No Case for Tightening the Age Pension Means Test: A Response to Michael Keane’s Analysis

Michael Keane’s recent Austaxpolicy piece, Better Targeting of Australia’s Age Pension, based on a CEPAR working paper co-written with Fedor Iskhakov, is flawed because it does not adequately explain the paper’s significant limitations. While the dynamic modelling involved adds weight to the arguments in favour of retaining the age pension means test, it does not support further tightening of the test as Keane claims.

Low tapers used in the study

First, the paper and the Austaxpolicy article use a simplified version of the income and assets tests as applied in 2009, not as they actually exist today. The paper refers to an income test taper of 27.7% whereas the test at present has a taper of 50%, which applies above a threshold ($174 per fortnight for singles and $308 per fortnight for couples). Taking into account the interaction with the personal income tax, the taper above the threshold is generally between 65% and 70%, well above the ‘doubling’ of the taper to 55.5% recommended in the paper and used in the modelling.

The assets test used has even more limitations. The paper uses a simplified taper of 0.5% (the Austaxpolicy article strangely refers to 1.5%), whereas the current taper is 7.8% above the (admittedly very generous) thresholds ($258,500 for single home-owners and $387,500 for couples owning their own homes). So the recommended ‘doubling’ of the taper to 1% as used in the modelling, compares to an existing taper already nearly 8 times greater.

The assumption that the current means tests are very generous not only overlooks the tightening since 2009, but also understates the impact of steadily increasing superannuation savings. Drawing on the 2014 National Commission of Audit report (wrongly described as ‘independent’), Keane claims in the Austaxpolicy article that ‘some 80%’ of those of eligible age receive some age pension. The working paper seems to assume the figure is around 75%. According to the Department of Human Services data, by 2018, the proportion had fallen to 67% from 82% in 1998.

While projections are difficult given uncertainties about the level of the Superannuation Guarantee into the future and possible changes to the means test, it seems likely that as the superannuation system matures the proportion will continue to fall, probably to 60% or lower. Maximum rate pensioners have already dropped from 56% of those of eligible age in 1998 to 42% in 2018, and seem likely to fall further to no more than 30%.

Assets test already tightened

Keane is similarly incorrect in stating that people with ‘well over $2 million in assets’ (not including the home) can receive some pension. The Morrison assets test changes mean that the assets test cut-outs are now $567,250 for a single home-owner and $853,000 for a couple owning their own home. The cut-out points are higher for the minority who do not own their own homes, but are still at most slightly over $1 million. These do not, by definition, include the value of a home.

So, even if the current means tests were tightened somehow, the budget savings would almost certainly be considerably less than the working paper suggests; accordingly, the dynamic modelling would need to assume a lesser reduction in personal income tax rates presumably leading to lesser impacts on workforce participation, consumption and saving.

It may well be that the current high effective marginal tax rates under the pension income test have little negative impact on participation in the labour force. This is partly because the decision to work or not amongst older people is less often made at the margin but more often in terms of when to retire, or as the working paper suggests, to stop working full-time. Nevertheless, it is hard to see any strong case to increase the effective marginal tax rate beyond its current level.

Rationalise, rather than just tightening

With regard to the assets test, while arguably the thresholds are excessively generous, the case for relaxing – not increasing – the current taper is overwhelming. Certainly, retirees should be drawing down their savings not just living on the earnings. But under the current 7.8% taper, the more assets a person accumulates above the threshold (up to the cut-out point), the lower the net income even if the retiree is drawing down the assets as if they were a lifetime annuity. Accordingly, those approaching retirement who already have savings around the assets test thresholds face a serious dilemma about how much more to save and where to put their saving.

Rationalising, rather than simply tightening, the means test is required. A better approach would be to return to a merged means test where assets are converted into income (including by assuming drawdown of the capital) and then applying the income test to the total. This would be similar to reducing the assets test taper to around 3%, but with a lower threshold.

The one area where tightening the means test would clearly be sensible policy would be to include the home (main residence) in the assets test above some high threshold. However, this should be seen as a longer term initiative so as to avoid retrospectivity, allow people to plan for their retirement with reasonable certainty, take into account the still maturing nature of our superannuation system and allow financial institutions to develop suitable home equity release products. Keane does not explore these issues.

In the immediate term, there are more important retirement income issues to address than tightening the means test. These include how to help retirees convert their accumulated savings into secure income streams (managing risks sensibly without necessarily having to grapple with the system’s complexities), how to help people plan ahead as they approach retirement (say from age 50) with confidence about tax and means test arrangements, and how to reduce the excessive transactional and efficiency costs of our system. Hopefully, the review announced recently by the Government will focus primarily on these pressing matters.

 

Further reading

Modelling the Age Pension Taper: Reply to Andrew Podger, by Michael Keane

Better Targeting of Australia’s Age Pension, by Michael Keane