RDP 9603: Australia's Retirement Income System: Implications for Saving and Capital Markets 5. Impact on Saving

As has already been noted, Australia's gross national saving rate has historically been below OECD averages and has declined substantially in the past two decades. Much of this decline, illustrated in Figure 5, is attributable to reduced saving by the public sector. Gross private saving, as conventionally measured, has also been declining, though at a lesser rate, while household saving declined somewhat faster than the private sector total. In interpreting private-sector saving trends, Edey and Britten-Jones (1990) argued for a focus on aggregate private saving rather than on the separate household and corporate-sector components, since the exact boundary between them is somewhat arbitrary and there has historically been a high degree of offset between the two forms of saving. They also calculated an inflation adjustment of the private saving aggregate which corrects for the wealth transfers between public and private sectors effected by inflation. The adjustment has the effect of lowering the peak in private saving recorded in the 1970s and produces an estimate of the gross private saving rate that has been fairly flat, at least until recently. Net private saving, however, has still shown a trend decline, reflecting an upward trend in the ratio of depreciation to income.^[24]

Since there has not yet been a sustained increase in superannuation contributions, for the reasons described in the previous section, the historical data do not provide any direct basis for inferring what is the likely impact of compulsory superannuation on aggregate saving. The answer to this question will depend critically on the extent to which superannuation displaces other forms of saving. A historical estimate of the degree of offset between the two categories of saving, reported by Morling and Subbaraman (1995), obtained the rather high figure 0.75, implying around three-quarters of a given change in superannuation saving would be offset elsewhere. But this estimate is derived from a historical sample dominated by the voluntary contributions of mainly high income earners, and is unlikely to have much bearing on behaviour under the compulsory scheme, as the authors themselves acknowledge. The move to compulsory contributions and the expansion of coverage of the system among low income earners, who are more likely to be liquidity constrained, can be expected to reduce substantially the degree of substitution between superannuation and non-superannuation saving in the future. Other studies have cited lower offset coefficients. FitzGerald (1993) uses a coefficient of 0.5 while Covick and Higgs (1995) estimate a figure of 0.37 and cite international evidence for figures of around one-third.

Projections of the effect of the compulsory scheme have been made by the Retirement Income Modelling Task Force, using an assumed offset-coefficient of one-third.^[25] A summary of these projections is presented in Figure 6, which shows the estimated additions to saving relative to a baseline scenario.^[26] A sharp increase in aggregate saving is projected at the end of the current decade when the employee and government co-contributions come into effect. By the year 2003, when the schedule is fully implemented, saving is projected to have increased relative to the baseline by around 3 per cent of GDP. The peak effect is reached much later, reflecting subsequent reinvestment of fund earnings and the fact that significant increases in retirement rates do not occur until some time later. The projections take into account the fiscal revenue cost of superannuation tax concessions as applied to the increased contributions, and also the beneficial effect of reduced government pension outlays; these are eventually projected to fall by around one per cent of GDP when the system matures. However, a point of caution is that the funding for the government co-contribution in these projections comes from not proceeding with tax cuts that were already announced, but not yet implemented, when this component of the scheme was adopted. These tax cuts are included in the baseline scenario. Also included in the baseline is the cost of tax concessions applied to the existing level of voluntary contributions.

An important dimension of the overall impact of compulsory superannuation concerns its likely impact on behaviour of those around the retiring age. In Australia there was a substantial increase in the rate of early (that is, pre-65) retirement in the 1970s and 1980s, as illustrated by the declining male labour-force participation rates for older age-groups, shown in Figure 7. Anecdotally this trend is often argued to have been encouraged by the phenomenon of ‘double dipping’. This is where individuals who have accumulated moderate amounts of superannuation savings retire early, consume the bulk of those savings and then qualify for the government pension at age 65. Such a strategy is thought to be attractive where individuals have accumulated enough savings to reduce entitlement to the government pension, but not enough to generate a private income in retirement that would substantially exceed the pension. More generally, the interaction of the personal income tax system with the means testing of the government pension is argued to create very high effective marginal tax rates on saved income for some groups, and therefore to encourage low rates of labour participation.

It is possible that this disincentive effect, acting in the years just prior to retirement, is a more important potential source of leakage of saving from the compulsory scheme than other actions to offset higher superannuation saving taken by individuals at earlier stages in their working life. The size of the impact on saving and labour participation is not accurately known. However, the general observation that only a small minority of people currently receive their main retirement income from sources other than the government pension does seem to suggest important disincentives to save for retirement among low and middle income groups. This may well be a factor contributing to low labour-force participation rates in the 55–65 age group, even though the strict ‘double-dipping’ stereotype does not seem to be particularly common.^[27]

Given the policy objective of maintaining a reasonable safety net through a government pension, two broad strategies are available to reduce the adverse effects on incentives to save for retirement. One is to make the government pension universal, as is the case in a number of countries including New Zealand. This removes the adverse impact of the means test on effective marginal tax rates, but raises problems of equity as well as increasing the cost to the government, possibly reducing the overall level of support that can be afforded. The other approach is to tighten the enforcement of compulsory self-provision for retirement. This is broadly what is happening in Australia through various measures to increase the attractiveness of annuity benefits relative to lump sums, along with a gradual increase in the compulsory preservation age for superannuation benefits.^[28] These changes should reduce the potential for savings to leak from the system in the years immediately prior to retirement. But changes in these incentives are hard to bring about quickly because of a strong presumption that existing accumulated entitlements should be protected from significant rule changes.

Footnotes

Edey and Britten-Jones (1990) also argue that the depreciation estimates may be unreliable, so they prefer a focus on the gross figures. [24]

The Task Force is jointly sponsored by the Treasury, Department of Finance, and Department of Social Security. Non-official estimates of the impact of employer contributions give broadly similar results. See Bateman and Piggot (1992), AMP (1995), Corcoran and Richardson (1995) and Covick and Higgs (1995). [25]

The projections are discussed in ‘Saving for Our Future’ (1995). [26]

Survey-based evidence on this issue is provided by the Department of Social Security (1992). On the basis of this evidence Kalisch and Patterson (1994) argue that stereotypical double-dipping, in the form of holidays or other consumption expenditure financed by a lump sum, is rare. However, Bateman, Kingston and Piggott (1994) argue that there is still a more broadly defined incentive problem associated with the age pension. [27]

The preservation age is to be raised to 60 by the year 2025. Concerning tax incentives to encourage annuities, Bateman, Kingston and Piggott (1992) argue that recently introduced incentives in this direction are not very strong. [28]