On the day when the final building block of Paul Keating’s superannuation blueprint was put in place – with the superannuation guarantee charge rising to 12 per cent on July 1 – he felt compelled to issue a public warning to the Albanese government about its proposed paper profits tax.
For decades, Keating has been accusing Coalition governments of trashing the superannuation system, but now the threat is coming from his own side of politics.
Since 2022, Keating has bitten his tongue about the Albanese government’s lurch to the progressive left on economics and its rejection of sound policy.
But Jim Chalmers’ foolish proposal to tax the unrealised gains of those saving for their retirement was a bridge too far for him.
Keating could not in good conscience allow this to be waved through without a word; even if by criticising it he gave ammunition to his hated Tories.
Why? Because he recognises that this tax poses a threat to public confidence in superannuation; if not today, then in the future as the net it casts inevitably spreads, with its $3m threshold not to be indexed.
As Keating points out, a young person entering the labour force today and making no more than an average income across their working lives will, by virtue of the 12 per cent super guarantee and the compounding of their returns, accumulate more than this sum.
Treasury estimates that if the $3m figure is not lifted, 1.2 million people will be subject to this tax in 30 years.
By now, the central flaw of this tax is well understood.
The Treasurer and Anthony Albanese wrongly say it would represent a “modest change”, but as virtually every expert and commentator has recognised, it violates a fundamental principle of our income taxation system: thou shalt be taxed only on realised gains.
(Unrealised increases in land values are taxed by the states, but these wealth taxes are levied at very low rates, usually 1-2 per cent, and only for higher value properties.)
The wisdom and good sense behind this tax commandment is obvious. We do not send people tax bills on their profitable investments until they are sold, the act that generates the cash needed to settle them.
When purely paper profits are taxed, taxpayers can easily find themselves in a liquidity bind; unable to pay the taxman without selling their investments or going into debt, both of which will entail further costs.
While Chalmers’ paper profits tax will undoubtedly have adverse economic consequences – including stemming the flow of capital to high-risk, innovative start-ups and arbitrarily distorting effective tax rates on investments – its breach of basic tax morality sets it apart.
Why was the paper profits tax proposed in the first place?
In part, it is a response to the claim, repeated endlessly by economists who should know better, that middle to high-income people benefit disproportionately from “overly generous” taxation concessions.
By raising superannuation taxes on the better off, the argument runs, we are filling a gaping hole in our public finances, allowing us to better meet future public spending needs.
Proponents of this view invariably point to Treasury’s Tax Expenditures and Insights Statement, which suggests that concessional taxes on superannuation contributions and earnings cost $48.9bn in 2021-22, almost matching the Age Pension bill of $51bn in that year.
They seize on the fact that higher-income earners who will never need to rely on the Age Pension pocket the vast majority of these benefits.
I hate to break it to the class warriors, but this argument is bereft of economic merit and fiscal reality.
Let’s put it bluntly: the Treasury TEIS document is not worth the paper it is written on. When I was in the department, I was not the only one who felt this document was deeply misleading.
If you read its fine print, Treasury itself bells the cat.
In the TEIS, it tells us that the cost estimates do not tell us how much extra money would flow into Canberra’s coffers if the concessions were removed – affected taxpayers simply would direct their savings into other, more lightly taxed, vehicles. Perhaps the family home or a low-tax vehicle such as a trust.
But the real problem with the TEIS is the completely inappropriate income benchmark it uses.
Remember, if you argue that a tax concession costs something, you have to have an assumed cost-free income tax setting in the back of your mind.
In the TEIS, it is the income earner’s marginal personal income tax rate, which for people earning more than $190,000 is a whopping 47 per cent (including the Medicare levy).
But no serious economist thinks this rate, and applied at this income level, is a good idea.
If, for argument’s sake, we used Keating’s favoured top marginal rate of 39 per cent as the TEIS benchmark, the cost of superannuation tax concessions for middle and higher-income earners would immediately fall.
The deeper objection to the marginal income tax rate benchmark used by Treasury is that there are sound economic and fairness reasons to tax savings more lightly than regular income.
No serious economy taxes long-term savings in the same way that they do wages and salaries.
Economists who obsess about the budgetary consequences of superannuation tax settings are focusing on the wrong thing.
MYRIAD WAYS TO SKIN SUPER CAT
If there is a clear and present danger to our public finances, it’s on the spending side of the ledger. Haven’t they noticed that Canberra’s tax take is close to historic highs, leaving aside the pandemic?
But let’s, for the sake of argument, accept that people with more than $3m in their superannuation accounts should pay more tax than they currently do.
As we have seen, there are many ways this particular cat can be skinned, none of which require going after unrealised gains, including former Treasury secretary Ken Henry’s old idea of raising contribution taxes for higher income earners.
This unrealised gains tax grab was simply not necessary, so why did it ever see the light of day?
I think it comes down to two things.
First and foremost, it benefits our union-linked industry superannuation funds. It was no surprise to me that Garry Weaven, the so-called godfather of this sector, was an early supporter of the tax.
While industry fund members will also be hit with the paper profits tax, they will be able to draw down their balances to pay the Australian Taxation Office.
But as we know, those with self-managed superannuation funds with investments in illiquid assets such as farms or small businesses will not be so lucky; for some, it could be financially devastating, forcing them to sell out or borrow simply to meet their tax liabilities.
Big super, which also includes our retail funds, sees the growing popularity of SMSFS as a threat to their economic empires. While it controls more than $3 trillion in Australians’ superannuation savings, it covets the close to $1 trillion held by our 600,000-plus SMSFs.
And little needs to be said about the influence of industry super funds over the parliamentary Labor Party and its ministers.
Second, it was recommended by the Treasury department.
I was still working there when the paper profits tax was announced in 2023. My initial response was acute embarrassment on behalf of my colleagues who put it forward.
Weren’t they aware that we had never before supported taxing unrealised capital gains in our income tax system?
And if the aim was to target the very small number of SMSFs with large balances, then why not index the $3m threshold to limit the wider carnage it would cause? I saw this as another catastrophic failure of Treasury policy advice, exposing a naive and out-of-his-depth Treasurer and the government to needless controversy.
It was like a rerun of our mining tax disaster, when Henry dished up a theoretically elegant but completely unworkable idea to Chalmers’ hapless mentor, Wayne Swan, permanently destroying his credibility.
In both cases, there were viable alternative ways to achieve the stated policy objective but groupthink and ideological fervour blinded the department to them.
Mind you, Treasury has for some years been happy to go after our SMSFs, a reflexive antipathy I could never understand.
While these factors may explain why Chalmers’ paper profits tax was put forward, they do not tell us why Keating felt compelled to bell the cat on it.
RARE INTERVENTION
The Canberra bubble has been responsible for many policy disasters in its history, but former prime ministers rarely call them out in real time, as Keating has done.
After all, even John Howard did not see fit to criticise the $90bn (JobKeeper) blank cheque the Morrison government wrote for lockdowns by Victoria’s Daniel Andrews and other premiers during the pandemic.
And I have no doubt that several Labor grandees harbour serious misgivings about Climate Change and Energy Minister Chris Bowen’s ruinous net-zero crusade but so far they have kept mum.
So why the remarkable intervention from Keating?
While I don’t claim any special insight into his thinking, it has to be that he sees the paper profits tax as a threat to the superannuation system.
As one of its founders, Keating knows two social compacts lay at the heart of it when it was first set up. The first was between its union sponsors and employer groups.
The former, led at the time by Bill Kelty, agreed to scale back their wage demands to boost the economy’s profit share, business investment and productivity.
Once that last goal had been achieved, which lowered unit labour costs, employers could afford to pay an initial 3 per cent of their workers’ wages into super. Future productivity gains would allow this figure to be raised over time.
The second social compact was between the government and the community. Under compulsory superannuation, the former would force the latter to save a rising share of their incomes over time and, through preservation rules, bar early access to these savings. This was a heavy-handed move, not guaranteed to be popular.
In return, however, the government promised to tax these trapped savings at highly concessional rates and to avoid, where possible, penalising people who had abided by the rules and made their retirement plans in good faith with punitive retrospective changes.
In recent decades, the idea of higher employer superannuation contributions as a reward for union restraint has gone out the window. No recent increase in the superannuation guarantee has been accompanied by a productivity increase to pay for it.
And, more to the point of this piece, a succession of both Labor and Coalition governments, at the urging of Treasury, have serially mistreated the millions of people forced into the super system, imposing a dizzying array of adverse tax and regulatory changes on them.
(The only major exception was the Howard government’s decision remove taxes from funds taken out of super at the pension stage).
With this tax history in mind, I suspect Keating feels Chalmers’ unprecedented and unindexed paper profits tax risking being a “jump the shark” moment; an intervention that egregiously and recklessly strikes at the heart of the government’s implicit bargain with the community on superannuation. Kelty has virtually come out and said as much.
How will this policy drama end?
It is clear that Chalmers and his Treasury department are almost totally isolated on the paper profits tax.
Virtually every day, another respected business person, economist or investment manager comes out against it – many of whom have Labor connections.
That Sally McManus, the ACTU secretary, has called for the $3m threshold to be indexed is remarkable (although it is a pity that she does not call for our personal income tax thresholds to be similarly adjusted, which would prevent her members being robbed by bracket creep in the here and now).
With Chalmers clearly not for turning, the ball is in the Prime Minister’s court.
To date, his defence of the paper profits tax has been formulaic and lacking in conviction. It’s clear he has reservations about it.
If Albanese junks this proposal before the August reform roundtable he could reap a rare double dividend.
Not only will he clip the wings of an ambitious rival, handing him the biggest defeat of his political career, he will be doing the country a valuable service.
He might even be thanked publicly by Keating.
David Pearl is a former Treasury assistant secretary.
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In the long history of superannuation in Australia, which despite Labor mythology extends back to the 19th century, the events of this week can be described only as remarkable.