RDP 9603: Australia's Retirement Income System: Implications for Saving and Capital Markets 2. Background and Objectives

Australia first introduced an age pension in 1909. It was designed for poverty alleviation rather than as a comprehensive income support, and was tightly means-tested. Subsequently, however, the means tests were gradually relaxed and the system took on more of the nature of a general entitlement. The take-up rate increased substantially, from around 30 per cent when first introduced to a peak of around 85 per cent in the mid 1980s; this has since fallen slightly, partly as a result of various measures to tighten eligibility since that time.^[3] Although the pension provides a relatively low level of income support, its value is increased by a variety of health and public transport subsidies for which pensioners are also eligible, and there is some scope to earn supplementary private income. Also, in contrast to many countries, the large majority of elderly people own their own homes. The prominent role of the age pension across all but the highest income groups in the elderly population is illustrated by the summary of household characteristics presented in Table 1.

Voluntary superannuation has long been an important source of retirement income for a minority, comprising mainly high income earners and public-sector employees. As is common in many countries, voluntary superannuation savings benefited from generous tax treatment. Employer contributions, and earnings on accumulated contributions, were essentially tax-free prior to 1983, subject only to a final tax on 5 per cent of the accumulated lump-sum at retirement. The tax benefit was particularly valuable for taxpayers on high marginal tax rates, but was not necessarily attractive for low income earners for whom a significant factor in savings decisions could be the potential impact on entitlement for the government pension. Tax concessions for superannuation were substantially curtailed in 1983 with the introduction of a 30 per cent tax on lump-sum benefits accrued after that date, and the system was further tightened by changes made in 1988 and subsequent years, including introduction of a tax on fund earnings. Nonetheless, the tax treatment of superannuation remains concessional in a number of ways that are discussed further below.

The move to a system of compulsory superannuation had its origin in centralised wage negotiations that took place in 1985 and 1986. The federal government agreed to support a claim by the ACTU for a 3 per cent employer-provided superannuation benefit to be incorporated in employment awards in lieu of a general wage increase. This was endorsed by the Industrial Relations Commission in June 1986. The move was advocated as a means of making superannuation more widely available, and it was also seen as furthering macroeconomic goals by promoting private saving. As a result of the decision, the 3 per cent superannuation benefit was gradually incorporated in employment awards as they came up for renegotiation. These payments were directed either into existing funds or into union-created ‘industry’ funds which in other respects were the same as those already in existence (ie managed by private funds management firms).

In 1991 the government announced a significant expansion of compulsory superannuation, along with the introduction of a new compliance mechanism known as the Superannuation Guarantee Charge (SGC), which gave the system the basic shape it has today.^[4] The SGC legislation established a timetable for employer contributions to be increased to 9 per cent in most cases by the 2000/01 financial year, with tax penalties for non-compliance.^[5] Further measures were announced in 1995 to encourage additional contributions of 3 per cent by employees, to be supplemented by a matching contribution from the federal government, thus bringing the total level of contributions eventually to 15 per cent; strictly speaking, these employee contributions were not legislated but to be implemented through industrial negotiations, with the government co-contribution acting as an incentive. The move to a legislated system for employer contributions was partly a response to problems of administrative complexity and slow compliance under the award-based system. Award superannuation did not cover some significant parts of the workforce (for example the self-employed and part-time workers) and was taking longer than anticipated to implement because of negotiation delays.^[6] As shown in Table 2, superannuation coverage has widened substantially as a result of these measures.

The broad parameters of the compulsory superannuation policy have bipartisan political support, with the newly-elected government in 1996 having endorsed the overall targets set by the previous government, although not necessarily the implementation method for employee contributions. The new government announced further changes in the 1996/97 Budget including the introduction of Retirement Savings Accounts and a number of changes to the taxation of superannuation.

Introduction of the compulsory superannuation plan reflected a combination of policy concerns broadly related to the issue of raising aggregate saving. Like a number of other industrial countries, Australia has an ageing population structure. However, the aged dependency ratio is still quite low and is not projected to rise as steeply as elsewhere (Table 3), so it is ironic that Australia has moved comparatively early to establish the basis for a funded scheme. The timing of the initial move to award-based superannuation was in a sense accidental, and reflected the intricacies of the wage-bargaining process at the time. Nonetheless, the general policy thrust reflected underlying objectives of raising aggregate saving (an important macroeconomic objective in its own right) and of providing funded retirement incomes for the majority of employees. Once the principle of mandatory contributions was established, subsequent extensions to the scheme were aimed at increasing those contributions to a level high enough to ensure these objectives could be adequately met.

The objective of increasing national saving in Australia has been on the policy agenda since at least the mid 1980s, when a chronically large current account deficit became apparent. The deficit reached 6 per cent of GDP at that time and has since continued to fluctuate mainly in the 3 to 6 per cent range, regarded by the government and many other observers as uncomfortably high. It is also the case that Australia is a relatively low-saving country, at both national and household levels, as discussed further in Section 5. This combination of facts created a powerful prima facie argument for policies to promote aggregate saving. One important dimension of the policy debate has related to the role of fiscal policy, where there has been considerable emphasis on the need to improve cyclically-adjusted budget balances.

There is also widespread agreement in Australia on the desirability of promoting private saving. Households are argued to undersave for a variety of reasons, including an inherent tendency to discount the future too heavily, and disincentives to private saving created by the government pension system. Regarding the latter, the system is argued to have created significant incentives for low and middle income earners to qualify for the age pension by not saving ‘too much’.^[7] The high take-up rate of government pensions, discussed earlier, is often cited as support of this view. Purely incentive-based approaches to promoting private saving, as existed under the pre-1983 taxation arrangements, appeared to have little impact on saving by low and middle income earners. Given this background, and the objective of ensuring comprehensively-available retirement support, the move to a compulsory saving system seems a logical outcome. The existence of a significant private superannuation system when the policy was introduced, and a desire to achieve maximum returns, were probably both important factors in ensuring that a privately-run system was the preferred option.

Footnotes

For a discussion of this history, see Department of Social Security (1983) and Gruen (1985). [3]

Full details are set out in ‘Superannuation Guarantee Levy: Information Paper’ (1991). [4]

Vesting and preservation requirements were also standardised. Benefits were now required to be fully vested in the employee immediately, and to be preserved in a superannuation fund until at least age 55. [5]

75 per cent of employees had superannuation coverage by 1991, five years after the initial decision by the Industrial Relations Commission. [6]

For a review of these arguments, see Freebairn, Porter and Walsh (1989), Edey and Britten-Jones (1990), Robinson (1992), Bateman and Piggott (1993) and FitzGerald (1996). [7]