Adequacy and equity in super

Mike Goodall

Although this federal government has yet to legislate the purpose of superannuation, it stated in last year’s budget that it proposed introducing the definition first suggested by David Murray in his Financial System Inquiry, which recommended that a statement of purpose should be enshrined in legislation and proposed the following primary objective: ”To provide income in retirement to substitute or supplement the age pension.”

Unfortunately, this definition provides no guidance as to the equitable distribution of tax incentives nor the appropriate benchmarks for measuring whether the objective is met.

The point appears to be difficult for some of those in government to grasp, though it has been acknowledged as an issue. In the government’s discussion paper on the purpose of super, it said: “While adequacy provides a sense of targeting superannuation and is consistent with fiscal sustainability, there is no consensus of what adequacy means. While the OECD defines it through the use of replacement rates, implying people have different levels of adequate retirement incomes according to their wages, others may conceive of a single level of income applicable to all.”

And that is a key point. The last line – believing that a single level of pension income in retirement is adequate – is equivalent to believing there should be a universal wage for all, no matter the job, education or effort required. Close to a definition of socialism?

It’s important not to confuse two terms, adequacy and equity. The second part of the above paragraph substantially addresses the issue of equity rather than adequacy. The superannuation system should be equitable and the objective should be more specific regarding what this means.

To be equitable, a system should encourage and allow all Australians to attain a standard of living after retirement that bears a reasonable relationship to their pre-retirement standard. This relationship, known as the replacement rate, is widely accepted as a measure of a retirement system’s success and should be specifically referenced in the primary objective.

It’s worth noting that the 27 countries in the European Community with combined populations of nearly half a billion adopted a statement of objectives for an adequate and sustainable pension (Australia and New Zealand appear to be only countries that call it superannuation) system to ensure: “Adequate retirement incomes for all and access to pensions which allow people to maintain, to a reasonable degree, their living standard after retirement, in the spirit of solidarity and fairness between and within generations.”

Equity is a principle that should be enshrined in the objective with clear guidance as to its meaning. Some people appear to consider equity as meaning equal, including those who believe one target level of income for all should be an objective of superannuation. This is not the case and would result in an unfair and ineffective system.

To the extent that those on higher incomes have paid higher lifetime taxes, an objective that provides them with a higher retirement pension is fairer. Superannuation taxation should not be used as yet another income redistribution mechanism – in addition to our welfare system, means-tested age pensions and one of the most progressive income tax scales in the world.

Any tax concession to an individual or group of individuals not proportional to the taxes that individual or group has paid represents a transfer to or from that individual/group to another and is inequitable.

It is generally accepted internationally that in an equitable and advanced society, taxpayers should expect to retire on a pension that bears a reasonable relationship to their income before retirement.

The replacement rate is the widely accepted term meaning the pension as a proportion of a person’s pre-retirement income or, as the Henry report put it, the replacement rate “compares a person’s spending power before and after retirement”.

Although some organisations use pre-tax income during working life, given the distorting impact of income taxes (especially when considering different retirement systems), the Self-managed Independent Super Funds Association believes it is more appropriate to link pensions to after-tax income (consumption) during a person’s working life. A target replacement rate of 70 per cent of pre-retirement income is appropriate for those on lower incomes, falling to 60 per cent for those on higher incomes.

For there to be any chance of a better system being developed, there would have to be more widespread agreement on this and a number of other issues we will highlight in a future column.

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