Australian economics

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The unimaginable burden of trying to retire on $3 million

Superannuation is for retirement, not for financial wealth accumulation

Since 2023 the government has had a bill before Parliament to increase the tax on earnings from superannuation fund balances above $3 million – from 15 percent to 30 percent. It couldn’t get the bill through the Senate in the last Parliament, but it should now have the Senate numbers to get it passed.

As the ABC’s Ian Verrender explains, it is designed to make the superannuation system a little fairer, a little less open to tax avoidance, while still giving the well off significant tax breaks not available to most Australians: How Australia's superannuation system subsidises the wealthy. Independent tax experts, such as Chris Murphy of the Crawford School, are critical of the bill because it doesn’t go far enough in addressing inequities in our superannuation system.

Nevertheless it has met with howls of protest from some of the country’s most privileged.

If you reach the age of 65 with $3 million in your superannuation account you should be able to do rather well for yourself in retirement.

To work out just how well, you need to do a little arithmetic to estimate how much you can draw over the rest of your life. By the time you reach 65 it will probably be 40 years since you did high-school mathematics: as a reminder, below is what is known as the annuity formula. An annuity is the amount A you can draw annually from a fixed sum S, over n years, if the return on your investment is r.

So if you have $3 million, hope to live to 100 (that is 35 years more), and conservatively estimate that your real (after inflation) return will be 4 percent, that should give you an inflation-indexed annual cash flow of $160 732. (Note that this is one’s drawing from the fund, which is somewhat higher than $120 000 income from the fund, because it includes a depletion of capital.)

This $160 732 cash flow compares with the single age pension of $29 977.

For those whose memory of high school arithmetic is hazy, or who want to use their own assumptions, there is a linked spreadsheet with the annuity formula.

And remember that in retirement the income from your first $2 million is tax-free, and income from the next $1 million is taxed at only 15 percent. So someone with $3 million in superannuation invested at 4 percent would be paying only $6 000 income tax. Someone with an income of $120 000 earned through wage or salary employment, or who is living on investments outside superannuation, would be paying around $27 000 income tax.

Also remember that the government’s plan is to increase taxation only on income earned from balances above$3 million, and that the tax rate on that income will be 30 percent – the marginal rate paid by most taxpayers with incomes between $45 000 and $135 000.

So why the fuss?

Perhaps it’s because the extra tax would apply not only to the cash flow of investment income (dividends, net rent), but also to unrealized capital gains, which some wealthy account holders claim would result in cash-flow problems.

Ben Phillips and Richard Webster of ANU consider this claim in a paper High balance superannuation holders: a statistical overview. They find that only 87 000 individuals have more than $3 million in their superannuation accounts and that “high balance superannuation households have substantial wealth not only in superannuation but also other asset classes”, and should have plenty of liquidity to pay the extra tax. There is nothing unprecedented in taxing unrealized capital gains: that’s the basis for local government rates, paid by all householders, including those on very low incomes.

In any event, while it may make sense for people to hold illiquid, indivisible capital-appreciating assets in the accumulation phase of their superannuation (“investment” housing is the obvious example), such assets make no sense in the retirement phase.

That is, unless people are accumulating funds to amass financial wealth to be passed on as inheritances, or to help children into the property market, rather than to provide retirement income, which is the original purpose of providing tax breaks for superannuation.

In a short podcast – Superannuation has become a de facto tax dodge for the wealthy – Alan Kohler describes how in 2007 the Howard government changed superannuation regulations to allow the wealthy to accumulate financial fortunes. “[Chalmers]should make the tax system less of a subsidy for the children of the rich”, he says. Most countries have an inheritance tax, but as Kohler explains we actually subsidize inheritances with tax subsidies.

One of the silliest objections to the government’s reform is that in time, because of inflation, it will catch younger Australians.

Really? Let’s see how long it would take for a $100 000 superannuation balance – a little larger than the present median balance – to grow to $3 million as a result of 2.5 percent inflation. The answer is 137 year, over which period some government, possibly a Liberal Party government that has learned basic economics, might have shifted the thresholds. Richard Denniss of the Australia Institute dismisses the inflation issue and other claims about problems with the government’s superannuation tax changes in a 7-minute clip on ABC News.

Then we have the claim that the taxation of unrealized gains will capture superannuation investment in agricultural land. The GrainGrowers Association refers to  the problem in its comment on the tax:

For decades, growers have structured their approach to retirement by placing their land into superannuation accounts. According to the Superannuation Fund Association, there are around 17,000 super accounts holding farmland. Of those, 3500 have land valued at more than $3m, placing them directly in the crosshairs of this poorly considered proposal.

In that statement they expose how a number of prosperous farmers have misused superannuation – as a store of business wealth rather than as a vehicle to provide a cash flow in retirement. For retirement one is best served by divisible assets that can be slowly converted to cash, such as equities. A farm, by contrast, is an indivisible business with an ongoing life.

A basic principle applying to any business is that personal and business financial matters should be kept separate, which is why normal business practice is to keep a business such as a farm as a private company. In a private company physical assets are generally carried at original value: they are revalued only when there is a sale or some necessary capital restructuring. There is a problem of taxation of nominal capital gains whenever a long-life business is sold – a farm carried at book value for 50 or 100 years will show a huge nominal gain on sale – but that problem relates to the mess the Howard government made of the capital gains system in 1999 when it abolished the Hawke-Keating government’s indexation of capital gains. It has nothing to do with the present superannuation reforms.

Having polled Australians on their attitudes to the government’s changes, the Australia Institute finds that “despite ubiquitous media coverage of the wailings of the worried wealthy”, the changes are well-received by the public – the 99.5 percent of Australians who will never have $3 million in their superannuation accounts.

Perhaps the fuss is because wealthy Australians are worried that we might realise how rigged the system is in their favour, writes Greg Jericho in The Guardian. He explains how wealth inequality has risen so strongly this century – a rise that has been much steeper than income inequality.

In a 10-minute clip on The Business Robert Breunig of the ANU Tax and Transfer Policy Institute puts forward ideas for more just and efficient methods of taxing wealth, and says that Australia needs to stop treating rich retirees like they’re poor. “If Labor falters in getting this proposal through then we have no chance of future further tax reform”, he warns.

A broader context of these superannuation breaks is the general bias in our taxation system, which disproportionately collects tax from wage and salary earners, while lightly taxing those who live off capital income. On The Economy Stupid Peter Martin discusses with Dan Ziffer and Nassim Khadem the mechanisms the wealthy use to minimize their taxation: Won’t somebody think of the millionaires?. They cite data from the ATO’s recently-released 2022-23 Taxation Statistics, which reveal some of the extraordinary inequities in our tax system, including the fact that 91 individuals with incomes above $1 million paid no tax in that year.

On the same program Martin, Ziffer and Khadem go on to describe how many small businesses have been using workers’ superannuation entitlements as working capital and are outraged that the government is stamping down on this practice by requiring employers to pay superannuation at the same time as they pay wages (“payday super”), rather than accumulating a liability to pay. Ziffer is co-author of an ABC post pointing out that Australian workers lose more than $4.7 billion a year in unpaid super, and that the ATO does little to chase up non-payers. Most offenders are found in construction and hospitality industries. This softness on compliance seems to be yet another way governments coddle small businesses, at a cost to the public interest.)

There are two even broader contexts of these issues on tax and superannuation.

One is that while many welfare agencies and political commentators put great effort into the problems of income inequality, slowly accumulating wealth inequality is comparatively unnoticed, even though wealth disparities are greater than income disparities, are less responsive to immediate government policies, and are corrosive of support for our democratic system.

The other is that, as we are observing so starkly in the USA, the far-right is valorising oligarchy. It’s not a particularly left-wing idea to suggest that rewarding idle investment, and allowing monopolies to grow unchecked undermine the basic workings of market capitalism. But straight out of the blocks after his 175-vote win in Goldstein, the Liberal’s Tim Wilson has joined the chorus of the wailing wealthy to oppose the government’s superannuation tax reforms.

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Five years to build two bush huts: what hope for 1.2 million houses?

There is a way to meet the government’s housing goals. If they want to take it both the right and left need to re-frame their ideas.

In 2020 two bush huts in the ACT’s Namadgi National Park were destroyed in a bushfire. Unlike some structures in national parks which are seen as environmental blights, bush huts in the high country national parks are valued as part of the nation’s heritage, and they also serve as important emergency shelters. We might recall that earlier this year a hut in the Kosciusko National Park sheltered lost walker Hadi Nazari.

After the fires there was no question that the two huts in the ACT should be reconstructed, adhering as closely as possible to their original rude design.

Five years later, the huts still lie in ruins. Apart from site safety works immediately after the fires, no work has been done. The ACT government announced in 2023 that it was committed to their reconstruction, and produced attractive concept designs, but it has made no material progress on their reconstruction, because they have been in the process of undertaking heritage assessment, even though heritage experts see no problem in reconstruction going ahead.

There is no budgetary constraint. The cost of the materials is trivial. The labour to reconstruct bush huts is generally provided by volunteers, who themselves are obsessive about heritage values. Access is easy – one of the huts, Demandering, is on a fire trail just off a main road.

This is a story with many variants. It’s about years-long gaps between announcements and progress on roads and urban metro systems, about projects delayed by years of repeated consultations and legal challenges, about projects once started proceeding at a glacially slow pace.

Examples of project delays abound. Perhaps the standout is the Tullamarine to city rail line, first the subject of a government promise in 1970. In 2007 the Howard government announced that Canberra would be connected to the Hume Freeway with a proper link: so far only 10 km of the 35 km link has been built: the other 25 km are out in the never-never. In Canberra a 1.7 km extension to light rail has a five-year construction schedule – 340 meters a year.

These particular delays result in large part from responsibility-shifting in our three-layered federal system. But others result from NIMBY and similar movements, taking advantage of regulations that can be used to block projects, or to subject them to such delays that the proponents pull out. The most prominent examples are provided by anti-renewable energy lobbies who use environmental regulations to block wind and solar projects.

These cases are directly relevant to our need to construct 1.2 million houses in the next five years, where we see projects stymied by NIMBY objections and by powerful and privileged groups who dig in against governments trying to redevelop land for housing. The most recent example is the Australian Turf Club’s refusal to sell its urban race track to the New South Wales government to build 25 000 houses.

Libertarians on the right use cases such as these to bolster their call for deregulation. Authoritarians call for governments to get tough on groups blocking progress. Liberals and other progressives are left feeling powerless: they are all in favour of making housing more affordable, but they are also strong defenders of environmental and safety regulations, which are being turned against them.

Ezra Klein and Derek Thompson in their book Abundance – how we build a better future  acknowledge the problem, and illustrate it with many examples of stalled and abandoned projects.

Rather than proposing some compromise between the interests of the left and the right, they reframe the problem and its solution in terms of state capacity. It’s not about bigger government (the left’s traditional solution) or smaller government (the right’s approach), but effective government. It’s often about governments making better use of resources they already have, for example by drawing on the talent within the public service rather than employing expensive consultants, and delegating administrative decision-making and responsibility down the line to avoid the bottlenecks associated with hierarchical and risk-averse management. 

Klein and Thompson argue that policy and administrative reforms, promoted by well-meaning progressives over many years, have resulted in governments becoming process-oriented rather than outcome-oriented. Commenting on the US situation they say “We got so good at stopping projects that we forgot how to build things in America”.

They cite numerous examples of terminally stalled projects, including many to do with housing. In states with liberal governments, such as California, regulatory requirements have made it so difficult to build new houses that supply has fallen way behind demand, increasing prices and worsening homelessness. By contrast in states such as Texas, under successive Republican governments housing is far more affordable.

The parallels with Australia are clear.

Their work may have passed largely unnoticed, dismissed by the left as another push for deregulation, and by the right as another justification for government. As they point out, the right’s only interest is in small government, not in good government.

But they have gripped the imagination of at least two of our ministers. Assistant Minister for Productivity, Competition, Charities and Treasury Andrew Leigh has written a positive review of their work on his website, and has drawn on it in an address to the Chifley Research Centre – The abundance agenda for Australia. Treasurer Chalmers says that he has read the book and called it a “ripper”.

When busy ministers take time  to read books and write reviews, it says something about the ideas that are influencing our policymakers. Public servants make sure that they read what their ministers are reading. In fact Abundance makes reference to the work of Mancur Olson, whose 1982 work The rise and decline of nationswas influential in shaping the ideas of the Hawke-Keating government. Olson’s contribution was to point out that in established “developed” countries coalitions of interest groups are able to come together to protect their interests by using their political power to block economic reform. He attributed the postwar rise of Japan to the fact that economically the country was starting over again, in a new system in which the traditional interest groups did not have a foothold. That’s now history, but it’s the absence of blocking coalitions that helps explain China’s extraordinary success in building infrastructure so quickly.

Abundance has many contributions around housing, urban, and energy policies. But its unifying theme is around the need for governments to develop state capacity. That is, the demonstrated ability to do stuff that people want, and that the private sector cannot do or cannot do so well.

So far in Australia we haven’t heard much about the idea of “state capacity”. It’s clearest articulation is by the Niskanen Center, a group who describe their economic philosophy as “guided by the belief that a free market and an effective government are mutually dependent”.

That’s about as economically orthodox as you can get, but the idea of state capacity has not been taken up by the Liberal Party who for the last 30 years have been contemptuous of government and who see the idea of effective government as an oxymoron, because government is simply a big unproductive economic overhead.

But the idea of state capacity should be attractive to a newly re-elected social democratic government. Also Klein and Thompson’s optimistic cover of renewable energy is surely attractive to a party that has been through almost twenty years of climate wars. They point out that the abundance of low-cost renewable energy will do so much to improve people’s material standards that it will transform the political and economic landscape, in ways similar to America’s New Deal or our own postwar reconstruction.

John Hawkins of the University of Canberra has a summary of Abundance on The Conversation: Can a book help the left rebuild the good life? Ezra Klein’s Abundance is the talk of Washington – and Canberra. Or even better, buy it: it’s well-written and short enough for busy ministers to read.

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How the Reserve Bank gets it wrong

The Reserve Bank does a poor job at setting real interest rates

The Reserve Bank’s decision to keep interest rates on hold took almost every economist – and 27 million other Australians – by surprise. Its statement explaining the Board’s decision to leave the cash rate at 3.85 percent offers no compelling reason for its hesitancy. Its main theme is that the economic outlook is uncertain, but can anyone name a period in their lifetime when the economic outlook wasn’t uncertain?

Peter Martin has devoted the main part of The Economy Stupid to the Bank’s decision, in a discussion with Nicki Hutley and Michael Pascoe. The session is titled A divided RBA, in recognition that the decision was a majority (6:3) rather than a consensus one, as had been the usual pattern before recent changes in the RBA governance.

Emerging from that discussion are three possible explanations for its caution.

One is that the Board is not sure that inflation by its preferred measure – movement in the underlying CPI over twelve months as indicated by the “trimmed mean” – is firmly in its target range of two to three percent. The trimmed mean for the year to the March quarter was 2.9 percent, and as measured by the monthly indicator to May was 2.4 percent. Neither the RBA nor the government explains the use of twelve-month lagging figures to estimate what inflation is now, rather than the use of the CPI movement in the latest quarter or month brought to an annualized figure. If the cops pull me over for speeding the relevant measure is my speed as I just passed through the radar: offering as a defence my average speed over the last 12 km isn’t going to stand up in court.

The Board has said that it will wait for the June quarter CPI, due out on July 30, in time for its August 11-12 meeting. Anyone who has worked in the public service has experienced the procrastinating “let’s wait until we have another month’s data” syndrome. Nothing happens until it has to happen, and then it’s too abrupt.

The second possible explanation is stated in its press release, which remarks that “labour market conditions remain tight”. The Board seems to be concerned that workers are too secure in their jobs: it seems that they would be more comfortable if workers felt a little less secure, more subservient to their bosses, and less inclined to seek pay rises which Board members believe would be inflationary.

This is twisted thinking, inferring that the public purpose is served better when workers are insecure and anxious. It is also lousy economics, because in a so-called “tight” labour market employers have to compete for workers, and those employers who offer higher wages will usually be those whose businesses are able to use labour more productively. That’s not inflationary.

The third possible explanation is that the Board, now that it is formally constituted as a board of “experts”, just wanted to demonstrate its independence.

Those are criticisms of the Bank’s most recent decision. Luci Ellis, formerly the RBA’s assistant governor and now Westpac’s chief economist, suggests that the RBA has consistently been too cautious with its interest-rate decisions.

It’s hard to verify that claim, but it does appear that the RBA has been slow to act in response to changes in the CPI.

A starting point for such consideration is to look at the cash rate since 2002.[1] Its responses to two shocks – the global financial crisis and the pandemic are clearly revealed.

This is a plot of the nominal interest rate. The real interest rate, which indicates the return to investment, or the cost of borrowing, takes inflation into account. In terms simple enough for this illustration, the real rate is the nominal rate minus inflation.[2]

The following graph repeats the graph above, with the addition of CPI inflation (red line), and the resulting calculation of the real interest rate (green line).

In the best of all worlds, where the central bank has perfect foresight, that green line would be fairly flat, somewhere in mildly positive territory – around one percent according to recent RBA suggestions, although it would have been higher in times past.

The most obvious revelation from this graph is that the RBA has had a tough time getting it right, particularly around the times of the global financial crisis and the pandemic. It is also notable that around 2016 it started to reduce interest rates even though inflation wasn’t falling, and that it allowed real interest rates to fall into negative territory most of the time until 2024.

The RBA had its reasons at the time: it was trying to stimulate an economy in the doldrums. But that period of negative cash rates, which translated into very low housing loan rates, probably encouraged many people to borrow beyond what would be reasonable amounts if real interest rates had been closer to their historical level.

People are inclined to blame the RBA for mortgage stress brought on by its recent and rapid rate rises – an accusation with some validity because of the way it raised the expectation that rates would be held low. But at least some of the resulting mortgage pain, as it applies to those who took out loans between 2016 and 2019, is surely due to its failure to raise rates in the period leading up to the pandemic. It appears from the graph that it is now erring in the opposite direction, but both errors seem to have their root in the RBA’s reluctance to move until there is overwhelming pressure, which means its belated movements are necessarily very sharp.

Its single big lever is a strong one, but it is slow to take effect. As any engineer knows a system with high gain and slow response (think aircraft carriers) is prone to instability unless it is managed very carefully. Has the discipline of economics incorporated the practical theories of control system design?

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1. I have chosen this date because it is clear of the disruption to the measured CPI associated with the introduction of the GST in 2000. ↩

2. Strictly it is the nominal rate minus expected inflation, and the RBA is theoretically guided by its expectations of inflation. But all we have to go on is what inflation actually was, subject to that measurement lag. Also the equation is not a simple arithmetical subtraction: rather it takes into account the cross-product of inflation and interest rate. The graph uses this proper method, but a simple subtraction does not produce significantly different numbers when inflation is within reasonable bounds. ↩

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An inconvenient truth exposed

It’s official – we’re not paying enough tax

Writing in Substack Gulsun Uluer explains the Papua New Guinea word “Mokita”, the truth everyone know but dares not utter.

That is, until someone accidentally, or perhaps even deliberately breaks the taboo.

Was it really accidental that Treasury was less than diligent in redacting a response to Daniel Ziffer’s FOI request for access to the incoming government’s brief?

In that document is our Mokita revealed: “Tax should be raised as part of broader tax reform”.

The graph below is the latest update of one regularly included in these roundups – Australia’s taxes in comparison with other high-income “developed” OECD countries.

Among those countries – countries with per-capita GDP > $US60 000 – we’re not the lowest taxed, but two of the three countries below us, Ireland and Switzerland, are tax havens, and the third, the USA, runs a fiscal deficit of six percent of GDP. If the USA had our more modest fiscal deficit – around one percent of GDP – without any contraction in expenditure its taxes would be higher than ours.

We don’t know what followed in the redacted text explaining Treasury’s support for higher taxes, but it’s a fair bet it included most of the following five reasons:

1. The need to close what they call the “structural deficit”, which some refer to as “budget repair”. The standard economic theory is that over a business cycle taxes and outlays for recurrent purposes should balance.
2. Because our population is ageing, outlays for health care, disability care and government pensions will rise faster than offsetting savings in education and child care. This is regularly covered in Treasury’s Intergenerational Reports.
3. The (supposed) need to increase defence spending.
4. The intrinsically labour-intensive nature of government services. Government services in health care, disability care, teaching, and policing are necessarily labour-intensive, and do not enjoy the same productivity improvements as in private sector activities. Therefore to maintain a level of government services spending has to rise as a proportion of GDP.
5. The need to reverse unwise and costly privatizations. Successive governments gripped by a “small government” obsession have called on the private sector to do many things that can be done at lower cost and with more efficient resource allocation through public funding and provision. Toll roads, private health insurance, and privatized electricity transmission are the most prominent examples of high-cost privatizations.

We know, from regular Per Capita tax surveys, that most people believe Australia is a high-tax country. There are many possible reasons for this false belief. We talk more about the “tax burden” rather than “public value”. We are subject to an unending stream of right-wing “small-government” propaganda. Most of us have little exposure to the highest-cost government services – care for the very ill and disabled, criminal justice, defence. If we are to make progress on tax reform we need a better public understanding of public finance.

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How the pub test has delivered bad economic policy

The case for strengthening government capacity to shape sound public policy

Is this where economic policy should be made?(Junction Hotel, Canowindra)

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“At some point this century, reasoned and disciplined policy making was replaced by complacency and a celebration of ‘common sense’”.

That’s a quote from Ken Henry’s Stan Kelly Lecture, delivered in May for the Economic Society, for which he has given permission to put on my website.

That celebration of common sense has led to the “pub test” to replace evidence-based advice of professional economists as the criterion for setting good economic policy. As he describes in detail, the “pub test” has delivered bad economic policy, which is why his lecture is titled “The role of the economist in securing the nation’s future”.

On reading that title one may believe that Henry is about to embark on a defence of the neoliberal policies that have dominated economic policy in the Anglosphere over the last 40 years. That’s far from Henry’s message, however: using quite orthodox economic logic, he points out the shortcomings of neoliberalism. Our embrace of neoliberalism has led to destruction of our natural habitat, the scarcest of all resources, in order to achieve short-term gains in our export income. It has led to “repeal of the world’s best climate policy”. It has led to poor outcomes in education, health, aged care and disability support. And in privileging the owners of capital over other Australians, it has led to inequalities in income, wealth and opportunity that threaten the durability of our capitalist democracy.

He points out that our dependence on exporting mineral commodities to an industrializing China has led to “slow, labour-intensive growth; low unemployment; low productivity; and low average real wages growth”. That’s just what orthodox economic theory predicted would result from our mercantilist policies – policies that passed the pub test and rewarded governments with successive re-election.

We need a set of structural reforms that will boost productivity. Unsurprisingly much of his message is about reforming our tax system to encourage more capital-intensive production. There is no future in an economy built on low-capital labour-intensive activities, relying on the occasional commodity boom to boost incomes. He mentions many areas for tax reform, going beyond his 2010 recommendations, the need for reform having grown more pressing over the last 15 years.

Scrutinizing policies by subjecting them to the pub test won’t deliver reform. He concludes by reminding us that the concentration of economic policy expertise must reside in the public service.

… that is why it is ironic to see politicians, from time to time, seeking to claim policy credibility by promising to cut public service jobs, other than those in ‘front line’ service roles of course. It is even more ironic to see those same politicians telling the denuded ranks of the public service that their responsibility is merely to implement policies conceived by politicians, most of whom have very little understanding of economics.

In a well-functioning democracy, citizens will have a reasonable expectation that their elected representatives invest in maintaining a set of professional, non-partisan, advisers who are not only technical experts, but who have a deep understanding of, and commitment to, the development of high-quality public policy.

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