Australia has a compulsory superannuation scheme, and I have questions about it. These questions have been floating around in my head for a while, but the catalyst for thinking about them this week was this article by Brian Toohey, which I discovered through the Australian political blog Larvatus Prodeo. I’ve always been a supporter of Australia’s compulsory superannuation laws, which seem to be popular across the Australian political spectrum and were introduced by one of the two great men of modern labour politics, Paul Keating, but over the last year I’ve seen an increasing range of criticisms of the underlying concept and the Australian system in particular. I’m no economist, but some of these criticisms seem so basic that it’s hard to believe they haven’t been thought of and dismissed by people who understand these kinds of systems, and the logical answer to them appears to be a shift away from the neo-liberal model of personal retirement savings and back to a Keynesian (?) version of government-funded pensions. The conclusions of a sustained criticism of the Australian system, one way or the other, probably have relevance to the ongoing US debate about privatizing social security.

This post, then, is an attempt to frame these questions in the hope someone out there will answer them. It’s clearly off-topic, so sorry about that.

How it Works

The Australian superannuation system basically works like this: all Australian employers are required under law to contribute 9% of their employees’ salaries at least every three months to a registered superannuation fund. This 9% is on top of the employer’s wages, and is meant to represent a kind of top-up of their wages into a pool of funds that are reserved for their future. Soon this top-up will go to 12%, and many employers choose to top-up more. Employees can also choose to set aside some proportion of their wages – I typically put a small amount aside – and all of this is sequestered away in an account until they turn 55 (or older), when they get the resulting vast scads of cash. Employees who put their own money aside get tax breaks on that money which can be quite lucrative (especially for the higher income earners).

The system was introduced in 1992 by Paul Keating, at which time the compulsory contribution was 3%. This contribution is generally seen as taking the place of a pay rise, that is Australians forewent a 3% pay rise in order to obtain this superannuation security in their old age; but many commentators have pointed out that this is a disingenuous comparison (one made by Toohey in the linked article above) since it’s unlikely that the government could have mandated a 3% pay rise for all employers – if not diverted to superannuation this money would be going into the pockets of employers, not employees, and then (in theory) 30% of it would be taxed as corporate taxes.

For the purposes of my questions about super, though, I want us to assume a few basic principles about superannuation as it’s presented to us:

  1. Fears about the ageing of the population are true: part of the justification for the superannuation guarantee (at least in retrospect) is that the population is ageing so we need to devote more money to retirement funds, or at least change the balance of private to public funding, since there will be less taxpayers in the future
  2. The superannuation contribution would otherwise be a pay rise: we don’t need to assume that the entire proportion of it would be a pay rise, but let’s assume that at least a decent proportion of the superannuation contribution would otherwise be delivered to employees as a pay rise
  3. The main alternative to compulsory private superannuation is government pensions: that is, if we don’t have a compulsory system of superannuation, the government will provide everyone with a (means-tested?) pension from general taxation

So, let’s consider the objections I have heard over the past few years.

The Libertarian Objection

As I said, compulsory superannuation seems to be generally well supported across the political spectrum in Australia. Free market types like it because it moves responsibility for retirement savings from government to individuals, but at the same time it doesn’t leave (many) people uninsured, which is always the risk with wholly private systems. That is, it introduces a private savings mechanism without having a problem of free-loaders. Government intervention types like it because it maintains a safety net through its compulsory nature. Most libertarians in Australia are pretty practical about their libertarianism, so tend to accept limits on the economic “freedoms” that their libertarianism would lead to, so I think many libertarians would support this kind of policy too. However, there is a common libertarian objection I have read, which is this: for the lowest earning people in the labour market, their compulsory superannuation contributions will also be low, and at the end of their working life they will get a very small pension from their superannuation account. So, accepting that the contribution to superannuation is foregone wages, these people are being forced to forego a small improvement in their current poverty, in order to guarantee them a retirement future of … poverty. A 9% pay rise at the bottom end of the income distribution is much more valuable than at the top end; yet when they retire, low income earners’ superannuation will provide them nothing better than they would get from any economically reasonable state pension. So from a libertarian perspective, these people are being forced to spend their money now in a way that doesn’t benefit them later. They’d be better off receiving that 9% now, spending it on cocaine and dancing girls, and retiring on the state pension.

Note that this libertarian argument assumes the existence of a state pension. So it’s contradictory in libertarian theory, but I think it’s very true in a real world. The superannuation system benefits the wealthy far more than the poor. Of course, this argument fails if assumption 2 (the contributions would otherwise be a pay rise) were not true. But a variant exists even then: if the employers pocketed that 9% contribution, 30% of it would go to the government as corporate taxes, and some proportion of that would support a higher level of state pension, and poor people would benefit most from that increased state pension.

The Perverse Tax Cost of Compulsory Superannuation

The system as currently constituted provides tax breaks to people who make voluntary contributions to their superannuation, in order to encourage individual contributions. These tax breaks are now estimated to cost up to $100 billion, which is more than the state pension would cost if everyone were accessing it. We can see this through a few simple calculations of what we could spend this money on if we didn’t blow it on tax breaks for superannuation:

  • A universal government wage: That $100 billion could be turned into a guaranteed income for every Australian of $4500 a year, a long-held libertarian goal. This would lead to the abolition of the welfare system, which money could also be turned into a guaranteed income, which would probably go up to about $6000. We could then simplify the tax system to get rid of poverty traps and other disincentives for poor people to work, which most people think would both increase the tax take and reduce the number of the absolute poor – a worthy goal. And because the universal wage holds across your lifetime, working parents can put their childrens’ wage into trust for their education, and will receive the universal wage as a pension when they retire. Is this a less efficient use of $100 billion?
  • A decent aged pension + maternity scheme: Australia’s current paid parental leave scheme costs about $150 million a year. This $100 billion dollars of superannuation tax breaks could easily be used to institute a well-paid state pension for the over 65s, along with a huge increase in the scope and value of the paid parental leave scheme – in fact, I would suspect that $100 billion could be used to basic pay every Australian the equivalent of a full-time wage as a parent, achieving the long-held feminist goal of paying women (or, in the modern world, men too) for the value of their household labour. One of the main justifications for the superannuation scheme is the demographic shift predicted for the next 30 years, with an increase in the ratio of dependents to tax payers, but this can be reversed easily by increasing the birthrate, and the accepted best way to do this is a good paid parental leave scheme. So by spending this money on the state pension plus the parental leave scheme we guarantee a stable, reliable pension into the future.
  • A return to free education: The single best investment a poor person can make in their future is education, and some argue that the best way to guarantee that this will happen is free access to education. The money could be spent on the education system, and better educated poor people earn more, so are better able to voluntarily save for their retirement.
  • Changes to the housing system: Housing in Australia is becoming hideously expensive and creating increasing amounts of inequality. The easiest way to make young people safe for the future is through a massive change in Australia’s housing system, and this could easily be achieved through judicious spending of this $100 billion[1]

Regardless of the particular spending benefits of this money, it seems crazy to me that the tax breaks on superannuation should exceed the cost of a decent government-funded pension.

The Equity Objection

One of the strongest ongoing objections to these kinds of social insurance systems – where your contribution to the system and your ultimate repayment from it are proportional to your income – is that they benefit the rich more than the poor. A 9% foregone pay rise at the bottom income quintile is a much more punishing idea than 9% foregone at the top, but at the end of their working life the people at the bottom income quintile get a much lower return for that foregone pain than the people at the top. Under a fixed state pension, funded from general taxation, the rich benefit much less from the scheme than the poor. Both have received that 9% pay rise, both have paid taxes, but at the end of their lives the poor have gained more from those taxes than the rich because the pension is a much higher proportion of their pre-retirement incomes than it is for the wealthy. This is the essence of progressive taxation, and it’s a strange quirk of history that a labour government introduced such a regressive system.

The Boom-and-bust Objection

One significant consequence of the superannuation scheme is that it has led to a massive increase in the amount of Australian money floating around in investment funds, causing trouble. Current estimates are that $1.2 Trillion are floating in the investment market, paying $18 billion in commissions to fund managers. All this private money looking for somewhere to invest is supposed to do good in the local economy – fund managers invest in shares, which promotes the growth of industry, which is good for economic growth. But this money also is a lure for all sorts of ponzi schemes and economic bubbles – bubbles tend to happen when large amounts of money are available to invest. Other countries (e.g. the UK) are operating similar schemes, and naturally once the pool of available funds exceeds the capacity of the real economy to absorb the money, the remaining funds start being invested in capital growth schemes, which then burst because they have no real foundation, and cause crashes. Is it a coincidence that the world’s last few big crashes correspond to an era when huge quantities of money are available for investment through 401(k)s, superannuation schemes, and sovereign funds? I don’t think so.

Also note the cost of this money – it’s $18billion to invest $1.2 trillion. Is it possible that if that money were collected as taxes, the $18billion would be spent on jobs in the public sector spent administering that money? Is a job in the public sector worth less than a job as a fund manager? Does either person contribute less to society? And can we say after the GFC and the subsequent economic troubles it has caused that the $1.2 trillion would not be better spent on government infrastructure investment? Especially given that one of the major causes of inflation in Australia is infrastructure bottlenecks and environmental problems?

There is a general argument that the private sector distributes money more sensibly (?) or efficiently (?) than the public sector, but is this still true when the available investment funds exceed the capacity of the market to spend them? Governments can store that money as surplusses, against hard times; investment funds piss it against the wall in investment bubbles and ponzi schemes.

The Stored Wealth Objection

Money invested in superannuation for the future is seen as providing for one’s retirement, but that money doesn’t suddenly appear when you retired as a golden watch, a bottle of champagne and food and medical care for the next 20 years. It appears as money to spend on those resources, but if those resources haven’t been secured in the period between your investing the money and realizing the returns, or if they have become scarce in that time, then your money won’t actually provide for anything. The superannuation funds focus on increasing their own value, but they don’t necessarily do that by increasing the size of the actual economy where you actually live. So for example your fund could invest in high-return farming projects in Iceland, Africa and Russia, so that when you retire you get lots of money – but then you have to buy food imported from those high return farms overseas, because no-one was investing locally.

Superannuation funds are under no particular obligation to improve the economy of the people who invested in them, so in the long run do they actually help to maintain a good environment for the superannuant? Shouldn’t at least some of this money be being spent by the government, to avoid the risk of market failure? (And is this objection any different to the Boom-and-Bust objection?)

The Poor Returns Objection

The Stored Wealth Objection can probably be answered by pointing out that the issue it addresses is handled by inflation. But the performance of superannuation funds over the past 20 years has been dreadful, with their average returns only 0.1% higher than long-term inflation. So really, the money would be better spent if it were just saved in a normal bank account, or invested in cash or government bonds. So why the special system of compulsory superannuation? The money from the foregone 9% pay rise might be better used if it were kept by the companies to use in investment or profits (which are taxed, and then used by the government to fund infrastructure development, which lowers inflation) or paid directly to employees (where it is taxed, and then used by the government to fund infrastructure development, which lowers inflation) to be spent (economic growth) or saved (future economic security). None of these alternative options could possibly provide a lower rate of return than the superannuation funds have offered.

It’s all a Big Scam

(This is also an objection). Some have implied that the whole thing has been set up by the finance industry as part of its 10 year long march into control of the economy, and the main beneficiaries of the whole process over the long term have been the funds management industry. This is partly ameliorated by the observation that the biggest superannuation funds in Australia tend to be union-related, industry-specific funds, not big bastard international banks; but I’m sure the people in charge of those industry funds are still managing to feather their nests nicely compared to doing a real job. So who really benefitted from this program?

Final Notes

Looking at these objections, it seems to me that Paul Keating conned us (or, more likely, got it wrong). We’re better off with a state-funded pension system supported through taxes, and the problem of the demographic shift that will undermine our ability to support old people in the future is better dealt with by addressing it directly – through schemes to increase the birth rate, lengthen the working age, etc. The huge flood of money into the private sector has led to increased boom and bust cycles, reduction in affordability of housing, and inflation, at a time when Australia needs its government to be spending huge amounts of money on infrastructure development and environmental improvement. However, my understanding of the details of these arguments is limited so please, if you have an alternative opinion, out with it in comments!


fn1: and obviously everyone would also get a pony