Given the chance, Paul Keating, and to a lesser extent Bill Kelty and Garry Weaven, those relics of Australian labour politics and the union movement from the 1980s, champion the Australian compulsory superannuation system as a huge win for the average worker. They claim credit for winning an industrial battle to grant superannuation to the workers. Prior to their glorious victory, they viewed super as a privilege for a wealthy few. I suppose they keep banging on about it because they could be fearful of the average worker finding out one or two home truths about compulsory superannuation that are perhaps not so glorious after all.
Every $10 of wage otherwise payable to an average income worker, when paid as a superannuation contribution makes the average worker worse off. Wages are about 50% more valuable to an average worker than superannuation contributions. For an average paid worker on an annualised income of $75,000, the income tax rate including Medicare levy is 34.5%. An extra $10 of wage ends up as immediate net income of $6.55. Should that extra $10 of wage be paid instead as a superannuation contribution, it is taxed, deferred and reduces the entitlement to the age pension. After allowing for these effects, the present value of the contribution is around $4.26. That is, the value of a wage is around 50% higher to an average worker than superannuation. How did it come to this?
The fundamental error made by those in the union movement arguing for compulsory superannuation was to think it was in addition to wages, not in substitute for. Perhaps it was envy politics, perhaps a limited understanding of the economics of labour but in any case, the politicians of the left and labour unions claimed they had won a great victory for workers by having superannuation made compulsory. When superannuation contributions are made compulsory, employers adjust wages to compensate. All that happened was that some wages were paid in an alternative form.
The error was compounded by the Labour government introducing tax on fund earnings and contributions. A flat rate tax was levied on all contributions meaning that the perceived tax advantage was immediately weakened, substantially so for those on lower rates of income tax. That $10 of superannuation contribution is reduced to $8.50 immediately in the fund, then is invested for many years deferring the utility that would otherwise be available to the individual to use that money in whatsoever way they wanted – to invest, to borrow less, to consume more etc. This loss of utility can be measured by observing rates of interest in the personal loans market. Consumers value ready liquid cash – that is why they pay high rates of interest to borrow to fund personal consumption. Borrowing costs in the personal loans market display a significant variation, from 5%pa to more than 10%pa.
The final insult occurs on retirement and the means test that is applied to the retiree’s pension entitlement. Every extra $8.50 of assets will reduce the annual pension by approximately $0.66. By assuming a 20 year time horizon, a 2.5%pa real return and 6%pa real as the discount for loss of utility, the present value of the worker’s net superannuation $10 contribution is around $4.26. Whereas, the value of the $10 wage was $6.55.
It is true that before the advent of compulsory superannuation, only those on higher incomes were typically superannuated. The complex interaction of the tax and welfare system meant that super could be economically justified for the higher paid. Employers knew this. I’m not convinced Keating and his coterie have grasped this point yet.
Australian Actuary 
David I would question some of your assumptions but resoundingly endorse one of the points you make.
Firstly in relation to the interest rate assumption. When I look at the investment return assumptions of six of the country’s leading industry funds for their default options (or what appear to be the default options) I get the CPI plus the following six returns: 4%, 3.25%, 4%, 3.5%, 3%, 3%. So your 2.5% looks to me to be on the light side.
As for utility discount – I’m not really very sure about that one, I’ve never needed to use a utility discount and I’m not familiar with any standard benchmarks (if there are any?).
But to me, the most important qualification to your calculations is that your calculated reduction in age pension will only occur if the member will fall within the part pension range due to the impact of the assets test. I acknowledge that this will be true for a significant proportion of retirees, but there are also
* self-funded retirees,who will form an increasing % of the retiree population as compulsory super matures;
* there are others who won’t ever reach the lower threshold of the assets test, due to low and/or casual incomes and/or periods out of the work force; and finally
* still others will have some income in retirement so the assets test won’t apply because the income test will.
But where I strongly support your comments is in relation to the new (post 1 January 2017) assets test. It’s bloody stupid. Effectively, if you are in the asset-test impacted range, you can put your money in the bank and earn 2%. Or throw it out the window and “earn” 7.8%, indexed, for life. If ever there was a public policy change which will have “unintended consequences” it’s this one. If you take this as gospel for the next 30 or 40 years it will be a serious disincentive for middle Australia to contribute to super. Or maybe people should contribute to take advantage of the difference between super contributions tax and their personal marginal rates but use the extra to pay down their home loans on retirement (increasing the net value of an asset-test exempt asset).
And as a member, how do you plan your financial future when you don’t know what harebrained scheme they’re going to come up with next??
Ultimately I think the unintended consequences will mean that they will have to “fix” the asset test taper rate which is much too high. Then super will come back into its own as a reasonable long term savings regime for middle Australia.
Thanks a lot for your thoughtful article, which does throw down the gauntlet to those who think of our super system as being close to world’s best practice. But maybe the truth is that our super system is pretty good – but our social security legislation isn’t!
Hi JDR, thanks for your comments, which all make sense. On the assumptions side, perhaps 2.5%pa real is a little light. But my employer’s current investment model is telling me that is at best what to expect from a typical balanced portfolio over the next 10 years. On the utility discount, I don’t think there are standard benchmarks. I have not heard or read others trying to put a measure on it. It is my own view that the personal loans market is probably as good an indicator as any for the demand for cash among the lower to middle paid in our society. What the right rate is could be discussed. But I’m confident it is a meaningful number – otherwise we would observe much more in the way of voluntary super savings among the lower paid. In my calcs, the reduction in age pension was quite small – again it could be refined and made more theoretical I expect. It could be removed and would not affect my main point that compulsory super and the consequential adjustment to wages, hurts the people on lower to middling incomes more than it helps. Higher paid people won’t discount the loss of utility anywhere near as much – they have surplus cash already and it is the utility discount that drives the conclusion.
thanks again.
BTW, PJK wrote to today’s AFR on the topic – right on cue.