“The projections in this report are very unlikely to unfold over the next 40 years exactly as outlined.”
Whilst the above disclaimer in the Intergenerational Report (“Report”) suggests we should treat its forecasts with a fair degree of scepticism, there are interesting observations in it that every Australian should note. That includes Paul Keating, the architect of Australia’s super system. In particular, those in or approaching retirement or battling away with their retirement fund should note that this Report provides little support for the sustainability of our current retirement regime.
Today’s Macro View does not attempt to critically analyse the forecasts. Rather we will draw from the Report to show that some of Australia’s current economic and social policy settings will not achieve their stated intentions. Indeed that is the key takeaway in the Report, although based on the disclaimer it would seem that it is based on unrealistic assumptions.
For instance, the Report expressly assumes that current fiscal policy settings are maintained for forty years. The Report assumes that government expenditure as a percentage of GDP continues in an upward trajectory – based on the ageing of the population – whilst taxation as a percentage of GDP stays constant. Because taxation rates are not adjusted in response to predictable social cost increases, the conclusion is predictable. Based on these assumptions, Australia may never balance its budget again despite having one of the highest birth rates and population growth rates in the developed world.
The Report offers no solutions or alternative ways of thinking. We therefore humbly suggest that its authors change their disclaimer to …“The projections in this Report will never occur because surely we are not that dumb!”
What is the Intergenerational Report?
Every five years, the Australian Government is required to produce an Intergenerational Report. These reports assess the long-term sustainability of current Government policies and how changes to Australia’s population size and age profile may impact economic growth, the workforce and public finances over the following 40 years. The 2015 Intergenerational Report is the fourth such report in the series (previous publications were released in 2002, 2007 and 2010).
Figure 1. Australia’s demography – an international perspective
Source. Box 1.3, Intergenerational Report
Payments to the aged
It is an established part of Australia’s social safety net that the Age Pension provides income support to older Australians who need it, while encouraging pensioners to maximise their incomes through superannuation and private savings. Australian Government expenditure on payments to the aged is currently 2.9 per cent of GDP or 13% of budget outlays. Concurrently, total superannuation assets in Australia amount to $1.82 trillion or 116% of GDP.
The Age Pension is a means tested payment for people over 65. From 1 July 2017, the qualifying age for the Age Pension will gradually increase to 67 by 1 July 2023. The 2014-15 Budget announced that the eligibility age would increase at the same rate to reach 70 by 1 July 2035.
In 2013-14, about 70 per cent of people of Age Pension age were receiving the Age Pension. Of these recipients, 60 per cent receive a full rate pension. Under the current policy scenario, the Report forecasts that the proportion of people of Age Pension age receiving the Age Pension will fall to 67 per cent by 2054-55.
Think about that forecast carefully, and you will realise that something is very wrong with our current retirement policy settings. Compulsory Superannuation commenced in Australia in 1992 and has been operating for 23 years. By 2055, it will have been operating for 63 years and yet it is estimated to result in a drop of only 3% in eligible pension recipients! That would appear to be a very poor outcome from the trillions of dollars of super contributions that will occur over the period.
In passing, we note that as Australia’s superannuation system matures and compulsory contributions increase, the proportion of part-rate pensioners relative to full-rate pensioners increases. However, the proportion of retirees receiving any pension is not projected to decline to any significant extent over the next forty years. Therefore the administration cost of means and asset testing pensions will continue to grow and grow. This suggests that a national contributory pension scheme might make better sense than the current compulsory scheme, which in spite of its size achieves so little for so many.
The superannuation system has been designed to help Australians to enhance their retirement incomes and reduce reliance on the Age Pension. Since the advent of compulsory superannuation in 1992, employers have been required by law to make minimum payments to a complying superannuation fund to help employees save for retirement. This rate is currently 9.5 per cent and is scheduled to rise to 12 per cent between 1 July 2021 and 1 July 2025.
Compulsory superannuation savings appear to have made a significant contribution to national savings (1.5 per cent of GDP in 2011 rising to three per cent over the next few decades). This is despite some reduction in other forms of savings. The Financial System Inquiry (FSI) noted a Treasury estimate that the size of the sector could reach $9 trillion by 2040. Yet from the analysis above, it is suggested that it will not materially decrease the proportion of pension recipients as a percentage of retirees.
The Report discloses some statistics regarding super balances that are truly alarming. The median superannuation balance for a person in the accumulation phase in 2011-12 was estimated to be around $30,000. The median account balance for a person aged 60 or over in the accumulation stage in 2011-12 was estimated to be $95,000.
Because these retirees might have received no compulsory superannuation or lower Superannuation Guarantee (SG) contributions for a large part of their working lives, the resultant balances are manifestly inadequate. These statistics show that for a significant part of the population, there is no chance that super is a viable alternative to the pension.
In our view, super for many low and middle income earners is merely a charade that feeds the massive financial institutions – for no real social or fiscal benefit. The great bulk of low and middle income earners would be better served by contributing to and relying upon a public pension scheme. Should they so desire, then a supplementary super contribution could be made for their own personal benefit. For those with super balances of $1 million (individual) and $2 million for a couple, the receipt of a guaranteed pension, to which they have contributed, would be a welcome supplement alleviating the stress of declining retirement earnings.
In the future, retirees are likely to achieve higher balances as a result of receiving higher SG payments for longer periods. However, because of poor legislative structuring, the benefits of super are abused by a minority of high income earners who exploit the fact that there is no means or asset testing of the significant taxation benefits available.
Aged care spending
The Australian Government provides aged care funding for residential aged care and a range of community care services, including care in the home. In 2014-15, the Australian Government provided 0.9 per cent of GDP for total government aged care expenditure or some $15 billion. Based on current projections, Australian Government Aged Care expenditure is projected to rise from 0.9 per cent of GDP in 2014-15 to 1.7 per cent of GDP in 2054-55.
The dominant influence on aged care spending projections is the number of people over the age of 70, reflecting the government’s commitment to provide 125 aged care places per thousand people aged over 70. According to the Report, the number of people aged 70 years and over is expected to almost triple over the next 40 years, reaching around 7 million people by 2055. For interest, see the rapid growth and the projected number of centenarians expected by mid-century in the chart below.
Figure 2. Number of Centenarians
Source. Chart 1.7 Intergenerational Report
Figure 3. Changing consumption patterns
Source. Chart 2.26 Intergenerational Report
These observations suggest that private retirement savings, if supported by a sensible national pension scheme, could be skewed towards aged care contributions or an aged care scheme. Former PM Paul Keating once noted that longer life expectancy was essentially made up of the “stretch to death”. It is public financing of this period that will likely catch out our society if planning is not soon addressed. Indeed, this is an ideal area for the development of infrastructure to house a growing number of aged citizens in quality accommodation – funded by contributions from future residents. Today’s super needs to deal with tomorrow’s issues.
Figure 4. Total government spending & taxes by age (2009 – 10)
Source. Intergenerational Report
Public Sector Superannuation
No discussion of future long term liabilities can ignore the largest of the Australian Government’s future superannuation obligations. These are the defined benefit schemes for civilian and military employees. These schemes have historically been mostly unfunded, with the bulk of entitlements being funded at the time benefits are paid rather than when they accrue. The unfunded superannuation liability as at 30 June 2014 for these schemes was estimated at $155 billion (just under 10 per cent of GDP).
Almost all of the unfunded superannuation liability relates to the Commonwealth Superannuation Scheme (CSS), the Public Sector Superannuation Scheme (PSS), the Defence Force Retirement and Death Benefits Scheme (DFRDB) and the Military Superannuation and Benefits Scheme (MSBS). The first three of these schemes are now closed to new entrants, and the Government has announced that the MSBS will close from 1 July 2016.
The Future Fund was established by the Australian Government in 2006 to assist future governments in funding the cost of the superannuation liabilities of the Commonwealth public sector.
From 2020, superannuation payments will be financed by drawing down on assets in the Future Fund rather than from general revenue. This will ease the fiscal adjustment task associated with other projected fiscal pressures.
Whilst the Future Fund had assets of $101 billion as at 30 June 2014, it is still underfunded and as a result of drawdowns from 2020, the balance is projected to be depleted by the late-2040s. In total, the Fund is projected to fund around $400 billion of Commonwealth superannuation payments. These are payments that would otherwise have to be funded from general government revenue and borrowings.
Whilst many ex- and current public servants can rest easy with their entitlements to a commonwealth pension, the rest of the community does not have that luxury. And although the Future Fund will have saved the taxpayer future contributions to an unfunded scheme, it did so from the transfer of public assets when it was set up (remember 12% of Telstra).
Some final observations
The foresight that created the Future Fund is rare in both our political leadership and our bureaucracy. Unfortunately it has not been transferred to any planning of a Future Fund for our or our children’s future. Indeed, that is the greatest problem with Australia’s super system. It has been remarkably efficient at raising capital, but it has not solved the requirement for a large portion of the population to generate and rely upon a pension.
Elsewhere, the Intergenerational Report was remarkably silent on the projected future costs of education. Readers may like to check out the section on education that appears to have a whole section deleted – is that a political impasse or is there no real view? Download the Intergenerational Report.
Finally, the press lit up this week with a debate between former Treasurer Keating and the current Treasurer, Mr Hockey. The debate centers on a suggestion to allow young people to access their super to pay off a housing loan or indeed other debts (for example, HECS debt). It has become an emotional issue for the former Treasurer as he was the system’s architect. Whilst a national savings scheme is essential, there is little hope that the current system can achieve its aims for the majority of people, based on the forecasts of the Report.
Today, with our massive household debt, the high cost of living, the extraordinary cost of education and the unaffordability of residential property, it is time for urgent debate. If we fail, the market place will have its own ideas that will be inflicted upon Australia’s future generations. A self-imposed recession caused by inefficiencies across the country remains our biggest risk. The Report hit on the biggest problem confronting Australia – we cannot fund our growth from current policies and we urgently need to re-think.