- On 02/03/2020
- retirement, superannuation
The current Retirement Income Review has generated more news about superannuation. In the perennial debate about the virtues of our mandatory superannuation system, some commentators have questioned whether the Superannuation Guarantee (SG) regime increases Australia’s national savings, or simply cannibalises existing savings.
The debate lies in two parts – do people save more of their annual income given the mandatory requirement to contribute to superannuation, or do SG contributions simply substitute for savings that would have been made anyway? Secondly, does the superannuation system help families accumulate more wealth for their retirement than they could under other regimes?
During the period of compulsory superannuation, we have also had a huge growth in the value of residential real estate. As with other real assets, this has been a function of falling interest rates. Household debt has risen, and this has been used by some to show that national savings are weak, whereas this additional debt comes mainly from the mortgages that have been necessary to allow families to buy homes at elevated prices.
Savings and consumption
The economy relies on people spending a large proportion of their income as this consumption generates revenue for businesses and provides employment. However, if no one saved, we would all end up with a modest retirement, so some income does need to be set aside for the future.
In periods of low wage inflation, as we have had for several years, disposable income falls, and people spend more and save less. However, all employees pay 9.5% of their income into superannuation, which is therefore a floor to the savings rate.
Clearly, for those on modest incomes, the SG contributions add to their savings as they would have had little capacity to save otherwise. Those with higher levels of disposable income have more scope to determine how much to save. This is not always easy to measure, as the wealthiest families might appear to save less than they do due to negative gearing which is used to reduce personal taxes and to leverage assets.
Similarly, people taking out large mortgages to buy a family home will have less disposable income, though the mortgage payments are also a form of regular saving.
Over time, savings ratios can rise and fall due to macro-economic conditions. However, Australia has a relatively high rate due to our conservative fiscal policies and the compulsory superannuation system. The latter has been estimated by Treasury in 2011¹ to add about 1.5% of GDP to National Savings from the private sector and a further 0.4% from the public sector with these together growing to about 3.7% when the SG gets to 12% of wages.
Not surprisingly, our national savings ratio is relatively strong when compared to other developed nations.
Apart from inheritances, personal wealth is built from saving some of your wages and investing it for the future. Those with higher incomes can save more due to having more disposable income so household wealth rises with income.
The SG has delivered healthy growth in personal savings not only from being a forced saving that is held for a long time, but also due to the high real growth rates that have been earned over long periods by superannuation funds for their members. This has led to relatively high median retirement benefits today, which are expected to grow even higher in future years. As a result of these higher balances, people have shifted from full to part pensions much earlier than had previously been expected.
The national wealth is also reflected in the huge capital pool managed by Australian superannuation funds. In fact, recently we became a net exporter of capital for the first time ever.
Despite this success, some commentators have suggested that other national pension systems are better. For example, several submissions to the Retirement income Review suggested we move to a universal pension and abolish the means-test. While this would simplify our system, the costs would be unaffordable without increasing taxes significantly.
The New Zealand system uses a universal State pension, but the benefit is set at a lower level than the equivalent Age Pension we provide in Australia. Further, it is on track to cost their taxpayers more than twice as much as ours when expressed as a percentage of GDP² (and their costs are rising while ours will reduce).
The median levels of private superannuation and other savings are very low in NZ compared to levels here, with 40% of Kiwis having virtually no other income in retirement. Total retirement benefits here are much larger across all income deciles. Even with the means test on the Age Pension, the average Australian is likely to be better off in retirement than their Kiwi counterpart.
Without the SG, people would initially have higher levels of disposable income. However, if we look at behaviour in other countries, individuals will largely spend most of the extra cash and not increase their savings. Some might have higher savings by buying more expensive residences, which is far less efficient for the economy than investing in infrastructure and businesses. In addition, the increase in disposable income would prove to be temporary as tax rates increase to finance an increase in Government pension costs from the current 2.7% of GDP to something closer to the OECD average of 8%.
An RBA Research Paper gives an indication that the SG adds significantly to savings. In a 2008 Research Paper³, Ellis Connolly concluded that every dollar added in superannuation contributions increased household wealth by between 70 and 90 cents, showing that the level of cannibalisation is small.
Overall, we should be proud of our system. It still has many flaws which we expect the Retirement Income Review to address. We should also not expect superannuation to solve everything – some issues require broader measures. For example:
- It is true that low-income workers would welcome more disposable income now, but it is the role of the tax and transfer system to look after this group.
- We have pockets of retirement poverty which need to be addressed – such as those single pensioners who are renting in private markets.
- Females tend to have significantly less retirement provision than males. This should be addressed through a combination of superannuation policy, employment policy and availability of affordable childcare.
- The taper rate on the Age Pension is punitive for many people, especially in a low interest rate environment, and it should be softened.
² The New Zealand Treasury’s 2016 Statement on the Long Term Fiscal Position projects that the cost of the pension in New Zealand will increase from 4.8% of GDP in 2015 to 6.3% in 2030 and 7.9% in 2060. https://treasury.govt.nz/publications/ltfp/he-tirohanga-mokopuna-2016-statement-new-zealands-long-term-fiscal-position
Rice Warner projects that Australian Age Pension expenditure as a percentage of GDP will fall from 2.7% in 2018 to 2.5% in 2038. https://www.ricewarner.com/the-age-pension-in-the-21st-century/