Statement of Anthony Blunn, Secretary,
Commonwealth Department of Social Security, Australia;
as presented by Paul O'Sullivan, Deputy Chief of Mission, Australian Embassy
Testimony Before the Subcommittee on Social Security
of the House Committee on Ways and Means
Hearing on "The Future of Social Security for this Generation and
the Next" -
Experiences of Other Countries
September 18, 1997
Australia, like other OECD countries, is facing a steady ageing of its population. The Australian Bureau of Statistics has estimated that between 1994 and 2015 the proportion of Australians aged 65 years and over will increase from 11.9 per cent to about 23 per cent of the population. Like other countries, this projected demographic change has highlighted the need to develop a retirement income policy that is fiscally sustainable.
The Australian Government is committed to a retirement income policy that provides encouragement for individuals to achieve a higher standard of living in retirement than would be possible from the Age Pension alone, but also ensures that all Australians have security and dignity in retirement. This will be achieved by:
In the first section of this statement for the Sub Committee we will briefly outline Australia's social security system; and Australia's three pillar model of retirement income provision and factors contributing to its evolution; before turning in detail to describe the features of the superannuation pillar.
The second section analyses the major issues arising, including demographic and fiscal issues recent initiatives which are foreshadowing some possible future directions for Australian attention.
In conclusion, we outline the major advantages of the Australian system, with reference to our own institutional, political and economic context.
1. Australia's svstem - general features and context The Social Security System
Unlike the United States, a national, general revenue funded system of social assistance is the principal means of providing social security payments in Australia. The historical focus of Australian social security has tended towards adequacy and income redistribution objectives rather than providing earnings-related pensions. Income support payments are flat rate, that is, the same rate of pension or benefit is paid to everyone regardless of their previous earnings, but has regard to current capacity for self support.
In Australia social security covers diverse target groups including the aged, people with disabilities, the unemployed, young people and families. Payments for families include sole parent pension, maternity allowance and child support. The Australian social protection system is financed from general taxation revenue. Welfare expenditure in Australia comprises 37% of total government outlays, including payments to veterans and child care. This represents 10% of GDP, or A$47 billion per annum currently.
Australia' s system provides means-tested income security payments to over 4.6 million adults out of our total population of 18.2 million. Categorical income support payments are provided according to principles of 'need' rather than previous income. Need is assessed by an income and assets test.
Social protection mechanisms are also evident in a range of Australian institutions and programs, including the recently introduced family tax initiative for low to middle income earners; superannuation; universal health insurance (Medicare); subsidised child care; high levels of home ownership; and award-based sickness benefits.
Australia's Retirement Income System
The Australian retirement income system can be described as a three pillar model. The first pillar provides a flat-rate, means-tested pension known as "age-pension." The rate of payment is not related to prior earnings. Rather, it is set at 25 per cent of Male Total Average Weekly Earnings (MTAWE) for a single person. The married rate of pension paid to each partner of a couple is currently 83% of the single rate. Eighty-four per cent of all aged Australians receive this pension (including Service Pensions). of the Age Pension recipients, 65 per cent receive the maximum amount and 35 per cent get a partial pension.
The second pillar mandates compulsory concessionally taxed saving for retirement through an employment-based system known as the Superannuation Guarantee (SG).
The third pillar encourages individuals to supplement the first two pillars, particularly through voluntary superannuation assisted by tax concessions and other saving.
The first elements of a national social security system began in l909, with the introduction of an Australia-wide, non-contributory and means tested age pension scheme. There were unsuccessful attempts to introduce a contributory social security scheme in 1928, 1938 and 1975. In the 1980s a brief trend towards a universal age pension was reversed when income and asset tests were reintroduced.
Policy trends in recent years have encouraged self provision, particularly through superannuation and private saving, so that those who have the capacity to support themselves without recourse to public assistance do so. This has also been reflected in the modifications that have been made to social security legislation and the income and asset test in particular.
The Age Pension is one of the largest Commonwealth government expenditure programs, with some 1.6 million customers and program outlays of A$12.1 billion in l995-96, or around 33 per cent of total DSS program outlays.
The Age Pension is paid to Australians who have been a resident for a total of 10 years (unless modified under shared responsibility social security agreements). It is payable to men at age 65 and women at age 61 years. However, the age for women is being slowly increased to 65 over the next 16 years (reaching 65 years in July 2013).
Payment is targeted at those in financial need through the application of income and assets tests. Under the income test pension is reduced by 50c for each dollar of income over a specified 'free area' of income. Some pension can be received until other income reaches $A806.40 a fortnight for single people and $A1,347.20 a fortnight for couples. Under the assets test, pension is reduced proportionally for assets over specified limits. The test which results in the lower pension rate is the one which applies.
The rate of age pension paid is indexed every March and September, according to movements in the Consumer Price Index. The single rate of pension is also benchmarked to 25 per cent of MTAWE. As at 20 September 1997, the single rate of pension will be $A347.80 a fortnight (25.3 per cent of MTAWE) and the married rate of pension will be $A290.l0 a fortnight for each member of a couple.
Superannuation (Private Retirement Provision)
The role played by superannuation in Australia's retirement income policy has grown considerably in importance since 1983 and is expected to have considerably greater influence in the future. It is important to have some knowledge of the way in which occupational superannuation has evolved as it is unique to Australia and other countries might not experience the same circumstances.
Superannuation in Australia is a long term savings arrangement that operates primarily to provide income for retirement from paid employment. Since contributions are made usually in the form of a percentage of earnings, superannuation tends to provide end benefits that are related to pre-retirement income.
Superannuation differs from social insurance in that it is privately managed (albeit publicly regulated) and occupationally based.
Australia expects that its superannuation arrangements will lead to increased household and national savings in the long run. The superannuation arrangements can be viewed in part as a move by the Government from an unfunded age pension to a partly Government partly private, funded retirement income scheme.
In 1983 less than 40 per cent of employees had some form of superannuation coverage. These employees were concentrated in the public sector and in higher income private sector employment.
There was little regulation to ensure that superannuation savings were preserved to deliver income in retirement. There was limited opportunity for portability of benefits between schemes, consequently, superannuation mainly served to provide higher income earners with concessionally taxed windfalls on change of employment.
A process of reform commenced in 1983. Firstly, the tax on that component of lump sum benefits relating to employment after June 1983 was increased to reduce the bias against people taking benefits as annuities and pensions. A higher tax was also imposed on benefits taken before age 55 to encourage superannuation savings to be preserved until retirement after that age. Also, rollover vehicles, namely approved deposit funds and deferred annuities, were created in 1983 to provide people with the opportunity to preserve their superannuation benefits within the concessionally taxed environment until retirement, and to facilitate the portability of superannuation benefits when people changed jobs.
In 1986, the then Government sought to encourage the spread of superannuation through the workforce by agreeing to support the peak employee body, the Australian Council of Trade Unions (ACTU), in seeking through industrial awards a universal 3 per cent employer provided superannuation benefit in lieu of an equivalent productivity based general wage rise. Award superannuation was to be fully vested in the member and subject to preservation until retirement after age 55. Endorsed by the Industrial Relations Commission, industrial award superannuation became the principal vehicle for increasing the superannuation coverage of wage and salary earners.
Award superannuation played a principal role in extending access to superannuation to some 72 per cent of employees by July 1991. However, it suffered a number of problems, including:
In an effort to overcome these problems and in recognition of the fact that a voluntary tax assisted private savings system could not of itself be relied upon to deliver a secure retirement other than for the wealthy, Australia moved to formally adopt a three pillar retirement income policy with the introduction of the Superannuation Guarantee (SG) in 1992.
The SG is a compulsory, occupational based, defined contribution superannuation system. Under the SG employers are required to make on behalf of their employees prescribed minimum contributions to complying superannuation funds. The required minimum contribution was set at 3% of employee earnings in 1992 rising to 9% of employee earnings in 2002- 03.
Administration and Investment
Superannuation funds operate as trusts with trustees being solely responsible for the prudential operation of their funds and in formulating and implementing an investment strategy. Duties and obligations are codified and trustees are liable under both civil and criminal law for breaches of obligations. Superannuation funds face few investment restrictions. There are no asset requirements or floors, no minimum rate of return requirements, nor a Government guarantee of benefits.
As a result, superannuation funds tend to invest in a wide variety of assets with a mix of duration and risk/return characteristics. The recent investment performance of superannuation funds compares reasonably with alternative assets such as ten year bonds.
As at March 1997 there were 151,311 superannuation funds with assets totalling around A$279.5 billion. However, some 98% of all member accounts are held in approximately 8,000 funds.
Superannuation Industry Regulatory Framework
The prudential regulation of the superannuation system is currently the responsibility of the Insurance and Superannuation Commission. Concurrent with the introduction of the SG, a number of reforms were made to the superannuation regulatory framework to enhance the security of retirement savings. The new prudential regulatory regime is embodied in the Superannuation Industry (Supervision) Act 1993 and provides, in particular, for:
Superannuation taxation arrangements and voluntary contributions
The income of complying superannuation (and approved deposit funds) is generally subject to concessional taxation under the Income Tax Assessment Act 1936 at a rate of 15%. Superannuation pensions and lump sums (within specified thresholds) are also subject to concessional taxation. Additional voluntary contributions (up to a prescribed reasonable benefit limit) also receive concessional treatment.
2. Social security reform in Australia - Issues
Forecast impact of social security reform
Currently around 84 per cent of Australians of Age Pension age draw on the Age (or equivalent veterans' Service Pension), with some two-thirds of pensioners being paid the full rate pension. It is projected that expenditure on Age and Service Pensions will rise from 3.2 per cent of GDP in 1994-95 to 4.7 per cent in 2050 taking into account the reduction in pension outlays resulting from the superannuation savings accumulated under the compulsory SG arrangements. Without the SG, pension outlays would increase by a further 0.3 per cent of GDP by 2050.
Fiscal pressures and saving
The continued high levels of Australia's current account deficit (CAD) are of major concern. Unemployment cannot be reduced on a sustainable basis without adequate investment. Therefore, unless additional savings are available, including from the public sector, the CAD will not be reduced over time.
Increasing dependence on foreign savings, as reflected in growing net foreign liabilities, exposes the economy to sudden shifts in market confidence, leads to higher borrowing costs for Australian business and makes the economy more vulnerable to external shocks. Inevitably, the effect of these risks is to place an external 'speed limit' on the pace at which economic growth can be sustained.
The Government's medium term fiscal strategy is to follow, as a guiding principle, the objective of maintaining an underlying balance on average over the course of the economic cycle. This approach will ensure that over time the Commonwealth budget makes no overall call on private sector saving and therefore does not detract from national saving; it will provide the Government with the flexibility to allow fiscal settings to change in response to economic conditions over the course of the cycle and to respond to external shocks.
The Government is committed to introducing legislation to ensure greater fiscal discipline and enhanced reporting arrangements in accordance with its election commitment to a Charter of Budget Honesty.
There is also a need to increase private saving and household saving in particular. Private saving comprises household and corporate saving. After reaching a peak in excess of 14 per cent of GDP in the mid-1970s, the gross household saving rate trended steadily downwards with some small temporary rises reflecting cyclical peaks in economic activity before flattening out over the past five years at around 7.75 per cent of GDP. over the same period, the gross corporate saving rate has risen from around 4.5 per cent to a peak of 6.75 per cent of GDP in 1993-94, with a small fall since then.
Despite six years of recovery since the recession of l990- 91, gross private saving remains at around l5 per cent of GDP compared with an average 16 per cent in the 1960s and 18 per cent of GDP in the 1970s.
Recent developments - measures introduced
Australia's retirement income policy faces a number of challenges including to:
Towards this end, the current Government elected in 1996, while generally endorsing Australia's current three pillar retirement incomes policy, has introduced a number of reforms aimed at successfully meeting these challenges.
These reforms have been strongly focused on improving the operation of the retirement incomes framework including incentives, and further enhancing the principles of self provision and capacity to pay - underpinned by a commitment to benchmarking the adequacy of the age pension. A number of initiatives now serve to broaden choice within the third pillar of retirement provision. These recent announcements are likely to set the future direction for retirement policy reform in Australia.
Specific reforms announced in the 1996-97 Budget and in the Government's 1997/98 retirement income policy statement, Savings: Choice and Incentive, by the Hon. Peter Costello MP, Treasurer; and Senator, the Hon. Jocelyn Newman, Minister for Social Security, are outlined below.
To improve choice and competition within the superannuation system the Government introduced Retirement Savings Accounts (RSAs) in the 1996/97 Budget to provide a simple, low cost, low risk product especially suited to those with small amounts of superannuation.
Certain institutions including banks, building societies, credit unions, life insurance companies and prescribed financial institutions may apply to the Insurance and Superannuation Commissioner to become an RSA institution, that is to provide superannuation without a trust structure. RSAs are required to be 'capital guaranteed'. The RSA Bill provides that where an RSA provider undertakes poor investment decisions which result in negative investment returns, these cannot be passed on to the RSA holder to reduce the balance in the holder's account. They are fully portable, owned and controlled by the RSA holder, and are subject to the retirement income standards applying to other superannuation products, including preservation, contributions eligibility and disclosure rules.
To ensure that superannuation savings are directed towards producing an income in retirement the Government has announced a phased increase in the preservation age from 55 to 60 by the year 2025 and tighten preservation rules.
Further, the Government aims to make the Social Security means test treatment of income streams simpler, more consistent and more equitable. From I July 1998, income streams will be more effectively classified and means tested on the basis of their characteristics. Consistent with these changes, the superannuation regulations will also be amended to provide superannuants with greater choice as to which income stream products qualify as 'complying' pensions or annuities for purposes of gaining access to the higher superannuation pension reasonable benefit limits.
To improve the flexibility of superannuation arrangements for low income employees, from 1 July 1998, people earning from $450 to $900 per month from an employer (or $1,800 over two months where the person is under 18 years of age) will be allowed, with the employer's agreement, to choose to receive wages or salary in lieu of employer SG contributions.
To enhance competition within and between superannuation funds and RSA providers the Government has announced a measure whereby employers will be required to give employees 28 days to make a choice from among five (or more) complying superannuation funds or RSAs nominated by the employer. For existing employees, employers must provide a similar choice within two years of the date of effect of the legislation.
Providing cost effective and equitable assistance to household saving for life cycle needs in a manner which recognises the importance of individual choice, a tax rebate will be available to individuals who make undeducted (ie, already taxed) member superannuation contributions, and/or who earn net personal income from other savings and investments, up to an annual cap of $3,000. The rebate will be phased in at a rate of' 7.5 per cent from 1 July (a maximum rebate of $225), rising to l5 per cent (a maximum of $450 per annum) from 1 July 1999. Finally, the Deferred Pension Bonus Plan offers people of Age or Service Pension age a positive incentive to defer retirement. Under the plan a person who defers retirement and access to the Age or Service Pension will accrue a tax exempt bonus of 9.4 per cent of his or her basic pension entitlement for each year of employment beyond Age or Service Pension age, up to a maximum of 5 years, when the bonus reaches 47 per cent of entitlement for each of the deferral years. The starting date for bonus accrual will be 1 July 1998. The bonus will be paid as a lump sum on pension take-up. At current pension rates, the maximum bonus would be $21,251 for a single person, and $35,450 for a couple who qualify for the maximum rate of pension.
Advantages - an Australian perspective
In recognition of the interests of the United States Sub Committee on Social Security the advantages of the Australian system focus in four main areas.
Firstly, the Australian Social Security system was developed according to Australian needs and history and it works appropriately for this country. Demographic conditions, institutional arrangements and political circumstances have had an impact on the direction that the social security system in Australia has taken. Within this framework Australia has developed its system to ensure that it meets the needs of Australians in a comparatively equitable manner.
The provision of uniform and flat rate benefits result in a high degree of equality and uniformity in pension and benefit rates and the structure of rights is based in legislation with a well established system of rights to appeal.
Secondly, the Australian Social Security system has been historically based on the principles of adequacy and income redistribution and is widely recognised as having one of the most highly progressive tax and transfer systems. As a consequence it is highly successful at directing social benefits to the poorest sector of the community compared to other countries.
Thirdly, Australia has demonstrated that it is possible, under the right circumstances, to add an earnings related scheme onto a non-contributory system. In particular, Australia's experience - although it is clear that the system is not yet fully tuned - demonstrates that major retirement income reform can proceed incrementally according to a country's institutional and other requirements.
The full impact of the use of superannuation in Australia will not be evident until around. However increasingly, aged people have access to more private resources. over time there has been a sustained increase in the percentage of age pensioners receiving a part-rate pension because of the level of their private income. In June 1987, 25.6 per cent of age pensioners received a part-rate pension; by June 1997 this had increased to 32.6 per cent. This is expected to continue to increase as superannuation coverage and benefits increase over time.
Finally, as a consequence of well established legislation, infrastructure and support, Australia has been able to fund its Social Security system from general revenue without adverse effects on the rate of Social Security payments. Australia' s efficiency in its administration of the means testing system has assisted in keeping costs down. Recent data indicates that the Australian cost of administering social security as a proportion of total transfers was 3.8 per cent.
A major advantage of a targeted approach (via income and asset testing) combined with general revenue financing is its flexibility in dealing with economic, social and demographic changes. Spending decisions are more likely to be based on current and future priorities and economic conditions. Income and asset testing of social security benefits in Australia has also constrained social expenditure to levels far below those in most other OECD countries.