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The new tax expenditure and insight statement and Labor’s proposal to put higher taxes on superannuation funds with more than $3 million of assets is sending people into a tizz.

It is also leading people to ask a lot of questions. This is good, but it is important to focus on the right questions.

Some questions are misleading. One is: “Is it unfair that rich people get most of the tax concessions from superannuation?” This is akin to asking whether it is unfair that people at the bottom of the income distribution get most of the payments from JobSeeker.

A better question might be: “Are people at the top of the income distribution paying their fair share of tax?” (The answer to that one is probably yes – the top 3.6 per cent of taxpayers pay 31 per cent of the tax and the top 10 per cent pay 50 per cent of the tax.)

Another question has concerned the effective tax rates on super. Some argue they are lower than they appear on paper because of franking credits; others argue they are much higher because even low tax rates accumulate to very large tax rates when assets are held over long periods.

It is obvious that superannuation is highly desirable in tax terms. That is why people put so much money into it. As the tax expenditure statement shows, the largest contributions into superannuation happen later in life, so the argument about tax rates accumulating over long periods would seem less salient.

But this question also sends us down a potentially misleading path. Maybe a lot of money flows into superannuation not because it is taxed too lightly but because other things are taxed too heavily?

So, let’s focus on the actual problems and the right questions.

Too much ad hoc tinkering

The first problem, as clearly shown in the statement, is that some income items have very large tax concessions and others have small ones. This raises a question: “Why are we taxing different savings vehicles so differently?” A lot of literature shows that people respond strongly to differential tax rates on savings. This is bad for the economy as people are investing not based on economic return, but rather on tax rates.

The second question is: “At what rate should we be taxing superannuation and savings more generally?”

The solution to these questions is not more ad hoc tinkering. Here’s why. Every time we change one element in the tax system, we create additional complexity. Additional complexity means additional tax planning opportunities.

If you make superannuation tax concessions less generous, what will happen? First, money will stop flowing into superannuation. Second, money will flow in greater quantities to more tax-preferred alternatives. Third, more money will flow into trust structures with their ability to deliver pretty much any tax rate a trust owner might want.

Other things that I can’t even imagine will happen. Small business structures with their 25 per cent tax rate might present new possibilities.

Tax thinking over the past 40 years has moved towards a view that income from savings should be taxed at a lower rate than income from earnings. There are three reasons for that: the income is already taxed once, when it is earned; the desirability of encouraging savings; the aforementioned problem of tax rates which compound over time when an asset is held for a very long time. If held long enough, the tax rate becomes 100 per cent. It works like compound interest, but in reverse.

Two simple steps

Superannuation tax concessions, concessions for capital gains and the generous treatment of owner-occupied housing all reflect a desire to tax savings at a lower rate than earned income.

In this sense, the benchmarks in the tax expenditure statement are misleading. You would not want to tax all elements of superannuation at an individual’s marginal tax rate. This would lead to strong political opposition to the entire system and is not desirable from a tax system design perspective.

The solution is deceptively simple and involves two elements.

  1. A flat, low-rate tax on all forms of savings. This would include superannuation in both the accumulation and retirement phases and owner-occupied housing. A tax on all savings (except housing) in the range of 10 to 15 per cent and a 0.1 per cent tax on all land would solve the problem and be revenue enhancing.
  2. A small concession for superannuation contributions. Optimally, this would be a concession linked to age. The concession for contributions could be fully refundable and set at 30 per cent for a 20-year-old, 17.5 per cent for a 40-year-old and 5 per cent for a 60-year-old.

This is feasible. All sides of politics should be able to get on board with this. It would remove many of the existing problems with trusts and with the debate around franking credits. It would be Australian policy innovation at its best and, like our superannuation and health systems, would give us a claim to world’s best practice.


First published at the Australian Financial Review on Thursday 2 March 2023.

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