debated in their own right. What can be said, however, is that such a tax would have less impact on the lifetime incomes of today’s elderly, most of whom will remain in their current homes, than it would on that of their heirs. And those heirs would also face the tax on any property they own, as would their children.
Whatever the tax’s merits (and it has plenty of demerits), durably altering the distribution of income between generations is consequently not likely to be among them.
The case for including owner-occupied housing in the means tests is somewhat stronger, though it would need to be done carefully if it is not to induce considerable hardship among older people who are housing rich but income poor.
But to yield real benefits, any such change ought to be part of a broader reform of those tests, which are unnecessarily complex, too often yield perverse results and, in overall terms, unjustifiably punish work effort. Broadening the base of those tests should, as with other taxes that discourage aspiration, lead to lower, not higher, penalties on saving – which is the exact opposite of the changes that have been made in recent years.
Ultimately, expropriating the elderly is the fool’s way of ensuring intergenerational equity. And merely mouthing the slogan “intergenerational equity” doesn’t make it any smarter.
If 40-year-olds are now vastly better off than their parents were at that age it is certainly not because incomes were shuffled from one group in the community to another; it is thanks to sweeping economic reforms, accompanied by greater fiscal discipline, that laid the basis for sustained economic growth.
That we have descended into relying on the smokescreen of mumbo-jumbo to legitimate robbing Peter to bribe Paul shows just how far we are from the political courage and intellectual insight genuine reform required then – and, even more surely, requires now.
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