Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 503

The net cost of superannuation concessions is not so gross

A more-informed debate on the cost of superannuation concessions is needed. The number dominating the headlines recently is that the concessions are costing $52.5 billion a year but this estimate has not been robustly challenged. By highlighting the gross cost rather than allowing for offsets, it significantly overstates the cost of concessions and has the potential to mislead the debate.

As mentioned in my article last week, the 2021 Intergenerational Report (IGR), forecast changes in government expenditure to be as follows:

Government Expenditure

% of GDP (2021-22)

% of GDP (2060-61)

Health

4.6%

6.2%

Aged Care

1.2%

2.1%

Age and Service Pension

2.5%

2.1%

Superannuation, strongly encouraged by appropriate concessional treatment, is playing a valuable macro role, and the real aggregate cost of superannuation concessions, should be interpreted in this light. As superannuation continues to mature, the reduction in age pension costs (as a % of GDP) is a welcome development. Notwithstanding this macro view, the need to address equity and fairness issues in super remains.

Where do the tax concessions arise?

The loudly-trumpeted $52.5 billion is sourced primarily from Treasury’s tax estimate figures in the Tax Expenditures and Insights Statements (TEIS) for 2022-2023. Treasury uses this definition:

“A tax expenditure arises where the tax treatment of a class of taxpayer or an activity differs from the standard tax treatment (tax benchmark) that would otherwise apply. Tax expenditures can include tax exemptions, some deductions, rebates and offsets, concessional or higher tax rates applying to a specific class of taxpayers, and deferrals of tax liability.”

The TEIS shows the three major items contributing to revenue foregone are:

  • Capital Gains Tax (CGT) main residence exemption - $48 billion
  • Rental deductions - $24.4 billion
  • CGT discount for individuals and trusts - $23.7 billion

The major components of the so-called superannuation concessional tax costs (2022-23 estimates) are:

  • Employer superannuation contributions - $23.3 billion
  • Superannuation entity earnings - $21.5 billion
  • Deductibility of insurance premiums inside superannuation - $2.38 billion
  • Personal superannuation contributions - $1.55 billion
  • Non-superannuation termination benefits - $1.55 billion
  • CGT for superannuation funds - $1.35 billion

Lots of targets there for opponents of superannuation concessions.

Treasury recognises the weaknesses

The problem is that the Treasury tax estimates are an unreliable guide to the real cost of concessions, or the revenue gain if government removed or reduced the concession. For example, they don’t allow for social security offsets or behavioural responses if concessions were removed.

This is explicitly acknowledged by Treasury in the most recent Tax Benchmark and Variations Statement:

Revenue forgone estimates reflect the existing utilisation of a benchmark variation and do not incorporate any behavioural response which might result from a reduction or removal of the variation to the tax benchmark. They measure the difference in revenue between the existing and benchmark tax treatments, assuming taxpayer behaviour is the same … revenue forgone estimates are not estimates of the revenue increase if a variation to the tax benchmark were to be removed.” (my bolding)

A similar statement appears in the TEIS.

These caveats are overlooked in the general commentary on the cost of superannuation concessions, including by Government, the Australia Institute, the Grattan Institute and most of the media who rely upon these information sources. These figures, or at least the use of these figures, are used for a purpose for which they were not intended.

Insufficient analysis has been done on the real cost, or net cost, of superannuation concessions.

A robust attempt was made by the Association of Superannuation Funds of Australia (ASFA) in 2016 (‘Mythbusting Superannuation Concessions – March 2016’) which concluded that the real cost of concessions was just over half the gross cost, as follows (note at the time that the estimated cost of concessions was $30 billion):

  • Annual reduction in age pension expenditure as a result of super: $7 billion
  • Impact of behavioural change (people shifting money from one tax-effective vehicle to another) that would occur if super tax concessions were removed: $7 billion
  • Real cost: $16 billion

The SMSF Association (SMSFA) reached similar conclusions in its submissions to the Tax White Paper (2015) and the Tax Expenditure (TES) Consultation Paper (2017). The SMSFA concluded an even lower net cost using slightly different methodologies, noting that that:

“the TES measurements of superannuation tax concessions … have the following unrealistic assumptions:

  1. They are measured against a ‘comprehensive income’ benchmark which measures tax concessions against an idealised tax system where all income is taxed at people’s marginal tax rates. The choice of this benchmark has a substantial influence of the cost of the concessions.
  2. The measurement ignores the fact that people may seek other concessions such as discounted capital gain investments or negatively-geared investments to minimise their tax liability.”

To arrive at a net cost of superannuation concessions needs allow for offsetting social security costs as a result of building healthy superannuation balances.

Retirement Income Review (RIR)

Even the esteemed RIR relies almost entirely on gross costs in its commentary and quantification of the costs of superannuation concessions, largely consigning estimates of net costs (to allow for behavioural changes) to the ‘too hard’ basket.

It observes that people with very large superannuation balances can receive large superannuation earnings tax concessions, including that:

  • In 2018-19, a person with a superannuation balance of $5 million would have received, assuming a net earnings rate of 6%, around $70,000 in earnings tax concessions
  • Using the same assumptions, a person with a superannuation balance of $10 million would have received more than $165,000 in earnings tax concessions.

(In a footnote, it states that this assumes all superannuation assets are held in the accumulation phase, the assets would be taxed at the person’s marginal tax rate including the Medicare Levy if they were not held in superannuation and there are no unrealised capital gains).

But the RIR also notes:

“This Review uses a comprehensive income tax benchmark to measure the cost of superannuation tax concessions. This means tax revenue actually collected is compared with the estimated amount that would have been collected if contributions and earnings were all taxed at full marginal rates.”

So the RIR makes (or relies on) the same assumptions as Treasury.

Whilst not advocating for a continuation of the current level of concessionality for very large account balances, the narrative needs to be better informed. 

It is worth noting that the RIR does quote some Treasury work on page 418 which attempts to account for a reallocation of savings if the concessions (‘revenue forgone’ or RF) did not exist. These ‘revenue gains’ (RG) are estimated for employer contributions and the earnings tax concession. However, the RIR largely dismisses them because:

“... the RG earnings estimate is 14% lower than that for RF. This is because the earnings on these alternative tax-preferred vehicles are subject to lower marginal tax rates than those used in the RF estimate.”

However, it is not clear what assumptions Treasury makes regarding alternative investments outside superannuation, including shares with franking credits, negatively geared property investment and the likely increased utilisation of family trusts and company structures.

Further, the proposed Stage 3 tax cuts will widen further the gap between the gross cost of concessions and the real or net costs.

Will the cost of superannuation concessions exceed age pension costs?

As an added perspective to colour the debate, commentary regarding super concessions is often claimed to ultimately ‘cost’ more than the age pension. On 20 February 2023, Treasurer Jim Chalmers said:

“Right now, we’re on track to spend more on super tax concessions than the age pension by around 2050. I’m not convinced that’s a sustainable way to get to our destination – good retirement incomes for more Australians, now and into the future.”

The framing of these comments infers a material problem rather than a natural, intended and overall positive outcome of public policy design. That said, I acknowledged in my previous Firstlinks article the need to reduce concessions on very high account balances.

One source for the Treasurer’s comments is potentially the RIR which observed that:

“Government expenditure on the age pension as a proportion of GDP is projected to fall slightly over the next 40 years to around 2.3%. Higher superannuation balances reduce age pension costs. The cost of superannuation tax concessions is projected to grow as a proportion of GDP and exceed that of age pension expenditure by around 2050. This is due to earnings tax concessions. The increase in the SG rate to 12% will increase the fiscal cost of the system over the long term.”

Again, all these observations are based on the gross cost of superannuation concessions. Different conclusions would apply if the real cost of superannuation concessions were used.

With an ageing population, which will drive increasing aged care and health costs (as a % of GDP), the fact that the cost of age pension will be declining (as a % of GDP) is a notable and positive achievement.

Address high balances but inform the debate properly

Treasury admits its estimates of the cost of superannuation concessions represent gross costs, and a closer examination suggests the real cost may arguably be closer to 60% of the popularly-quoted level.

Whatever the figures, superannuation concessions need to be sustainable and to have a higher degree of equity and fairness, but they meet neither criterion at the moment.

Whilst not advocating for a continuation of the current level of concessionality for very large account balances, the narrative needs to be better informed. The net cost to the public coffers should allow for behavioural change and social security offsets.

 

Andrew Gale is an actuary, public policy expert in financial services, a non-executive director and a former Chairman of the SMSF Association. The views expressed in this article are focussed on public policy and are personal views not made on behalf of any organisation. This article is not financial or tax advice and it does not consider the individual financial circumstances of any person.

 

26 Comments
Declan Thomas
April 12, 2023

Why not just have marginal taxation in superannuation also.. If you have a 15M fund get taxed like you have a 15M fund... If you have $100K, maybe you should be taxed anything.

Ted
April 11, 2023

Jim Chalmers should know better. He is following a similar line to Bill Shorten's disaster with franking credits. Lying by omission is still lying, ask any tax evader. Why cannot governments conduct proper cost benefit analyses on their proposals. Instead we get political arguments pitching one group against another without reference to the full story. Utopia here we come!

J
April 09, 2023

What is the “rental deductions” that cost 24 billion? Is that negative gearing? Can people deduct rent from their income?

James
April 09, 2023

Rental deductions are any of the legitimate costs that can be claimed against the rental income, thus reducing treasury's optimal tax take. It presumably includes mortgage interest, repairs, maintenance, property management fees and depreciation and yes negative gearing losses can be claimed against their salaried income thus reducing their salaried income tax. This plus the CGT tax free status of the PPOR and it's no wonder we have a property Ponzi scheme in Australia! All aboard, including Albo who has 3 investment properties!

John Dillon
April 06, 2023

A very sensible commentary Mark. We need much more of this in the debate about what is fair and reasonable. At the moment it’s fed by media hysteria and populist politics. Whilst I think there is some scope for scaling back concessions to limit very large super balances we need to make sure that they are well thought through and that we don’t disincentivise super savings for those who do not have these extreme super balances. People are rightly very wary of super because politicians are constantly tinkering with the rules and the results can be very damaging.

David
April 07, 2023

couldn't agree more

Dudley
April 07, 2023

Fair & reasonable: Age Pension for all including those who paid for it all & no compulsory saving.

Jim Bonham
April 06, 2023

Hi Andrew,
Thanks for this excellent discussion.

Super “costs” the government nothing. It is not a cash expenditure like the age pension. Once a contribution is made, it is simply invested and eventually withdrawn together with compounded earnings.

The claim that super costs $50-odd billion, actually refers to the opportunity cost of not charging higher taxes. It is akin to complaining of the cost of not buying a wining lottery ticket.

There are at least three fundamental problems with the TEIS:

1) The language (“tax expenditure”, “revenue forgone”, “benchmark”, “concessional”) is emotive and misleading, and grossly so. It strongly invites the sort of misuse we see from the government and others.

2) Once a contribution is made or investment earnings received, the money is inaccessible - possibly for decades - until a condition of release is met. This means the character of the contributions and earnings is utterly different from ordinary income. The notion that personal tax rates should be taken as a benchmark is simply indefensible - and the TEIS makes no attempt to defend it.

3) The TEIS looks at each tax in isolation, for one year only, without any attempt even to list, let alone quantify, flow-on effects. For example, the 15% contributions tax has the effect of decreasing subsequent balances and earnings derived from “concessional” contributions by 15%, thereby reducing subsequent earnings taxes, but increasing eventual age pension costs. In cases I have looked at in detail, the increase in age pension costs caused by all super taxes, for someone who receives a part age pension at some stage of life, is almost as great (in present value terms) as the value of the taxes. Finally, the TEIS takes no account of the other benefits of super: a more prosperous, independent and healthier elderly cohort; the value of encouraging a savings culture; the economic impact of super investments.

Happy to provide more detail on the above if you wish.

GC
April 08, 2023

Great summary, maybe you could write the next Firstlinks article on the subject and provide a more balanced perspective.

John
April 09, 2023

Very impressed with your knowledge Jim. I would be interested in reading your thoughts about the fairness of the current system in relation to its intended purpose (Retirement v Estate Planning). Do you think improving the superannuation benefits of lower income individuals while reducing the benefits to higher income individuals might help Australia manage the looming aged care expense? (Please don't use other tax minimisation measures currently available to argue for no change). PS. I am a fully self-funded retiree.
Cheers
John

George B
April 09, 2023

John, surely the answer to the question about fairness is the progressive nature of tax system that we subscribe to during the course of our working lives. Lower income individuals not only benefit from the system by paying little or no tax while receiving the lion’s share of benefits they typically also qualify for the age pension following retirement. In contrast high income earners pay the lion’s share of tax while receiving fewer benefits (particularly if they also have private health insurance and pay for private education) and if they are self-funded retirees receive no age pension.

Andrew Gale
April 10, 2023

Hi Jim - thanks for your insightful comments.

I think it is a moot point as to whether or not concessions are a cost as you describe - they do impact the Government's fiscal position. The real issue is whether concessions are economically justifiable, sustainable, and with a reasonable degree of equity (allowing for social security costs for those who do not enjoy significant superannuation concessions) - I believe they largely meet these criteria except for very large account balances or TSBs (probably $5m+ but the Government has chosen TSBs>$3m).

I agree with your 3 points re problems with using TEIS revenue foregone measures. A couple of often overlooked dimensions with superannuation (including concessions) is the macro role it plays in helping finance an ageing society (aged care and health costs forecast to increase significantly as a % of GDP, but age pension costs decreasing), and the substantial role it plays in national savings and strong capital markets. For example, one of the reasons that Australian banks were able to recapitalise their balance sheets immediately post GFC was ready and quick access to the capital markets which are strongly represented by superannuation funds and their assets.

Would certainly be interested in more detail as you have offered, plus any other insights you wish to offer.

Jim Bonham
April 11, 2023

Thank you for your comments, Andrew, GC and John.

Andew: I will get back to you with some further comments, but it may be a week or so before I can.

John: I know it fits government rhetoric to complain about rich people using super as a tax shelter to grow their estate for their kids, but it's a complex issue. To the extent it's a problem, I think it's a legacy issue: contribution limits now make it very hard to build a very large amount in super. The danger with the rhetoric is that it can lead to inappropriate restrictions on ordinary people who are simply trying to manage their affairs prudently.

Jim Bonham
April 15, 2023

Hi Andrew,

I tried to provide some more detail on the interaction between taxes and the age pension, but I was unable to include a graph. Is there some way to do this, or could I send it an email address?

Thanks
Jim

Jim Bonham
April 18, 2023

Hi Andrew,
A gross omission from the TEIS methodology is consideration of the effects of taxation on eventual age pension costs. Thus, it is incapable of addressing one of the most important features of superannuation.
Here is a brief analysis of a model simple enough to be analysable but nevertheless realistic.
I took the case of a single homeowner, retiring at age 67 in 2023; with super in an account-based pension from which only the compulsory minimum withdrawal is made each year; and with negligible other assets or income apart from the age pension, subject to the asset test.
For investment returns and inflation, I used the default values in ASIC’s Moneysmart Account-Based Pension Calculator.
Rather than track an individual, I considered a population of people in identical circumstances. At retirement, the population consists of equal numbers of men and women. I used ABS mortality statistics to determine what fraction of this population is still alive in any given subsequent year.
The value of the super account was first calculated out to age 100, and the age pension entitlement follows from the asset test. Multiplying each year’s age pension by the probability that the retiree is alive in that year, converting to present values in 2023 dollars and adding the results gives the total age pension cost for this population of retirees.
Here I would have liked to post a graph of the total present value of age pension costs per original retiree versus their superannuation balance at the start of retirement. However, it’s easy enough to summarise.
If the initial value is below about $300k the retiree gets a full age pension throughout retirement, at an average lifetime cost of just over $500k, in 2023 dollars.
Between $300k and $800k the age pension cost decreases at a rate of 80 cents per dollar of initial super balance. (This is somewhat sensitive to the parameters assumed: a slightly higher investment return would see the rate become $1 for $1.)
By $900k, the total age pension cost per retiree has reduced to about $100k, and thereafter it tails away slowly.
Taxation in the accumulation phase necessarily reduces the superannuation balance at the start of retirement. This relatively simple analysis shows that, for a wide range of cases, the resulting increase in age pension costs roughly matches the present value of the taxes collected earlier.
There is scope for careful re-thinking of the purpose of taxing superannuation.

Dudley
April 18, 2023

"There is scope for careful re-thinking of the purpose of taxing superannuation.":

Abolishing Age Pension Means Tests and flat rate taxing Super Disbursement ('pension') Account earnings would be a simple modification of your model.

What flat tax rate would your model need to produce similar cost to current Age Pension?

Ray Cameron
April 06, 2023

When will the Prime Minister and Treasurer publicise how the TSB on their defined benefit superannuation will be calculated?

Franco
April 06, 2023

Ray you only ever use this complaint.
It seems you dont like the current PM but never mention any previous PMs defined benefits.
Its like saying" its not fair that billionares have so much"

What is good for the goose is good for the gander
April 07, 2023

@Franco, A relevant and deserving question, should only be asked once ?

The question asked by @Ray is still unanswered.

Geoff
April 07, 2023

Past Prime Ministers aren't making the changes to the super system - they're not particularly relevant.

And I think the point Ray is trying to make is not how it'll be calculated - 16 times the pension amount is the way the ATO does it currently - but how such a huge DB pension, paid for by the Australian people, and which will undoubtedly far exceed the $3m level, will be taxed. It's a reasonable question, given it's the CURRENT Prime Minister who is superintending the changes.

Dave Roberts
April 07, 2023

Ray,
I have a NSW defined benefit government pension after contributing after tax contributions since 1975. The TSB on that $40000 is calculated by multiplying yearly amount by 16. My TSB is $640000.

Jane Abbott
April 07, 2023

Dave, correct. Husband has a future Fund CSS Pension, CPI indexed, same amount. 40000 x 16 = $640,000…this has to be taken into account with his account balance of our SMSF to give him a Total Superannuation Balance. So how come this calculation applies to some but not all? Or are we just not informed about this for them?

Peter
April 10, 2023

Maybe comment on

https://treasury.gov.au/consultation/c2023-373973

Better targeted superannuation concessions

8 days left to have your say
31 March 2023 - 17 April 2023

Key Documents
Consultation paper 1.23 MB
Consultation paper 340.6 KB
On 28 February 2023, the government announced it would reduce the superannuation tax concessions available to individuals whose total superannuation balances exceed $3 million. The changes will apply from 1 July 2025.

This reform is intended to bring the headline tax rate to 30 per cent, up from 15 per cent, for earnings corresponding to the proportion of an individual’s superannuation balance that is greater than $3 million. Earnings relating to assets below the $3 million threshold will continue to be taxed at 15 per cent or 0 per cent if held in a retirement pension account.

The government is seeking views from interested parties on the implementation of these changes. Specific consultation questions are outlined within the paper.

Dudley
April 06, 2023

Cost of paying full single Age Pension to all age eligible (regardless of current residency criteria): = 26 * 1064.00 * (1715403 + 2049641) = $104,156,177,216 https://www.abs.gov.au/statistics/people/population/life-tables/latest-release#data-downloads Commonwealth budget 2022-23: Support for seniors/age pension: $55.3 billion. Super 'concessions': $50 billion? Total 'cost': $105.3 billion? Abolish Super and Age Pension Means Tests, adjust tax rates to claw back some Age Pension and reduce highest rates.

Self funder
April 06, 2023

This debate has become about the calculation method, the unrealised gains and the indexing, rather than the merit of a new tax on people who have saved for 30 years and done the right thing. I wonder whether this is a stroke of genius by the Treasurer to deflect attention from the $3 million. Once we were complainign about $5 million, now all we care about is how it is calculated.

Mark
April 06, 2023

Discussions on the merits are moot though. We can only focus on the things we might be able to change. There is no consultation on whether it is coming in or not. There are/were public submissions open for how it might work.

 

Leave a Comment:

RELATED ARTICLES

The mechanics of the $3 million super tax must be fixed

Prepare for the shifting sands in personal taxation

Super is about equity and fairness

banner

Most viewed in recent weeks

Vale Graham Hand

It’s with heavy hearts that we announce Firstlinks’ co-founder and former Managing Editor, Graham Hand, has died aged 66. Graham was a legendary figure in the finance industry and here are three tributes to him.

Australian stocks will crush housing over the next decade, one year on

Last year, I wrote an article suggesting returns from ASX stocks would trample those from housing over the next decade. One year later, this is an update on how that forecast is going and what's changed since.

Avoiding wealth transfer pitfalls

Australia is in the early throes of an intergenerational wealth transfer worth an estimated $3.5 trillion. Here's a case study highlighting some of the challenges with transferring wealth between generations.

Taxpayers betrayed by Future Fund debacle

The Future Fund's original purpose was to meet the unfunded liabilities of Commonwealth defined benefit schemes. These liabilities have ballooned to an estimated $290 billion and taxpayers continue to be treated like fools.

Australia’s shameful super gap

ASFA provides a key guide for how much you will need to live on in retirement. Unfortunately it has many deficiencies, and the averages don't tell the full story of the growing gender superannuation gap.

Looking beyond banks for dividend income

The Big Four banks have had an extraordinary run and it’s left income investors with a conundrum: to stick with them even though they now offer relatively low dividend yields and limited growth prospects or to look elsewhere.

Latest Updates

Investment strategies

9 lessons from 2024

Key lessons include expensive stocks can always get more expensive, Bitcoin is our tulip mania, follow the smart money, the young are coming with pitchforks on housing, and the importance of staying invested.

Investment strategies

Time to announce the X-factor for 2024

What is the X-factor - the largely unexpected influence that wasn’t thought about when the year began but came from left field to have powerful effects on investment returns - for 2024? It's time to select the winner.

Shares

Australian shares struggle as 2020s reach halfway point

It’s halfway through the 2020s decade and time to get a scorecheck on the Australian stock market. The picture isn't pretty as Aussie shares are having a below-average decade so far, though history shows that all is not lost.

Shares

Is FOMO overruling investment basics?

Four years ago, we introduced our 'bubbles' chart to show how the market had become concentrated in one type of stock and one view of the future. This looks at what, if anything, has changed, and what it means for investors.

Shares

Is Medibank Private a bargain?

Regulatory tensions have weighed on Medibank's share price though it's unlikely that the government will step in and prop up private hospitals. This creates an opportunity to invest in Australia’s largest health insurer.

Shares

Negative correlations, positive allocations

A nascent theme today is that the inverse correlation between bonds and stocks has returned as inflation and economic growth moderate. This broadens the potential for risk-adjusted returns in multi-asset portfolios.

Retirement

The secret to a good retirement

An Australian anthropologist studying Japanese seniors has come to a counter-intuitive conclusion to what makes for a great retirement: she suggests the seeds may be found in how we approach our working years.

Sponsors

Alliances

© 2024 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.