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Taxation of Superannuation


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May 20th, 2012


An informed discussion on what superannuation is, how it is taxed in Australia, and the inefficiencies and inequities inherent in a non-uniform tax rate across different forms of labour and savings time-horizons.


Professor John Freebairn

By Professor John Freebairn

 

Superannuation is a form of remuneration and labour cost, and it is a form of saving current income for future consumption in retirement. In terms of equity and efficiency, it is desirable that the taxation of superannuation be similar, if not identical, across different forms of labour remuneration and across different forms of long term saving. Demonstrably that is not the situation now. The result is inefficiency, and a loss of both vertical and horizontal inequity. These disadvantages can be reversed with a reform package. It is proposed that: contributions to superannuation funds be taxed at the personal rate as applies to wages and salaries; remove the current flat but low rate of taxation of fund earnings; and, retain the current tax free status of withdrawals from superannuation funds for retirement income. In effect, remuneration saved as superannuation would be taxed in the same way as remuneration saved to pay off a home. The reform proposal offers a doable taxation reform which will generate gains in national productivity and efficiency, and which is more equitable.

The current taxation of employer contributions to superannuation on behalf of employees, currently nine per cent of labour remuneration and to increase over the next few years to 12 per cent by July 2019, and additional salary sacrifice contributions, is as follows. The superannuation fund pays a flat 15 per cent tax on all contributions. From July this year another 15 per cent will be paid for contributors with a wage/salary exceeding $300,000 a year. A rebate (Low Income Super Contribution) effectively sets the tax rate on contributions for employees with incomes up to $37,500 a year at zero. The taxation of remuneration allocated to superannuation is not subject to as progressive a tax rate schedule as the taxation treatment of remuneration taken as wages and salaries, and the effective tax rate on superannuation is much lower. The income earned on what are employee owned savings held by superannuation funds is taxed at a flat rate of 10 per cent on capital gains and 15 per cent on other returns such as interest, dividends and rent received. For low income earners, this is a relatively high tax burden, and even higher than the tax treatment of interest and dividend income. For middle and high income earners it is a tax concession. For those aged 60 and above, funds withdrawn from superannuation, which are net of the tax on contributions and earnings, are tax free income. Superannuation funds withdrawn at an earlier age are subject to some additional taxation.

The most important form of saving by Australians is in their own home. Its tax treatment is as follows. Savings come from after tax personal income. Then, there is no further tax on the income earned in the form of imputed rent and capital gains. This is referred to as a prepaid consumption tax or a TEE system (for tax on entry to saving, T, no tax on earnings, E, and no tax on withdrawal of the savings, E). Interestingly, this consumption tax treatment has a neutral effect on decisions to save or not and on when to spend one’s income over the life cycle. By contrast, the current taxation of superannuation described above is a ttE system (for concessional tax on entry, concessional tax on earnings, and tax free on withdrawal).

Reform of the taxation treatment of superannuation to a TEE system, similar to the current taxation of owner occupied housing, would work as follows. All remuneration, whether in the form of wages, salaries, superannuation and fringe benefits, would be subject to the current progressive personal income tax. This provides for neutral taxation of all forms of remuneration, it is simple, and it achieves equity as represented by the progressive personal income tax rate schedule. The current flat rate taxation of superannuation funds would end. Current arrangements for the taxation of funds withdrawn, including a zero rate for those over age 60, or preferably increased to the Age Pension eligible age of 65, would continue. Combined, these changes place the taxation of savings allocated to homes and to superannuation on a neutral level, and a level that does not distort decisions on when to spend income.

The proposed changes to the taxation of contributions to superannuation would apply only to new contributions, while the reduction in taxation of earnings would represent a windfall gain on past contributions. Government revenue losses on the withdrawal of taxation of superannuation fund earnings will be offset by higher taxation revenue collected on fund contributions. The greater neutrality in choices of remuneration mix and in savings mix over time will result in a more productive and higher income society. From a distribution or equity perspective, those on lower incomes gain, and those on higher incomes lose.

 

Professor John Freebairn is an economics professor at the University of Melbourne. His research interests include taxation reform, labour economics, and natural resource economics. He was the Head of the Business and Economics Department from 1997 – 2002 and Director of the Melbourne Institute from April 2005 to April 2007. In 2008 Professor John Freebairn has been appointed as the Ritchie Chair. Read his faculty profile here.

The views expressed within this article are those of the author and do not represent the views of the ESSA Committee or the Society's sponsors. Use of any content from this article should clearly attribute the work to the author and not to ESSA or its sponsors.

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