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As the government prepares for a battle over its proposed superannuation tax changes on balances above $3 million, the Grattan Institute think tank has argued super reforms should go much, much further.
Key points:
- The Grattan Institute says all superannuation income should be taxed, including in retirement
- The report argues a 30 per cent tax rate on super earnings should apply to balances above $2 million
- The institute said its raft of proposals would save the budget at least $11.5 billion per year
In a pre-budget report outlining potential policy changes to the superannuation system, Grattan Institute researchers Brendan Coates and Joey Moloney argued forcefully that super required radical reform.
"Australia's current superannuation system is unfair and unsustainable," the authors concluded.
The report notes that super tax breaks currently cost $45 billion a year in foregone revenue and will soon exceed the cost of the age pension.
"These tax breaks are excessively generous – extending well beyond any plausible purpose for our superannuation system to provide for income in retirement – and their costs are unsustainable," the authors argued.
"Two-thirds of the value of super tax breaks benefit the top 20 per cent of income earners, who are already saving enough for retirement and whose savings choices aren't much affected by tax rates."
Instead, rather than boosting overall retirement savings, they argued that much of the money being sunk into super by higher income earners was being diverted from other potential savings vehicles to take advantage of lower tax rates.
"People with higher incomes and older savers tend to switch their savings into whichever investment vehicle pays the least tax," the report noted.
"Tax breaks on superannuation fund earnings may be a strong motivation for those making voluntary post-tax contributions, but many of these contributions appear to be prompted by tax minimisation strategies rather than additional retirement savings."
Moreover, the report found that a large, and growing, share of these retirement savings balances was not spent before death.
"As debate flares about what the objective of superannuation should be, everyone seems to agree on what it shouldn't be: a taxpayer-funded inheritance scheme. Yet that is exactly what super has become," the report argued.
"Much of the boost to super balances from tax breaks is never spent. By 2060, one-third of all withdrawals from super will be via bequests – up from one-fifth today."
Cap and tax high-income contributions
Grattan's first proposal is to lower the threshold and increase the tax rate on super contributions from high-income earners.
This would see anyone earning above $220,000 a year pay a 35 per cent tax rate on income flowing into their super account, as opposed to the current rule that imposes a 30 per cent tax rate on those earning above $250,000.
The report estimated the new threshold would affect about 213,000 taxpayers, while the higher rate would affect about 707,000 taxpayers, all of whom would be within the top 10 per cent of income earners, saving the budget about $1.1 billion a year.
At the same time, Grattan proposed expanding the low-income superannuation tax offset from a maximum of $500 to $800, while making it accessible to people earning up to $45,000 a year (currently, it cuts out at $37,000).
This change, it said, would benefit around 1.1 million low- to middle-income earners at a cost to the budget of around $530 million.
"These changes would mean low- and middle-income earners would receive at least a 15 per cent tax break on their contributions, compared to just 10 per cent for people earning more than $200,000 a year," the report observed.
The institute also proposes lowering the pre-tax contributions cap from $27,500 to $20,000 per year, saving the budget a further $1.6 billion per annum.
This change would affect a larger group of taxpayers (1.3 million), but Grattan said 75 per cent of the budget savings would come from the top 20 per cent of income earners.
It also wanted government co-contributions and pre-tax cap carry-forwards to be axed, saving a further $1.1 billion, arguing these were generally used for tax minimisation by high-income households with large existing super balances.
Tax retirement earnings
Perhaps the most controversial recommendation was to abolish the tax-free status of superannuation earnings in retirement.
This would affect around 2 million retirees, but Grattan said around 70 per cent of the budget savings would come from the 20 per cent of highest income retirees.
"All super earnings in retirement should be taxed at 15 per cent – the same as earnings before retirement – saving more than an extra $5.3 billion a year," the report argued.
"These changes are fair. Retirees would pay some tax on the earnings from their super – the same as those working today – and much less than younger workers pay on their wages."
This would raise an estimated $5.3-7.3 billion per year, which, Grattan argues, could help offset the rapidly rising cost of health and aged care services.
"Tax-free retirement earnings mean an increasing number of retirees are 'checking out' of the tax system, while the budget faces spending pressures associated with an ageing population," the report noted.
Grattan has also urged the government to go further than its current plan to impose a 30 per cent tax rate on the earnings of super funds with balances above $3 million.
It argues that threshold should be lowered to $2 million but indexed so that it rises with inflation, unlike the government's current proposal, which is not indexed.
"Balances of more than $2 million make up a tiny fraction of all accounts but hold nearly as much money as the two-thirds of Australians with less than $100,000 in super," the report observed.
This proposal would save the budget an estimated $3 billion a year, with total savings, if all Grattan's proposals were implemented, of between $11.5 billion and $13.5 billion.