Caution should rule in super tax changes - The Centre for Independent Studies
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Caution should rule in super tax changes

Reforming the taxation of superannuation is the flavour of the moment, particularly with GST changes apparently ‘off the table’. But some of the proposals under public discussion may generate marginal tax rates of over 100,000%, increase complexity, and cut super savings or take home pay for many Australians. Hence, these proposals require much more careful consideration before they are adopted.

Concessional super contributions are currently taxed at a flat rate of 15% for all except the richest taxpayers. Some proposals being floated publicly are for this 15% tax to be replaced by a tax rate that equals the contributor’s personal tax rate minus a rebate.

A rebate of 15% has been suggested by Deloitte Australia and the SMSF Owners’ Association, which would mean an individual on a personal tax rate of 47% would pay 32% contributions tax, while someone on 37% would have a contributions tax of 22%. In general, taxpayers will receive a net rebate if their marginal tax rate is below the rebate. The Financial Services Council argues that the rebate should be ‘at least 20%’. The Business Coalition for Tax Reform has expressed support for this rebate concept in broad terms, while a more complex variation has been put forward by the Australian Greens.

These proposals would mean that super contributions are taxed in a progressive way, with low income earners receiving a net tax rebate, while tax rates may increase for the rich, addressing a key criticism of the current model: it overtaxes super contributions of low income earners.

The table below shows the current and proposed treatments for two of the options under discussion. This does not include the Medicare Levy.

Income
Current super tax rate
Current personal tax rate
Options for tax on super contributions
Option 1 (20% rebate)
Option 1: change from current
Option 2 (15% rebate)
Option 2: change from current
<$18,200
15%
0%
-20%
-35%
-15%
-30%
18,200 to 36,999
15%
19%
-1%
-16%
4%
-11%
37,000 to 79,999
15%
32.5%
12.5%
-2.5%
17.5%
+2.5%
80,000 to 179,999
15%
37%
17%
+2%
22%
+7%
180,000 to 299,999
15%
47%
27%
+12%
32%
+17%
>299,999
30%
47%
27%
-3%
32%
+2%

 

The most important issue with these options is that they will create staggeringly large marginal tax rates on contributions for some people. For example, a person earning wages of $36,999 (and no other income) would have employer super contributions of almost $3,515 (9.5% of their wage). Under Option 2, this person on a personal tax rate of 19% would pay a super tax of 4%, or $140.60.

If this person earns just one more dollar in income, the super contributions tax goes from 4% to 17.5%, and they pay tax of $615.13. They have lost $474.53 from earning one dollar: this represents an effective tax rate of 47,453%.

The details of this calculation are in the table below.

Wage
Super contribution (9.5% of wage)
Super tax rate (15% rebate)
Super contributions tax
Super contribution after tax
Before
36,999
3,514.91
4%
140.60
3,374.31
After
37,000
3,515.00
17.5%
615.13
2,899.88
Change ($)
+1
+0.09
+474.53
-474.43

 

This problem exists for all wage earners earning just below tax thresholds. The effective tax rates are shown below for the option with a 15% rebate (the figures for the 20% rebate are similar).

Income
Contributions tax/rebate
Contributions tax on income + $1
Increase in tax
Effective tax rate
18,999
-259.34
+69.16
+328.50
32,850%
36,999
+140.60
+615.13
+474.53
47,453%
79,999
+1,329.98
+1,672.00
+342.02
34,202%
179,999
+3,761.98
+5,130.00
+1,368.02
136,802%

 

These examples use the fundamental calculation for marginal tax rates: how much more tax does a person pay when they earn one more dollar? Any taxpayer crossing a tax threshold will be affected by high tax rates — generally not as high as in the table above, but still sufficiently high to cause large reductions in net super contributions and exacerbate disincentives to work and earn income.

Proponents of these changes are probably not intending perverse results. However, the problems are real and need to be addressed, perhaps by phasing in of changed tax rates, or by having a higher tax rate charged only on contributions above a threshold. However, these will make the changes substantially more complex, and may come at a large revenue cost.

But the proposals are already complex, even before the high effective tax rate problem is fixed. How do we know this? There is already an extra tax on contributions for people earning over $300,000, and various industry participants have argued this tax is complex to administer — even though it only applies to just 1-2% of contributors. And the proposals above extend this complexity to all superannuation accounts.

There are other issues with the proposed changes to the contributions tax, including that it will exacerbate the impact of bracket creep; the tax hike that occurs because personal taxes aren’t indexed to inflation or wages growth. The linking of super taxes to personal taxes will ‘import’ the bracket creep problem into the superannuation system. We estimate the extra tax impost on super could be around $800m in three years’ time.

In addition, the option for a 15% rebate will increase super taxes for everyone earning $37,000 to $250,000 (see first table above), while some methods of implementing the change could mean a hit to take home pay.

All these issues suggest that these proposed changes to the taxation of super should be reconsidered, perhaps focussing on alternatives (such as proposed by the Henry Tax Review) that provide a rebate based on super contributions, rather than personal tax rates. These other options may be a better way of increasing the incentives for super contributions from lower income Australians.

Michael Potter is a Research Fellow in the Economics Program at the Centre for Independent Studies.