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Savings: a call to arms: paper presented to the IFSA Investment Management Conference, Melbourne, 8 May 1998

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Philippa Smith



Melbourne, 8 May, 1998


What has happened to the national savings debate?


As a recent arrival to the investment and superannuation sector, I have been puzzled by the relati vely limited amount of attention in the current public debate on the issue of Australia’s national savings and what encourages individuals to save, especially for the long term.


Savings was an issue that previously loomed large in public policy discussions. We had the Keating "banana republic" remarks, a major inquiry by Dr Vince FitzGerald, work by EPAC on whether we are saving enough both for the efficient operation of the economy or to fund our collective old age, and the report of the National Commission of Audit. All of these pointed to a need for increased private and national savings.


However, in the current tax debate the silence concerning national savings measures has been deafening.


The Government has given a few hints on its preferred general direction for tax reform. For example, it has expressed the view that there should be no increase in the overall tax burden, that consideration should be given to a broad-based indirect tax to replace some or all or existing indirect taxes. But on national savings there has been barely a word spoken.


One would think that the need to encourage savings should have a starring role in the current debates and tax reform process.




Superannuation is of course one of the major vehicles for savings. The great strengths of superannuation as a means for increasing national savings are that in general it supplements rather than replaces other forms of savings. It leads to less consumption now and more in retirement. The preservation arrangements and the need for periodic contributions ensure this.


Our three pillar approach for retirement has also been endorsed by the World Bank in its 1994 international review of retirement income policies.


In Australia the three pillar approach is made up of:


1. An a ge pension paid from current revenue;


2. Compulsory saving through regulated superannuation funds for employees (7% of wages from 1 July, rising to 9% by the year 2000 and paid by employers;


3. Voluntary savings


Indeed the Australian approach has been t he envy of a number of overseas countries.


The importance of the compulsory and voluntary savings over and above the age pension, which is set at 25% of male average weekly earnings becomes increasingly obvious as many of us ponder the prospects of our own old age. Unfortunately many leave their saving too late and will find that the savings generated from the age pension and mandated compulsory contributions will not be sufficient to meet our needs let alone expected lifestyle.


Some may also find that the effective marginal tax rate of DSS and tax combined means that their savings do not provide much gain at the end of the day. This is hardly fair and acts as a disincentive and creates disillusionment.


As the baby boomers hit retirement the budgetary pressures and difficulties for governments to sustain even the basic level of age pensions will also be hit hard.


Thirty years out the older demographics, and a smaller workforce, will require substantially higher income tax rates to sustain age pensions. On ASFA’s calculations an increase of 13% in personal income taxes would be required to sustain health care and payment of age pensions to all.


Why then has national savings slid off the agenda, and what has happened to government commitment to making sure that retirement incomes will be adequate?


The main problem is that governments generally take a short term perspective on such issues. The political equivalent of "not in my backyard" is probably "not in my term".


Governments have also developed schizophrenic views when it comes to super - as to whether the cost of tax concessions are large and excessive, or whether superannuation savings are an important base for the economy. Whether super is a way of supplementing and ensuring an adequate retirement income or just replacing future social security expenditures. The immediate but short term notion of a super "honey pot" has obvious attractions to governments.


We need to remember, and strongly articulate, the public policy objectives of superannuation savings and the need for a coherent retirement incomes strategy. This strategy needs to reinforce the three pillar approach I outlined before.


We cannot afford t o ‘lose the plot’ in terms of development of a coherent retirement income policy and the use of tax concessions and other policies to encourage this.


Superannuation and Investment


The provision of tax concessions for superannuation has formed a key part of this policy. The objective is to encourage superannuation and also limit the demands on the public purse through the social security system (the first pillar).


Savings and superannuation is also important for our economy and national investment.


The implications for national investment from our savings and retirement income policies are very significant. Currently there is over $400 billion of what could be described as managed funds in Australia. The superannuation sector is a dominant part of this and accounts for around $325 billion in assets as at December 1997.


These assets are not bank notes sitting in a vault somewhere. Over $120 billion is in shares and other forms of equity. This amounts to a quarter or so of the capitalisation of the ASX and just under $15 billion is invested in Australian property.


Australian superannuation funds are also the major institutional source of venture capital in Australia, and also invest large amounts in the private provision of infrastructure such as roads, airports, telecommunications and power companies.


Some commentators take these investments for granted. They assume that so long as the Superannuation Guarantee operates the flow of investment funds will be assured. However, a large proportion of these contributions are currently made voluntarily in response to available tax concessions.


For example in calendar year 1997 contributions to superannuation funds were $31 billion, up from $28 billion in the previous 12 months. Only about half of this however were compulsory contributions. There was another $5 billion in employer contributions (some of which would be salary sacrifice) and $11 billion in voluntary member contributions.


Understanding the incentives to encourage and lift these savings levels is important.


People need to be encouraged to save and most importantly to lock away their money for the long term.


This requires both a better understanding and transparency as to the incentives available and a confidence that government won’t change the rules.


This confidence and clarity has become muddied.


Research (both by the Tax Office and the sector) shows that there is real support in the community for compulsory superannuation contributions, but at the same time it is clear that most people have at best a sketchy understanding of superannuation and consider it much too complicated.


Should industry be doing more to make the system better and simpler?


As an industry it seems to me that we could be doing more to make the superannuation system better and more understandable for the average punter. Part of this might involve lobbying the government for improvements, it also should involve the design and marketing of better products. Communication more effectively is essential as well.


What people increasingly want is more control and ownership. To purchase rather than be sold a savings product. Lower fees and charges, flexibility, choice of investment, and good earnings rates are all important. So too is having products which meet the needs and changed work patterns of both men and women, high and low income earners, the old and the young.


Better communication is an essential part of this. It is interesting to note that in the USA the average managed funds investor receives a dozen or more communications a year rather than one or two. Savings targets are discussed and agreed to. The advantages of regular savings programs and targets (for the "cost of a doughnut and a coffee a day") are pushed strongly.


While Australia has a lot to teach the world in terms of retirement savings vehicles, we have a lot to learn in encouraging individuals in the hows and whys of saving.


Complexity of the system


Why is superannuation so complex? There are three main reasons, and these are tax, tax, and tax.


The complexity largely comes from government continually changing the system. On one count there have been around 2000 changes (some major, some minor) in the past 10 years.


Complexity comes as well from taxing superannuation at every possible taxation point (contributions, earnings and benefits) and having various tax permutations at each of these points. To top this off there is the grandfathering of entitlements, so that taxes paid can be affected by what a superannuation fund member did thirty or forty years ago.


There have been more or less rational reasons for most of the changes that have been introduced, but their cumulative effect certainly is not reasonable or rational. We are in grave danger of "losing the plot" in terms of development of a coherent retirement income policy and use of tax concessions.


Thus we have the paradox. The concept of superannuation and saving is simple enough, some incentives are still there for most people but the changing and complicated arrangements undermine confidence or indeed the transparency of those incentives.


Measuring superannuation tax concessions


While tax concessions are available for super they are not as large as some might have you believe.


Some very large figures about the cost to revenue of superannuation tax are sometimes bandied around. For instance, the Treasury claims that the revenue that the government forgoes as a result of tax concessions for superannuation currently exceeds $8 billion.


Whilst these figures are impressive they are misleading in both the short and long terms.


For a start, the estimates are a short term and immediate measure. The calculations do not include the trade-off between short-term costs and long-term benefits. It is also assumed that the behaviour of individuals in terms of savings and consumption decisions would not change if the tax arrangements were changed.


In somewhat perverse reasoning, high returns associated with long term managed savings in the form of superannuation are seen by the Treasury as increasing the cost of the tax concessions rather than reducing future claims on the government for retirement income support through the Age Pension. They calculate this "cost" each year even though in reality the savings are preserved and represent a deferred income stream for the individual.


In our view they should be taxed at the point of benefit or payment rather than contribution. Indeed in most countries revenue is collected only when benefits are paid. It is simpler and allows for incentives and revenue collection to be introduced most efficiently and more equitably.


If one takes this longer term view the costs of superannuation concessions are more in the order of $1.4 billion rather than Treasury’s higher estimates.


While the treatment of superannuation prior to July 1983 was highly concessional it has become increasingly less so in recent years. For some low income earners and some high income earners it now is not concessional at all.


Getting the government to make the system simpler and better


The inflated figures promoted by Treasury and others are dangerous in a climate where governments are wanting to fund other tax cuts or concessions.


Superannuation is not a magic pudding available to fund other initiatives. They are also member savings and we must retain their confidence


In light of this background ASFA’s pre-budget messages to the government have been two fold:


• don’t tin ker with superannuation in the short term.


• in longer term we need to develop a coherent retirement incomes strategy which tackles the overlap between DSS / Tax and Super and which simplifies our concessional arrangements. This will not be a simple task and probably needs to have bipartisan commitment and the willingness to unscramble some of the complexities, multi staged taxation and grandfathering provisions.


In the broader debate however, one would think that business lobby groups would be stressing the need to bolster national savings, especially given that its members are either relying on national savings as a source of their investment funds and / or are playing an active role in the collection and management of savings.


ASFA and IFSA certainly have been stressing the importance of tax reform measures being supportive of saving and the dangers for Australians, and our economy, if changes damage our savings rate. We have had some recognition of the validity of such argumen ts.


However, quite a few business groups have been more interested in addressing Federal / State taxation and revenue arrangements rather than in tackling national savings issues. The politics of gaining popular support for tax reform have played a role as well.


Unfortunately a tax mix switch with a reduction in marginal income tax rates and nothing more to encourage savings could be detrimental.


Studies both in Australia and undertaken by the OECD have indicated that even a substantial cut in marginal income tax rates and the associated handfull of dollars will lead to a negligible increase in savings, and and a possible decline in savings, unless the right incentives are put in place.


What is needed to stimulate savings is a mixture of savings related tax incentives and a degree of compulsion.


In this context I was concerned by the reports in the press that the Business Council said it is willing to trade off the savings rebate as a means for funding reform in the marginal tax rates. The savings rebate is not without its design defects, and ASFA was among the first organisations to point these out, but it would be much better to refine the savings rebate or replace it with another measure targeted at savings.


How to improve national savings


To improve our national savings we need to have in place tax incentives which support additional, long term savings. Doing away with the savings rebate and replacing it with say just lower marginal taxes will not lead to additional national savings.


A significant cut in marginal income tax rates will also impact on the attractiveness of superannuation tax rates, particularly those on contributions and earnings. For low income earners (those on a marginal tax rate of 20 per cent or not subject to income tax) a contributions and earnings rate of 15 per cent is not highly concessional at the moment. A drop in marginal income tax rates would make the tax attractiveness of super at best marginal.


For an individual currently on average earnings who pays 34 cents in the dollar on their wage income clearly a contributions tax of 15 per cent has its attractions, particularly if eventual superannuation benefits come within the $90,000 or so tax free benefit threshold for those retiring after age 55. However, the delay in access to superannuation funds does have a cost for individuals, and benefits taxes will apply to a degree to most middle income earners. If the marginal tax rate dropped by, say, 8 cents in dollar this would almost halve the margin between the super tax rate and the income tax rate.


ASFA is not opposed to cutting marginal tax rates, but it is important to keep in mind potential implications for the relative attractiveness of superannuation and implications for long term savings. If what the country needs is long terms savings, productive investment, and coping with an ageing population then maintaining the relative tax attractiveness of super will need to be part of the equation of tax reform.


It should also be noted that a significant tax mix switch would also have implications for self funded retirees. If a GST of 10 per cent or so was introduced ASFA would not press for particular compensation beyond that in the general tax system for current retirees. But a GST significantly higher than this does raise real questions of equity for the treatment of those who are consuming in retirement out of the proceeds of saving during years when relatively high income tax rates applied.




So in conclusion I would like to leave you with a number of points.


First , what we need is less tinkering and more planning for the long term.


The Government and we as a community need to think very carefully about what our national savings and retirement incomes policy should be.


Second , savings should be directed into areas where there is professional management and/or the potential to make significant and maintained real rates of return. Lower income tax rates are all very well, but both the government and individuals will be losers if they come at the cost of savings and long term investment.


Third , a long term vision is needed.


The choice for government is clear. It can continue to tinker around the edges of the superannuation system, thinking small and limiting both Australia’s savings and investment opportunities. Or it can think big and support high return and productive savings and investments.


Fourth , a coherent retirement incomes strategy needs to be articulated and developed.


"Don’t mess with our savings" needs to become the rallying cry for both individuals and business alike. I hope that both ASFA and IFSA can delivery this message clearly and I invite members to join in this cry in the run up to major tax reform in Australia.