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A more generous pension could be easily offset by reining in super tax concessions and adding the family home to the asset mix.

Why are we so stingy with access to the pension (to the point of discouraging pensioners from working), yet so generous with superannuation tax concessions, even though there is scant evidence they boost savings?

It’s one of the biggest questions Treasurer Scott Morrison will have to face as he decides the shape of his tax white paper, expected midyear.

We are proposing a rebalancing of super and pensions that we think would be popular and make Morrison an extra $20 billion a year, which would come in handy, given the state of his budget.

First, the pension.

The cost of the age pension is growing at only half the rate of super tax concessions. By OECD standards, our pension system is cheap, and it will still be cheap by 2050 when more of the population has aged.

The present income test cuts the pension by 50¢ for each dollar earned over $162 per fortnight for singles and $288 for couples. On top of income tax, it’s a powerful disincentive to work. From 2017, the separate assets test will cut out the pension fully at $823,000 for home owner couples and $1 million for non-home owning couples. But the home itself won’t be included, allowing well-off pensioners to have as much wealth as they like without tripping the assets test, so long as it is poured into the home in which they live. Other forms of saving cost them dearly.

We are proposing a much gentler income test, and an end to the assets test. Instead, all assets will be treated as income at a deemed interest rate, which could be 6 per cent to start with. The family home would be one of those assets. Own an expensive home and it will limit your ability to get the full pension.

We know the home is essential for security of retirees and especially important for many older women who have little in other savings. But we are not sure how long a sustainable system can disregard such an important asset.

A reform package that included the home could boost the rate of the pension to offset the impact of owning a typical home. And there would need to be scope for asset-rich but income-poor pensioners to borrow against the value of their homes, as proposed by the Australia Institute.

Our income test would cut the pension by only 35¢ for each dollar of income earned or deemed. But it would cut it straightaway; there would be no means-test-free zone. As a result, the pension would vary with the capacity of the person who got it, and there would be only a moderate penalty for boosting that capacity.

Superannuation is where we would make the biggest change.

The widely quoted estimate that super tax concessions cost the government $30 billion a year is wrong. That is what they would cost if the alternative is to fully tax contributions and earnings. We think that’s the wrong comparison.

A better comparison is to a system that fully taxes contributions but leaves earnings untaxed, on the grounds that they are merely compensation for deferring consumption. If that’s the benchmark used, the present system of concessions turns out to be still expensive, costing $12 billion a year.

There is no evidence that the $12 billion boosts savings. It certainly diverts savings into super, mainly the savings of high-income Australians, but that’s not the same thing.

We suggest contributions to super funds receive no tax concessions. Earnings in funds would be exempt and payouts would stay exempt. It’s the way our tax system treats homes.

Changing the system is conceptually simple but practically complicated.

To stop high earners losing more of their pay packets in tax, the contributions tax would be paid by the funds rather than the employers, perhaps at a rate of 30 per cent. Adjustments would be made after the Tax Office had processed each return. Low-income earners would get big rebates.

If introduced suddenly, the change would deliver a big windfall to Australians who already have money in super, at the expense of young people just starting out.

That’s why we would limit the exemption for fund earnings to new money flowing into super.

The accounts of existing workers would be segregated and their “old” investment earnings taxed at 15 per cent, as they are now. The earnings of funds now paying out to retirees would also be taxed at 15 per cent, as they should have been, given that their owners have enjoyed a lifetime of concessions on contributions.

The separate treatment would be complicated but would be no different to the separate treatment at present and unreasonably provided to the earnings of super funds whose owners happen to have retired.

All up, it would make Morrison’s budget $20 billion per year in the short run as the gains from fully taxing contributions were nowhere near offset by the loss from making the earnings of new funds tax-free.

It’s an idea that ought to make pensioners and the users of super funds pretty happy, but it’s only one. Morrison has his work cut out for him.

This article was originally posted in The Age, and is based on a Tax and Transfer Policy Institute Working Paper.

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