Australia's Future Tax System

Architecture of Australia's tax and transfer system

7.5 Savings and investment incentives

Australia's total savings (or national savings) is made up of the private savings of households and businesses (retained earnings) plus public savings (government budget surpluses or deficits).

The savings of individuals and households fulfil three important functions:

  • to provide a means for them to smooth their income over time — in particular, between the individual's working life and their retirement;
  • to meet transitory adverse shocks such as sickness and unemployment; and
  • to finance investment in capital that can be used to improve productivity, leading to higher incomes.

The decisions made by individuals and households in apportioning income between consumption and saving affect their wellbeing now and in the future. The tax—transfer system impacts on these consumption/saving decisions in three ways:

  • through marginal tax rates and access to transfers (including the means testing of savings);
  • by providing tax concessions to some savings vehicles; and
  • through compulsory savings for retirement (the SG).

These mechanisms can have a complex set of behavioural outcomes:

  • the existence of income support as a guarantee of income may reduce the incentive to save for periods when earned income is expected to be lower (for example, unemployment and old age);
  • incentives associated with different savings vehicles may lead to a change in saving preferences rather than a change in the level of aggregate saving; and
  • incentive effects may differ at different income levels.

The empirical literature on the effectiveness of tax‑preferred retirement savings plans in encouraging savings is mixed, with researchers finding effects ranging from significant impacts on savings to little or no effect (OECD 2004). If the concession results mainly in a switching of savings from one vehicle to another there may be no increase in overall household savings. Indeed, national savings may decrease if the value of additional savings is less than the cost of the concession to governments.

The OECD (OECD 2007d) considers that the distribution of concessions is an important indicator of the success of such savings vehicles. In this regard, the success of a policy in encouraging new savings depends on the level of take‑up by moderate‑income households. Higher income households are more likely to respond by switching their existing savings.

Means testing of income support payments can also affect the incentives to save or dissave by reducing existing savings. These effects are likely to be stronger where the level of savings results in a reduction in income support entitlements. As a result, they tend to be more significant for low to middle income earners.

Means testing is also likely to affect the savings decisions of individuals who have more frequent contact with the income support system — for example, an individual with an intermittent attachment to the workforce. For these individuals, the decision to save may be influenced by a tighter assets test and a liquid assets waiting period which forces some allowees to run down their savings before accessing income support. Overall, the effects on saving need to be considered in the context of Australia's targeted income support system.

Australia's tax‑preferred savings vehicles

Australia's principal tax—preferred savings vehicles are owner‑occupied housing and superannuation. Owner—occupied housing is generally exempt from capital gains tax and taxation on the value of rent saved from owning a home. Consistent with this treatment, expenses such as interest costs and maintenance costs are not deductible. In the transfer system, the owner‑occupied home is exempt from asset testing.

Unlike the returns on most other taxable savings, savings invested in superannuation are generally not taxed according to the individual investors' personal tax rates. Benefits from a taxed superannuation fund are paid tax free from age 60. Superannuation contributions and earnings are generally concessionally taxed. The value of superannuation tax concessions provided to contributions and earnings is estimated to be over $27 billion in 2008‑09, increasing to over $31 billion in 2010‑11 (Australian Government 2007a).

The changes to personal income tax rates since 2000 have had a significant impact on the concessions received by low‑income and middle‑income earners. Based on the 2008‑09 tax rates, it is estimated that around 1.2 million individuals do not receive a personal income tax benefit4 from the tax rate applied to their concessional superannuation contributions. In addition to the number without any concession on contributions, an estimated 1.2 million individuals only have a concession equivalent to 1.5 percentage points (the Medicare levy) in 2008‑09.

Chart 7.13 shows the effective marginal concession on superannuation contributions for a single income earner with no children at different levels of income. The higher the effective rate, the higher is the value of the concession. Concessions for higher income earners have been relatively stable since contributions were first taxed in 1988. However, the effective concession for people earning lower incomes has fluctuated over this time.

Chart 7.13: Effective marginal concession on superannuation contributions

Chart 7.13: Effective marginal concession on superannuation contributions

Assumptions: Single income earner with no children. The value of the concession at lower incomes would be higher for an individual with children, who would be affected by the phase‑out of transfers. Rates may change depending on family type.

Source: Australian Treasury estimates.

These fluctuations reflect changes in the arrangements for the phase‑out of the LITO and the phase‑in of the Medicare levy. From 2010‑11 a person earning a third of AWOTE will receive a concession of 1.5 percentage points on their concessional superannuation contributions. This compares to a concession of 16.5 percentage points for a person earning AWOTE and 31.5 percentage points for someone earning three times AWOTE.

The government superannuation co‑contribution is intended to provide access to more concessions for low and middle income earners. Under this scheme, post‑tax contributions are matched at $1.50 for every dollar up to a maximum contribution of $1,500. The maximum contribution is available for individuals with total income below $30,342 and phases out at the upper threshold of $60,342 (2008‑09).

It is estimated that around $1.1 billion of co‑contributions will be paid in 2008‑09 in respect of post‑tax contributions made in 2007‑08. Approximately 1.4 million individuals will receive a co‑contribution, which represents around 20 per cent of those individuals who would be eligible if they contributed.

4 The number of individuals where the net tax paid on their contribution and other taxable income is greater than or equal to the amount that would have been due had the contribution been taxed at their personal marginal income tax rate.