Even if flaws in the retirement support system are addressed, there would still be a good case for an inheritance tax on the largest transfers.
It has long been recognised that wealth inequality is much greater than income inequality. Furthermore, wealth inequality is increasing more rapidly.
What is perhaps less widely recognised is how much the inequality in the distribution of wealth is correlated with age.
As a recent study by the Productivity Commission found:
“The wealth of the average older Australian has grown remarkably since the turn of the century. It has been buoyed by strong real growth in house prices and almost three decades of growth in superannuation balances, alongside low rates of asset drawdown to fund retirement.”
Thus, between 2002 and 2018 the real wealth of the average baby-boomer born in the 1950s more than doubled from around $400,000 to $1,000,000. Today the real wealth of a baby-boomer now in their sixties is on average almost twice that of the previous generation when they retired 20 years earlier.
One consequence of this rapid increase in wealth is that the Productivity Commission found that: “Wealth transfers are large and growing — over $120 billion was passed in 2018, more than double in 2002.” And just over $100 billion in 2018 was in the form of inheritances passed on following death.
A common justification for inheritances is that parents want to help their children, and these days with the rising cost of housing, homeownership is becoming very difficult for many young people without parental help. But the reality is that inheritance recipients are typically middle-aged or older, with a median age of a little over 50. So, the likelihood is that most inheritors are already homeowners by the time they receive an inheritance, and they then have much less need for the money.
Many, including me, will consider that these (unearned) wealth transfers are essentially unfair, and will accordingly favour the restoration of death duties. However, before considering that issue, the efficiency of the retirement income system first needs to be assessed, as it is the present inefficiency that helps to make such large wealth transfers possible in the first place.
The retirement income system
It is not surprising that older people are wealthier than young people. Older people try to accumulate wealth through their working lives to help support them in their retirement.
But the data show that in fact the wealth of retirees typically continues to increase after they retire. In other words, they are not drawing down on their wealth to help support themselves in their old age. Instead, in many cases retirees are significantly relying on governments for support — both income and care support.
Partly this increasing untapped wealth is because the value of retirees’ dwellings continues to increase, but often their superannuation balances remain high as well, with many people drawing down only the minimum allowable amount of their superannuation.
A large part of retirees’ motivation for not drawing down on their wealth is precautionary. They fear that they may need to fund high aged care deposits in the future, face unknown medical expenses, and even that their money might run out given the uncertain time of death.
This situation essentially reflects a failure of the retirement support system. Retirees are experiencing a lower living standard than is potentially available, while they are relying more on the taxpayer than is strictly necessary.
The problem is that too often people have poorly informed views about the risks and/or are unable to manage these risks because of a lack of suitable retirement products.
Apart from ensuring that retirees are better informed, the main ways to improve retirees living standards would be to improve their ability to drawdown on their two principal forms of wealth — namely their superannuation and their housing assets.
What retirees need if they are to increase their rates of drawdown from their superannuation funds is ongoing protection against the key risks they face, including longevity, inflation, and market variability. These risks require insurance and cannot be managed efficiently by individuals.
The Murray report from the financial system inquiry recommended that superannuation funds offer “comprehensive income products in retirement” (CIPRs) which include longevity insurance. These CIPRs could provide an additional income stream in retirement where the amount of income support could be adjusted to reflect the needs at different life stages.
So far the take-up of CIPRs has been disappointingly low. But neither has the government pushed them, and at the very least they should become the default option for superannuants.
Currently about 85 per cent of aged Australians own their own homes, with about 80 per cent being mortgage free. This is their principal source of wealth, and if they were able to tap it without losing their homes, their living standards would substantially increase, although they would then leave a smaller inheritance.
To meet this need, the Hawke government introduced what is now called the Home Equity Access Scheme which is available to anyone of pension age (not just pensioners). This scheme allows retirees to get extra fortnightly payments to bring their total payment up to 150 per cent — or 1.5 times — the maximum age pension.
The payments stop when the loan balance reaches a ceiling of 25 per cent of house value at age 65, but this ceiling increases by 1.1 per cent each year as the retiree gets older. In addition, the maximum loan balance will also increase as the house value rises.
Notwithstanding the apparent attractiveness of this Home Equity Access Scheme the take-up has been very poor. Of the 4 million or so Australians aged 65 and over as few as 5000 have accessed the scheme.
In an effort to improve this take-up, in the last budget the government introduced:
- A no negative equity guarantee, so that users would never be asked to repay more than the value of the property, even if that fell; and
- Users can now take out part of their annual loan entitlement as two lump sums per year totalling up to 50 per cent of the full pension to help finance major one-off payments.
However, another way to improve the take-up of reverse mortgages would be to pressure pensioners to access this form of income by including the value of their home in the pension means test.
There is of course a good case for treating the home in the pension means test as being no different from any other asset. And if homes lost their means-test free status, this might boost the take-up of reverse mortgages to restore the pensioner’s income stream. It would at least benefit the taxpayer and perhaps the pensioner might then be induced to borrow more and augment their income as well.
However, to ensure an adequate income for pensioners who didn’t want to borrow from the Home Equity Access Scheme, it would be desirable to set a quite high exemption limit for the value of the home in the pension means test. That way only the value of the home in excess of the exemption limit would be counted in the means test.
A tax on inheritance
These proposed reforms of the retirement income system would encourage retirees to make better use of their wealth to support themselves, and consequently inheritances would be significantly less.
The Productivity Commission found, however, that the average inheritance was as much as $125,000 in 2018-19 which suggests that there would still be a significant taxable base for an inheritance tax even after successful implementation of the reforms to the retirement support system canvassed above.
Furthermore, the distribution of inheritances is heavily skewed in favour of a few very large sums. Averaging over a 12-year period, the Productivity Commission found that:
- larger shares of wealthier people received inheritances than poor people, and
- among those who received inheritances, the average amount received by the wealthiest 20 per cent of people was 3.5 times the amount received by the poorest 20 per cent of people.
Understandably therefore a common assumption is that these wealth transfers add to inequality, and they certainly increase the absolute amount of wealth held by richer Australians. However, because the poorest beneficiaries of wealth transfers have very little wealth to start with, their relative wealth inequality is typically reduced by the transfer of the inheritances they receive even though their inheritances are much more modest.
In other words, if relatively small inheritances were untaxed that is likely to improve equality of wealth, as well as helping the people concerned. For this reason, it is suggested that an inheritance tax should have a substantial free area.
In addition, it might be useful to suspend the collection of any inheritance tax where the estate is left to a surviving partner or where there is an ongoing family business, such as a farm. Widows should not feel forced to sell the family home just because their partner died.
Finally, any inheritance tax is likely to encourage parents to make gifts earlier, before they die. That is likely to be more useful, but it would require a gift duty to prevent excessive exploitation of this potential loophole.