You may haveread this weekthat Australias super tax breaks are excessively generous (well beyond any plausible purpose) and that their costs unsustainable.

The claim came from a Grattan Institute report,Super savings. But is it realistic?

The figures quoted A$45 billion a year or 2% of GDP and set to exceed the cost of the age pension are derived from TreasurysTax Expenditures Statementand the governments 2021Retirement Income Review.

The benchmark for these estimates involves the income tax rate that is applied toordinary income. Yet very few countriesactuallytax retirement savings in anything like that way.

$45 billion per year, but compared to what?

Grattan itself doesnt suggest employers super contributions and super fund earnings should be taxed like ordinary income.

If all its recommendations for scaling back tax breaks were accepted, the breaks it claims to be concerned about would still exceed $30 billion a year and still be on track to cost more than the age pension.

A better benchmark would be the arrangement in most member countries of theOrganisation for Economic Cooperation and Developmentin which savings are taxed at standard marginal rates on entering or leaving the system and untaxed while growing in the system, known technically as aTEE or EET regime.

In most cases, tax is applied only on leaving the system, an EET regime.

In 2017, the Treasury prepared aparallel calculationof superannuation tax expenditures using a TEE benchmark, meaning contributions taxed at full marginal rates with both earnings and withdrawals untaxed.

It found that instead of the tax break for employer contributions costing $16.9 billion per year and the low rate on fund earnings costing $19.25 billion, the first cost $16.9 billion and the second cost_minus_$9.45 billion (because Australia taxes fund earnings at 15% instead of zero), cutting the total cost by $30 billion.

Had the Treasury used the EET benchmark, which exempts contributions and earnings and taxes only withdrawals, its measure of total tax expenditure on super would almost certainly have been negative (largely because our super system is not yet mature and we dont yet have big retirement incomes to tax).

In fact, our present system has a similar impact to the EET system common among OECD countries, even though it is achieved differently.

Making it harder for high earners to save

Without offering a clear benchmark for comparison, it is impossible to properly assess the Grattan Institutes specific proposals.

Two would probably not shift the current regime too greatly away from the EET benchmark common in the OECD, although neither is essential. One is a more progressive tax on contributions.

The other is extending the 15% tax on fund earnings pre-retirement to presently exempt earnings in retirement (though this should probably be balanced by a reduction in the rate).

But another, a tightening the annual cap on pre-tax contributions from $27,500 to $20,000 and the cap on post-tax contributions from $110,000 to $50,000, has the potential to undermine supers role in spreading lifetime incomes for middle and high income earners.

The governments review that, for all but low-income workers, a retirement income of65-75% of pre-retirement incomewas needed to provide a reasonable balance between living standards in working life and retirement.

The average mandated contribution rate in the 35 OECD countries with specific pension contributions delivering this level of income maintenance is18.2%.

For those not eligible for any age pension (likely to be around 40% of retirees in the future), in one form or another, that is probably the level of savings they should be setting aside, though as the governments review noted many retirees have significant savings from outside superannuation.

That means the Grattan Institutes proposed $20,000 cap might cut in too soon, at about $100,000 a year, which is hardly a top income amongst those in their fifties, particularly amongst public servants and academics (many of whom are already contributing 15-20%).

The things Grattan missed

By continuing to focus on the taxation of super, Grattan is failing to focus on the desperate need to put in place the final piece of Australias retirement income system to help people convert their accumulated savings into secure incomes that maintain living standards and meet the risks of old age.

The Institute is right to highlight that too much of superannuation savings are being passed on in inheritances rather than used in retirement, with the real risk of exacerbating inequality amongst future generations.

Too many retirees are skimping in retirement and leaving more in inheritances than they want to because of fear about future risks including long lives and health and aged care costs.

Sensible proposals are being developed for a covenant requiring funds to offer products in retirees best interests, including those that help them manage risks. But they are yet to be implemented.

I suspect that implementation of the covenant will identify major challenges, including market failures that make it hard for funds to offer value-for-money indexed annuities and to identify what is in their members best interests given the complexities of the age pension income and assets tests.

It is very likely that the government will need to simplify the means tests and consider ways to encourage the provision of indexed annuities including the option of selling government-created annuities.

Now theres an agenda Grattan might usefully focus upon.

First published in THE CONVERSATION April 13, 2023