Australia's Super Priorities: Issues and Reforms
There’s been considerable debate about the rate of Australia’s superannuation system, in other words, what proportion of an individual’s wages ought to be sequestered and invested for retirement. Given that the Morrison Government went to the 2019 Election pledging to follow through on increasing the Superannuation Guarantee (SG) from 9.5% to 12%, it seemed highly likely that this would subsequently occur. The first increment was planned to go ahead from July 2021, raising the SG from 9.5% to 10%. However, as a consequence of the COVID induced recession with unemployment at 6.8% (at the time of writing) and real wages growth forecast to be flat or negative, there are a number of considerations to take into account. Regardless, the consideration of an SG rise prior to COVID was still a hotly contested topic with a multitude of different opinions even amongst professionals and experts.
The seminal question: Should we raise the SG rate?
There has been considerable deliberation from academics, former politicians, think tanks and actuaries as to whether or not Australians need – or indeed would benefit from – a higher employer contribution. This has mainly occurred in the last few years in the lead-up to the scheduled increase in the SG on 1st July 2021 [1]. As with all things economics-centric, the prospective increase in the SG begets the question of a trade-off. As readers may know, superannuation contributions come from an employee’s gross wages (wages before tax and the SG). Consequently, a rise in the SG means a decrease in real wages. The question this raises being: is this increase necessary, and what are its consequences?
As with many things in the dismal science of economics, the answer is ‘it’s complicated’.
Analysis by the leading think tank the Grattan Institute indicates that this prospective increase in the SG isn’t necessary. Grattan contends that a higher SG rate is both not necessary and would actually cost workers wages. The second part of Grattan’s contention is objectively uncontroversial-super was introduced via the Hawke-Keating Labor Government’s Accord with the ACTU in the early 1980s as part of measures to control inflation via lower wage rises. However, the first part of their contention has received significant flak. Grattan’s modelling indicates that ‘a typical worker would be $30,000 worse off during their lifetime’, (Coates, 2020) were the increase to be pushed through. Indeed, Grattan also estimates that it would cost the Australian workforce an extra $20 billion in foregone wages were the SG to rise from 9.5% to 12% (Coates, 2019). Grattan also states, based on their research, that Australians can actually look to have a more comfortable retirement than in their working life. They also contend retirees spend less as they age and sometimes even save throughout their retirement. What this comes down to is the replacement rate, in other words, how much of a given individual’s income will be replaced by their retirement income. An adequate replacement rate of income is 70% of pre-retirement earnings. They also state that a higher SG would most likely benefit the very wealthy and could lead to a poorer retirement for middle Australians, as it would leave them with more capital and consequently a pension payment from the Government due to the pension assets test.
Grattan’s conclusion is that the higher SG would lead to lower wages over an individual’s working life, meaning lower consumption and investment, and potentially a poorer retirement due to the interaction with the pension assets test. Additionally, Grattan argues this would also cost the budget money. This is because superannuation is taxed concessionally at a flat rate of 15% up to $25,000 per year as opposed to being taxed at an individual’s marginal income tax rate. Consequently, this would lead to lower income tax revenues.
However, there are counter arguments to Grattan’s contention. The most compelling comes from the principal architect of the Compulsory Superannuation system, Harvard trained econometrician Dr Vince Fitzgerald. Dr Fitzgerald, who authored a paper to the Keating Government’s Treasurer John Dawkins, stated that increasing the SG to 12% would lead to lower wage growth and softer consumption. Fitzgerald is ‘strongly committed to 12% super’ (Kehoe, 2019) but believes the increments should be moved to 25 basis points as opposed to 50 per year (Kehoe, 2019). Dr FitzGerald did not agree with all of Grattan’s modelling and was a strong proponent of the Government’s review into superannuation (yet to be released at the time of writing). He also stated that the 15% contributions tax and any earnings taxes should be replaced by taxes on withdrawals at the individual’s marginal income rate, to allow balances to accumulate faster.
Other concerns come from Dr Don Russell, chair of Australian Super and former Private Secretary to Paul Keating as Treasurer and Prime Minister, who rejected Grattan’s modelling regarding super’s impact on pension outlays. Russell pointed to the age pension constituting only around 2.5% of GDP, very low compared to other OECD countries (Boyd, 2019). Similarly, actuarial firm Rice Warner wrote in a paper that their modelling indicates ‘An SG rate below 10% would result in median income earners relying on the Age Pension for most of their retirement income’ (Rice Warner, 2019).
Exante Data’s Grant Wilson [8] posits that increasing the super guarantee is actually in the national interest. He points out in a column in the AFR that for every increment of 0.5% increment in the SG, the increase in inflows to the super sector approximates $5 billion. What Wilson underscores specifically is the role that superannuation plays in the arena of national savings. That being, superannuation helps to reduce the shortfall between what Australia spends and its national savings base. Superannuation now represents a savings base of around 150% of GDP or nearly $ 3 trillion, relative to our pre-COVID GDP of $1.895 trillion. Consequently, given the scale of the sector Australia’s status as a debtor country is slowly being eroded. Conversely, Australia is likely to be a creditor country in the future meaning that the nation has net inflows of capital as a consequence of its offshore investments. This has been reflected in the current account, which has been in surplus for around a year after recording its first surplus in 44 years in 2019. This is, in part, due to very weak domestic demand for overseas funds but also it’s due to superannuation. The corollary of this has been to reverse Australia’s chronic current account deficit, one of the intentions of the advent of the system. This largely corresponds to a decline in Australia’s net debt.
Reform priorities outside the SG
Whilst the super system has yielded considerable aforementioned advantages to Australia, there are still systemic problems with it that exist outside the debate for a change in the SG. The largest problem with the super system in Australia is a lack of competition and high fees. The Grattan Institute reports that Australians spend more than 1.5% of GDP on super fees per year, around $31.8 billion per year [9]. To put that in perspective Australians spend more on super fees than on energy fees at $23 billion per year.
Part of the problem stems from multiple super accounts due to people being defaulted into new super accounts when switching jobs which they are subsequently charged fees on. This costs Australians super accounts $2.6 billion per year. One of the proposed reforms to ameliorate this issue was posited by the Productivity Commission (PC) is only defaulting members without a super account, e.g. those new to the workforce or without an account. A way of ensuring that new labour force participants would be defaulted into a high performing super fund was also addressed in the PC’s report-through a best in show list to choose from [9].
Likewise, an additional way to drive down fees would be to have more competition in the sector without active fund management. Harvard trained UNSW economist Dr Richard Holden has proposed that the introduction of index-tracking funds – like Vanguard – which are not actively managed and simply track the stock market index. Most often index funds perform better and cost less than those which are actively managed, which has been the subject of research by Nobel Laureate Eugene Fama. The central contention being that markets inherently price and perform best. Relative to the average of 1.1% fees superannuants pay on their accounts, an index fund could cost between 10 and 20 basis points, or 0.1-0.2%. The primacy of more competition and a better performing, cheaper fund would mean that superannuants’ balances were eroded less by high fees.
Early super access: a bad idea?
Albert Einstein opined that ‘compound interest is the 8th wonder of the world. He who understands it, earns it; he who doesn’t, pays it.’ Clearly, an unfortunate proportion of Australians don’t understand it and are subsequently going to pay for the early release scheme.
It appears that 2.5 million Australians or 20% of the labour force have drawn down on their retirement savings [10]. Firstly, there are a number of grounds for which super can be accessed early. Normally, super cannot be accessed early and is instead preserved until people reach a certain age. However, there are various hardship measures for which early access is permissible and the Government decided that as an ancillary measure to or JobSeeker, people could access up to $10,000 in the financial year ending 30 June 2020 and an additional $10,000 in the financial year beginning July 1st, 2021. There were a number of criteria to being able to release funds, including reduction in hours worked, redundancy, youth allowance and JobSeekers etc. [11] However, the ATO did not actually check the eligibility of members when receiving applications [12] instead taking people on face value. This has led to many people emptying their balances, some of whom have gambled away their lump sum [13]. Others have used it to fund home construction or reduce personal debt [14]. On average, people who withdraw super take out around $8000 of a balance worth $50,000 or less [15]. This will bring about many problems, which Dr Alex Joiner highlights [16]. Firstly, the best way to allow superannuation funds to accumulate is to ‘leave it alone’. The other is that the bond yield after the RBA’s ‘yield-curve control’ on Australian bonds is currently around 0.8%. He argues instead of calling on people to reduce or in some cases empty their retirement balances, it would have been better to for the government to borrow the money instead and pay a record low-interest rate. Not only does reducing or emptying one’s super fund forgo the crucial compounding periods required to accumulate a reasonable sum, he also notes it may lead to provide higher pensions in future. Most presciently, he notes the returns on prospective and historical members’ funds would have been many multiples of the 0.8% interest rate the government would have paid, had it simply borrowed the money instead and left super alone.
Ultimately, it would seem that early release of super as an alternative to higher unemployment benefits is a poor idea, particularly in the long-term for both individuals and the government’s fiscal position. It also drains the balance of the system at a time when the country needs to have the superannuation pool contributing to engineering a recovery. With regards to super reforms, it is clear that the Australian system is imperfect and does require some changes but ultimately is a very sound system. Whilst there does seem to be merit in raising the rate, there is a legitimate question as to whether that should be initiated now in the throes of a recession. This is an especially exigent question given the resumption of normal life will occur at a point currently unbeknownst.
• References
[1] https://www.ato.gov.au/rates/key-superannuation-rates-and-thresholds/?page=24
[2] Coates, B., 2020. The Case For Higher Compulsory Super Hasn’T Been Made. [online] Grattan Institute. Available at: <https://grattan.edu.au/news/there-are-no-good-arguments-for-lifting-compulsory-super/> [Accessed 6 October 2020].
[3] Brendan, C., 2019. Super Shock: More Compulsory Super Would Make Middle Australia Poorer, Not Richer. [online] The Conversation. Available at: <https://theconversation.com/super-shock-more-compulsory-super-would-make-middle-australia-poorer-not-richer-120002>.
[4] Kehoe, J., 2019. Slow The Rise To 12Pc Super, Says Keating Economist. [online] Australian Financial Review. Available at: <https://www.afr.com/policy/tax-and-super/slow-the-rise-to-12pc-super-says-keating-economist-20191007-p52ydo>.
[5] Kehoe, J., 2019. Vince Fitzgerald Backs ‘Root And Branch’ Review Of Superannuation. [online] Australian Financial Review. Available at: <https://www.afr.com/wealth/superannuation/vince-fitzgerald-backs-root-and-branch-review-of-superannuation-20190117-h1a665>.
[6] Boyd, T., 2019. Aussuper Flags Concern Over Retirement Income Review. [online] Australian Financial Review. Available at: <https://www.afr.com/companies/financial-services/aussuper-flags-concern-over-retirement-income-review-20190930-p52w9l>.
[7] Warner, R., 2019. What Is The Right Level Of Superannuation Guarantee?. [online] Ricewarner.com. Available at: <https://www.ricewarner.com/wp-content/uploads/2019/06/Rpt-What-is-the-right-level-of-SG-Actuaries-Institute-June-2019.pdf>.
[8] Wilson, G., 2020. Increasing The Super Guarantee Is In The National Interest. [online] Australian Financial Review. Available at: <https://www.afr.com/policy/economy/increasing-the-super-guarantee-is-in-the-national-interest-20200823-p55ogd>.
[9] Brendan, C. and John, D., 2018. We Need To Switch Off These Superannuation Rorts. [online] Grattan Institute. Available at: <https://grattan.edu.au/news/we-need-to-switch-off-these-superannuation-rorts/>.
[10] Mather, J., 2020. One In Five Workers Call On Super In Pandemic. [online] Australian Financial Review. Available at: <https://www.afr.com/companies/financial-services/one-in-five-workers-call-on-super-in-pandemic-20200629-p5579y>.
[11] Ato.gov.au. 2020. COVID-19 Early Release Of Super. [online] Available at: <https://www.ato.gov.au/Individuals/Super/In-detail/Withdrawing-and-using-your-super/COVID-19-early-release-of-super/>.