Tag: Grattan Institute

‘Retrospective’ claims on super changes are a furphy

From The Conversation.

In his budget reply speech this week, Opposition leader Bill Shorten said Labor had “very grave concerns about retrospective changes” to superannuation being proposed by the government. The superannuation industry has been even more vociferous. But labelling the changes as “retrospective” in this case is a furphy.

For a decade, some older savers have benefited from superannuation tax breaks that did little to help younger generations. Understandably, they want to keep receiving these benefits. But they are wrong to claim the government’s proposed superannuation changes are retrospective simply because they adversely affect the future returns on their savings.

“Retrospectivity”, a legal concept, applies if government changes the legal consequences of things that happened in the past.

The Commonwealth government proposes two changes to superannuation rules in the 2016 budget. First, funds in excess of A$1.6 million in pension phase (when the fund holder pays no tax on earnings) will have to be moved into a separate account that pays 15% tax on earnings. In effect, retirees will pay no tax on the earnings of assets up to $1.6 million, and 15% tax on earnings after that.

Second, the budget proposes a new lifetime limit of A$500,000 on post-tax contributions to super. This includes any contributions made between 2007 (when reliable records begin) and budget night. If someone has already contributed more than this, there will be no penalty, but they will not be able to contribute any more from their post tax income.

The rationale for both changes is that they align superannuation more closely with its purpose of supplementing or replacing the Age Pension. A person with $1.6 million in a superannuation account, or a person contributing more than half a million from post tax income (in addition to pre-tax contributions), is going to be well over the asset limit for a part Age Pension ($805,000 for a couple home-owner).

The objection is that these changes retrospectively affect superannuation investments made in the past. But lots of changes affect investments made in the past, and no-one suggests they are retrospective. If I bought shares in a company yesterday, I expect that the future earnings on these assets will be subject to my marginal income tax rate. But if my income tax rates change, I would not expect that the old tax rate to be grandfathered to apply to all my future earnings.

This is the appropriate analogy for proposed changes to the earnings of superannuation accounts in excess of $1.6 million. The mere fact that no tax was paid on earnings in the past does not imply that earnings in the future are entitled to be tax free.

The retrospectivity argument is even weaker for the new cap on post-tax contributions. The only constraint is on additional contributions in the future. True, this is based on the amount that has already been contributed, but no adverse consequence flows from historic contributions; the change merely limits future contributions. To draw another analogy, it is not retrospective to change the asset test for the Age Pension merely because assets accumulated in the past are now taken into account for assessing future Age Pension payments.

Alternatively, we can analyse this problem using ethical concepts that are reflected in the legal doctrine of “estoppel”. This applies if a person reasonably relies on a promise of another party, and because of that reliance is injured or damaged.

The proposed changes do not fall foul of this doctrine.

Those who were induced to put more money into super would be a long way in front even if they had paid 15% tax on all earnings in retirement. Most contributions to superannuation are made from pre-tax earnings, and only taxed at 15%. Even those on very high incomes who pay tax of 30% on their contributions are still getting a discount of more than 15 per cent compared to post-tax savings. Once in the super fund, the earnings on those contributions are only taxed at 15% rather than at marginal income tax rates. The only people who could possibly have lost money contributing more to superannuation are those with taxable incomes less than A$19,000 a year – below the income tax-free threshold. If any of them have accumulated more than $1.6 million in superannuation, the ATO should probably be asking them some questions.

Superannuation tax concessions have been absurdly generous to older people on high incomes for over a decade. They have not served the purposes of the system. They are one of the major reasons why households over the age of 65 (unlike households aged between 25 and 64) are paying less income tax in real terms today than they did 20 years ago, even though their workforce participation rates and real wages have jumped. Misguided claims about retrospectivity should not be used as cover so that this older generation continues to gain unjustifiable benefits that will now be denied to younger generations.

Author: John Daley , Chief Executive Officer, Grattan Institute

Grattan Institute Defends Negative Gearing Reform

Long overdue changes to negative gearing and capital gains tax would save the Commonwealth Government about $5.3 billion a year, according to a new Grattan Institute report.

Hot property: negative gearing and capital gains tax reform shows that the interaction of a fifty per cent capital gains tax discount with negative gearing distorts investment decisions, makes housing markets more volatile and reduces home ownership.

The two measures in combination allow investors to reduce and defer personal income tax, at an annual cost of $11.7 billion to the public purse. Other taxes, which often drag more on the economy than a capital gains tax does, must be higher as a result.

And like most tax concessions, these tax breaks largely benefit the wealthy.

Gtattan-NegativeThe report recommends that the capital gains tax discount should be reduced from 50 to 25 per cent, and that negatively geared investors should no longer be allowed to deduct losses on their investments from labour income.

A smaller discount would save about $3.7 billion a year, while the change to negative gearing would raise $2 billion a year in the short term, falling to $1.6 billion as losses start to be written off against positive investment income.

The reforms would provide relief to the Budget in tough times and slightly improve housing affordability with little impact on how much people save, says Grattan CEO and report co-author John Daley.

‘We estimate property prices would be up to two per cent lower under these reforms than they would be otherwise,’ Mr Daley says.

‘Contrary to urban myth, rents won’t change much, nor will housing markets collapse. The effects on property prices would be small compared to factors such as interest rates and the supply of land.’

The report recommends phasing in the reforms, to make them easier to sell and to prevent a rush of investors selling property before the changes come into force.

While other proposals, such as restricting negative gearing to new properties or limiting the dollar value of deductions, would improve the current regime, they nevertheless leave too many problems in place and introduce unnecessary distortions.

‘These two sensible reforms won’t hurt private savings much but will save the government a lot of money,’ Mr Daley says.

Read the report

Why Australian governments should embrace the growing peer-to-peer economy

The rise of the sharing economy can save Australians more than $500 million on taxi bills, help them to put underused property and other assets to work, and increase employment and income for people on the fringe of the job market, according to a new Grattan Institute report.

Peer-to-peer pressure: policy for the sharing economy shows that the prize for getting this new online economy right is large and governments should not try to slow its growth in order to protect vested interests.

Peer-to-peer platforms such as Airbnb and Uber use online technology to help strangers interact and do business. Platforms host markets in accommodation, travel, art, finance and labour, among other fields.

Grattan Productivity Growth Program Director Jim Minifie says that while the private sector will drive the peer-to-peer economy, government has an important role to play in supporting its growth while reducing any downsides.

‘Some say peer-to-peer platforms bring hidden costs by risking work standards, consumer safety and local amenity, and by potentially eroding the tax base,’ Dr Minifie says.

‘These worries are not groundless but they should not be used as excuses to retain policies, such as taxi regulation, that were designed for another era and no longer fit.’

The report calls on state and territory governments to follow the lead of New South Wales, the Australian Capital Territory and others, and legalise ride-sharing services such as Uber.

In peer-to-peer accommodation, the report urges local councils to allow short-stay rentals run by platforms such as Airbnb, but recommends that state governments give owners’ corporations more power to limit disruptions caused by short-stay letting.

Tens of thousands of Australians are already working on peer-to-peer platforms. These platforms will mostly improve an already flexible labour market, but governments must strengthen rules to prevent employers misclassifying workers as contractors, and bring some platform workers into workers’ compensation schemes.

Tax rules must be tightened to ensure that platforms based overseas pay enough tax.

‘Not all traditional industries are happy with the rise of the peer-to-peer economy, but if governments act fast, consumers, workers and even the taxpayer can come out ahead,’ Dr Minifie says.

‘Catch up’ super contributions: a tax break for rich (old men)

From The Conversation.

It’s no secret that our superannuation system is unfair. Over half the value of the tax breaks goes to the top 20% of income earners, people who already have enough resources to fund their own retirement.

As shown in our new report for Grattan Institute, Super tax targeting, the system provides overly generous opportunities to contribute to super. These opportunities are usually defended on the grounds that people with broken work histories, especially women returning to work, can “catch up” before retirement. Super lobby groups make a lot of noise about middle-income people scrambling to build a decent nest egg for retirement, and our super system bends over backwards to help them.

But it’s hard to find many middle-income earners in real life who make large voluntary contributions to super. Instead the system mainly creates large tax-planning opportunities for many more people who already have enough resources to fund their own retirement. The plight of catch-up contributors is the tail that wags the super dog.

Author provided

Superannuation tax breaks allow people to pay less tax on their super savings than is paid on other forms of income. Annual caps on super contributions act as a brake on the system’s generosity, and its cost. If set at the right levels, these caps prevent high-income earners from abusing generous super tax breaks to lower their tax bills.

Yet Australia permits larger voluntary contributions to superannuation than many other countries. The flat 15% tax rate is applied to contributions made from pre-tax income – delivering enormous tax breaks to high-income earners on high marginal rates of income tax. Even where superannuation contributions are made from post-tax income, savers then benefit from generous tax breaks on super fund earnings, only taxed at 15%, or zero in retirement.

Catch-up contributors are a myth

All the evidence shows that very few middle-income earners, and even fewer women, make large catch-up contributions to their super funds. Only 12% of taxpayers, or about 1.6 million people, make large pre-tax contributions of more than $10,000 a year, and that includes compulsory super paid by their employer. Just 164,000 women earning less than $77,000 make such large pre-tax contributions. However 935,000 men earning more than $77,000 do so. These high-income savers get a tax break on the way in, and then pay little or no tax on their super earnings.

Author provided

Why do so few middle-income earners make large catch-up contributions? Put simply, they can’t afford to. In 2012-13, the median taxable income in Australia was $41,561. Gross incomes (before any deductions) are not much higher. More saving boosts incomes in retirement, but it reduces living standards today. This fundamental trade-off is rarely discussed in the superannuation debate.

Benefits flow to high-income earners

Not surprisingly it is mainly high-income earners who have the disposable income to put more than $10,000 a year into their super. They get large tax breaks, even though they are likely to retire with enough assets to be ineligible for an Age Pension.

The cap on post-tax contributions is even more generous. It allows people to contribute up to $180,000 per year. People under age 65 can also bring forward an extra two years’ contributions, so they can put in up to $540,000 during a single year, and that’s on top of up to $35,000 in contributions from pre-tax income.

These post-tax contributions total $33 billion a year – about three times the size of voluntary pre-tax contributions. Many post-tax super contributions appear to represent tax-planning rather than any genuine increase in retirement savings. Of all post-tax contributions, around half are made by just 200,000 people who already have at least $500,000 in their superannuation. Only 1.2% of taxpayers have total super account balances of more than $1 million, yet this tiny cohort accounts for 26% of all post-tax contributions. By contrast, the 70% of taxpayers with super balances of less than $100,000 make just 9 per cent of total post-tax contributions.

Author provided

Lifetime caps would likely make things worse, unless set at very low levels. To maximise their superannuation tax breaks, taxpayers who have not used up their lifetime pre-tax cap could sacrifice the entirety of their earnings into super. Such tax planning is likely given how super tax breaks are used already.

Counting the cost

Whatever the benefits of superannuation tax breaks, they must be balanced against the costs. Superannuation tax breaks cost a lot – over $25 billion in foregone revenue, or well over 10% of income tax collections – and the cost is growing fast. Lower-income earners and younger people have to pay more in other taxes – both now and in the future – to pay for the tax-free status of so many retirees.

The way forward

Caps on super contributions need to strike a better balance between allowing those with broken work histories to contribute towards a reasonable superannuation balance, and restricting the opportunities for tax minimisation by those unlikely to qualify for an Age Pension. That means being realistic about the level of catch-up contributions that are likely from those who are genuinely making up for broken work histories.

Grattan Institute’s new report, Super tax targeting, recommends three reforms to better align tax breaks with the goals of superannuation.

One, annual contributions from pre-tax income should be limited to $11,000 a year. This change would improve budget balances by $3.9 billion a year. There would be little increase in future Age Pension payments since the reductions in tax breaks would mainly affect those unlikely to receive an Age Pension anyway.

Two, lifetime contributions from post-tax income should be limited to $250,000. It won’t save the budget much in the short term, but in the longer term it will plug a large hole in the income tax system.

Three, earnings in retirement – currently untaxed – should be taxed at 15%, the same as superannuation earnings before retirement. A 15% tax on all super earnings would improve budget balances by $2.7 billion a year today, and much more in future.

Previous repeated changes to superannuation have been too timid. Decisive reforms must target super tax breaks at those who need them most, and limit the benefits for those who don’t need them. Until then the system will keep chasing its own tail.

Authors: John Daley, Chief Executive Officer , Grattan Institute; Brendan Coate, Senior Associate, Grattan Institute.

 

The Grattan Institute On Negative Gearing

Last weekend the Property Council and the Real Estate Institute of Australia released a consultants’ report that tried to show renters would pay much more if generous tax concessions to landlords were wound back. So interesting to read an article by John Daley and Danielle Wood published by The Australian, Friday 3 July, and posted on the Institute website entitled “Rent rise fears are overstated”

With increasing public scrutiny of negative gearing and the capital gains tax discount at a time of rising budget pressures, the industry’s response was textbook: release an “independent” economic report alluding to frightening economic impacts and wait for an unquestioning media to breathlessly report them. As spooked tenants were rolled out lamenting hypothetical rent rises of $10,000 a year, no doubt the big developers congratulated themselves on a job well done.

But these misleading claims shouldn’t go untested. The report does not support the headline-grabbing $10,000-a-year rent rises. Rather, it suggests the immediate removal of negative gearing is likely to result in a portion of the average $9500 net rental loss being added to rental prices — without any attempt to define how large that impact may be.

The report’s use of the $9500 figure is highly misleading. This amount is the average loss deducted from tax for people with negatively geared investment properties. The report assumes these landlords will try to pass on some fraction of their higher tax costs by pushing up rents. But will they succeed? Many other landlords with investment properties that are profitable and therefore don’t qualify for negative gearing won’t be paying higher taxes. Tenants will try to beat rent rises by threatening to move. So competition in rental markets will limit material rent rises.

In any case, current rents are ultimately a consequence of the balance between demand and supply for rental housing. In property markets — as in other markets — returns determine asset prices, not the other way around. Rents don’t increase just to ensure that buyers of assets get their money back.

Some investors may sell their properties if tax concessions are less generous. This may reduce house prices, but it will not increase rents. Every time an investor sells a property, a current renter buys it, so there is one less rental property and one less renter, and no change to the balance between supply and demand of rental properties.

Claims that removing negative gearing will push up rents often rest on a folk memory of increasing rents in Sydney between 1985 and 1987. But as proper examination of that history shows, real rents didn’t increase in Melbourne, Brisbane and Adelaide. Other factors drove the Sydney rent rise.

The industry report argues negative gearing boosts the supply of new rental properties. But 93 per cent of all investment property lending is for existing dwellings. As the report itself points out, the main constraint on the supply of new housing is land release and zoning restrictions, not the profitability of developments. Providing tax concessions in this supply-constrained environment mainly just bids up prices for the limited new supply.

The other argument the industry advances is that “ordinary Australians” use negative gearing. Once again the numbers it uses are highly misleading. Its report shows that those with taxable incomes under $80,000 claim most tax benefits from negative gearing for property — 58 per cent of the rental losses. But people who are negatively gearing have lower taxable incomes because they are negatively gearing. Correcting for this by assessing income before rental loss deductions shows that less than one-third of rental losses are claimed by people with incomes below $80,000.

In other words, taxpayers with incomes more than $80,000 — the top 20 per cent of income earners — claim almost 70 per cent of the tax benefits of negative gearing. For capital gains, taxpayers with incomes of more than $80,000 capture 75 per cent of the gains. If we are trying to look after middle-income earners, then general changes to income tax rates would be fairer than allowing negative gearing for a small proportion of middle-income earners.

So why are the Property Council and the Real Estate Institute making such claims? Presumably because reforms would reduce the price of assets held by their members. They have a strong incentive to obscure how these tax benefits impose costs on other taxpayers, push home ownership further out of reach for young people and distort investment decisions.

Australia is one of few developed nations to allow full deductibility of losses against wage income. As other countries realise, negative gearing distorts investment decisions by allowing investors to write off losses at their marginal tax rate but pay tax on their capital gains at only half this rate. Investors who hold off selling until they are retired pay even less tax on their capital gains. As a result, investors favour assets that pay more in the way of capital gains and less in terms of steady income. It also makes debt financing of investment more attractive. It all leads to the leveraged and speculative investment of the Sydney property boom.

As well as restricting the deduction of investment losses against wage and salary income, the capital gains tax discount should also be reduced. The industry report argues capital gains should receive a discounted tax treatment to ensure the inflation component of gains is not taxed. But with inflation rates low relative to investment returns, the 50 per cent discount overcompensates most investors. The discount magnifies the tax advantages of capital gains over other investment income.

Yet despite the compelling arguments for change, it seems the industry’s aggressive lobbying efforts will be rewarded. The Treasurer and the Finance Minister have both defended negative gearing arrangements by warning, against all credible evidence, that change would bring higher rents. The message to lobby groups is clear: if you pay enough to “independent” consultants you may be able to buy favourable policy outcomes, irrespective of the costs to the community.

High Super Fees Erode Returns By 5% – Grattan Institute

The latest report from the Grattan Institute – an independent think tank dedicated to developing high quality public policy for Australia’s future – is on superannuation. It reconfirms fees are too high, savers are getting lower returns than they should, and further reforms are needed urgently. We concur. You can read DFA analysis on super here.  As the balances on super accounts grow ever bigger, the imperative for significant reform builds.

Grattan Institute’s 2014 report, Super Sting, found that Australians are paying far too much for superannuation. We pay about $21 billion a year in fees. That report proposed that government reduce fees by running a tender to select funds to operate the default accounts used by most working Australians.

The Murray Financial System Inquiry came to similar conclusions to those in Super Sting. Its 2014 report finds there is not strong competition based on fees in the superannuation sector. It recommends a “competitive mechanism”, or tender, to select default products, unless a review held by 2020 shows the sector has become much more efficient.

This report analyses superannuation fees and costs in depth. It shows that there are excess costs in both administration and investment management. It evaluates recent policy initiatives to lower fees and recommends further reforms. Our new analysis confirms the conclusions of our previous report. In both default and choice funds, administration fees are too high, and take a toll on net returns. There is little evidence that funds that charge higher fees provide better member services. There are too many accounts, too many funds, and too many of them incur high administrative costs. We pay $4 billion a year above what would be charged by lean funds. Investment fees are also too high. Many funds do not deliver returns that justify their fees. Cutting fees to what high-performing, lean funds charge could save more than $2 billion a year. In sum, superannuation could be run for much less than the $16 billion currently charged by large funds (self-managed super costs another $5 billion).

The superannuation industry argues that its $21 billion costs are not excessive, and will fall over time. It opposes a tender for default accounts based on fees, claiming that it would reduce investment quality and net returns. But current initiatives to reduce costs are not enough. The Stronger Super reforms to reduce administration costs and make default products transparent will cut total default fees by about $1 billion. The Future of Financial Advice reforms could yield benefits for choice account holders. But even if regulators pursue these initiatives with zeal, they will leave billions on the table. If remaining excess costs are not removed, they will drain well over 5 per cent – or $40,000 – out of the average default account holder’s fund by retirement. Excess costs in choice superannuation are even larger.

Government must act to close accounts, merge funds and run a tender to select default products. The tender would save account holders a further $1 billion a year, and create a benchmark to force other funds to lift their game. A high performing superannuation system will take the pressure off taxpayers and give Australians greater confidence in their retirement.