Simply no sense in Labor super strategy

Eric Lobbecke

IF you believe the allegations being reported daily, Eddie Obeid may have earned twice as much out of the resource bonanza as the MRRT. It's comforting that at least one part of Labor takes seriously Wayne Swan's mantra of "spreading the benefits of the mining boom". But that is little help to the government in its desperate search for revenue.

According to Swan, Labor's fiscal woes are caused by an exceptionally low tax take. But that claim is difficult to accept. The government's latest published projections show 2012-13 revenue to be 24.0 per cent of GDP, which is above the historical average ratio of 23.6 percent. And even if revenue comes in at only 23.0 per cent of GDP, revenue as a share of GDP would still have grown since 2009-10, and grown in each of the past two years.

Rather, the government's fundamental problem lies on the spending side. And here, despite all the government's spin, the facts are simple. Under John Howard, real government spending per capita increased at 2.4 per cent a year; under Labor, it has increased more than twice as rapidly, at an annual average of 5.1 per cent. And to that must be added Labor's unfunded, but widely publicised, commitments to the Gonski reforms and the NDIS.

As they stand, those commitments are fiscal onanism: they are attractive to those who get frissons from the mere thought of spending other people's money. Such pleasures, however, are a wasting asset, and with the teachers' unions baying for the real thing, the dollars must be found.

Increasing taxes on superannuation will always seem the easiest way of doing so. The vast bulk of what would be taxed is already there and cannot be removed. Ongoing contributions are largely compulsory and are now rising to 12 per cent of earnings. As far as tax grabs go, this is shooting fish in a barrel.

Little wonder barely noticed projections in the 2012-13 budget already list taxes on super as the government's fastest growing revenue source over the next three years. Those estimates show super tax payments rising 60 per cent on an accruals basis, three times more than the overall tax take.

But there is more juice in the lemon. The real problem lies in making squeezing it politically acceptable. And that requires careful propaganda. At its heart is the claim that super is too lightly taxed, especially for middle and higher income earners.

But that claim makes little sense. Its proponents are therefore always careful to avoid presenting estimates of effective tax rates on super; rather, they calculate the difference between taxes on super and those that would be paid were super taxed as ordinary income, treating that difference as a "concession" to the undeserving rich. Yet that approach hides absurd results.

That is because taxing super as ordinary income would yield ludicrously high effective tax rates on retirement savings. Consider a taxpayer facing a 46.5 per cent marginal tax rate. Assuming a nominal return of 8 per cent and a real return of 5 per cent due to 3 per cent inflation, taxing that income earner's superannuation as ordinary income would imply an effective tax rate of about 70 per cent, in part because taxes would remove income that was simply compensation for inflation.

Indeed, for super held for 40 years, the effective tax rate would be 95 per cent, meaning that each dollar saved would fund 5c in future consumption. In other words, to pay for $1 in retirement consumption, a young person today would need to save $20, with 19 of those 20 dollars then being removed as tax.

As well as being inequitable, such tax rates would be manifestly inefficient. To the extent to which taxpayers could avoid them, they would save less or divert their savings into other assets, including the tax-sheltered family home.

As for compulsory super, imposing the higher tax rate on it would be exactly equivalent to an increase in the income tax, as the super payment that had to be made on each dollar earned attracted penal levels of taxation. The result would be to discourage working, reduce labour force participation and inefficiently decrease output. And instead of rising, the long-term tax take would shrink.

Given those consequences, it is unsurprising that no developed country taxes retirement savings as ordinary income. Rather, tax rates on private savings are generally well below those on ordinary income, especially for middle and high-income earners. The "dual" income tax systems pioneered in the Nordic countries, for example, tax income from savings at a relatively low flat rate (rather than one that rises with income). An international comparison of tax rates on private retirement savings would therefore show that far from being especially generous, our current rates, which (using the same assumptions as before) are slightly above 30 per cent, are in the middle of the pack.

But that comparison is unduly favourable to us. That is because in both Europe and North America, private retirement savings supplement public, defined benefit, schemes that are significantly more generous than the Australian aged pension to families with above average incomes. The contributory element in those schemes is taxed at low, often flat, effective rates, reducing the tax burden on middle and upper-income earners. In contrast, under our steeply means-tested aged pension, any super income reduces the pension entitlement, increasing the marginal tax rate on retirement savings above its already high average levels.

The claim that super is under-taxed therefore lacks any empirical basis; but that will hardly stop this government from snatching revenues where it can.

Yet none of that implies the current system is perfect: it is anything but. Paul Keating's original design put too little emphasis on ensuring access to predictable, stable incomes in old age and was poorly integrated with the aged pension. A scheme that provided for annuities, rather than favouring lump-sum withdrawals, would have been better. And taxes should have fallen entirely on eventual retirements.

But tax grabs and endless tinkering will do nothing to address those flaws. Sure, they can help Labor plug its spending hole. That will come, however, at the cost of further undermining confidence in our retirement savings system. If Labor can't do better than that, it really doesn't deserve to govern.