Taking the inefficient compulsion out of super

australian-dollar

by Brian Toohey   12 Sept 2016  Australian Financial Review

The worst thing about compulsory superannuation is that it’s compulsory. Sure, cuts to the super tax concessions will help cut the budget deficit. But the damage compulsion does is missing from the debate.

If the Turnbull government wants a big reform that also fits the philosophy of its conservative wing, it should junk compulsory super. Yet both the Coalition and Labor ignore how compulsion violates the 1980s reform principles widely credited as creating a economy better able to adapt to structural change.

Compulsion damages the economy by distorting the efficient allocation of resources. It artificially inflates the size of the funds management industry to the detriment of more efficient industries and stops people allocating their income in line with their preferences. It also distracts union leaders from their core job of improving their members’ take-home pay when subdued wages growth is hurting demand in some sectors.

Contrary to common assumptions, compulsory super isn’t needed to boost savings. We have a savings glut, not a shortage, as reflected by ultra-low interest rates. Moreover, the household savings ratio was higher on average before the introduction of compulsory super than afterwards.

Nor is compulsory super  the only form of savings people will have in retirement. The age pension will remain far more important to low and middle-income earners in retirement than super. Veteran economic analyst Geoff Carmody argued in this newspaper in March that it would be cheaper to pay everyone the age pension and abolish compulsory super. It would be even cheaper, but more administratively cumbersome, to abolish compulsion and keep a means-tested pension.

A recent Grattan Institute analysis showed that super balances only account for about 15 percent of household wealth. The rest mainly comprises other financial assets, the family home and other property. Like the age pension, the cost of the tax concessions for super adds to the budget deficit. The main difference is that the concessions turn the long-established principle of means-testing on its head – their value is heavily biased towards those who could afford to fend for themselves.

Harmful effect

The harmful effect of compulsory contributions is similar to that of other forms of industry protection. Most people understand it would be folly to compel people to buy an Australian-made car on a regular basis. This would not only chew up resources that could be used more efficiently elsewhere, it would stop individuals from deciding how much to spend and save from this component of their income. Individual choice is usually the most efficient way to signal where resources should go.

However the market-distorting policy underpinning compulsory contributions is the main reason Australia has the fourth biggest funds management industry in the world, but only the 12th biggest economy. Perversely, this pumps up salaries in this protected industry to much higher levels than most employees will ever receive.

This mightn’t matter so much if the funds managers were good at mobilising capital for productive new investment. But they mainly focus instead on trading existing financial and property assets. To its credit, the lobby group Industry Super Australia, representing unions and employers, presented a research paper to the Financial Services Inquiry showing the overall finance sector is now almost three times less efficient at capital formation than before compulsory super. But this doesn’t stop fund managers boasting the current superannuation pool of $2.2 trillion will rise to $9.5 trillion in 2035 – a terrible outcome that will slow economic growth unnecessarily.

Union officials on the boards of industry super funds are badly conflicted. They fail to acknowledge that forcing people to contribute to super for their old age cuts their standard of living while working. This opportunity cost adds to the heavy financial pressures that subdued real wages growth creates for employees. Given a choice, many might prefer to allocate a larger slice of the income to pay off a house, obtaining better job qualifications, raise a family and so on.

Scrapping compulsion and paying existing contributions as part of normal after-tax pay would have major economic benefits. Those on $33,000 a year would have over $52-a-week extra to spend or save as they saw fit, while those of $70,000 would had an extra $85-a-week. This would have the added bonus of slashing the budget deficit by cutting $18 billion a year from the cost of the tax concessions – without reducing demand in the economy.

Original article here

 

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