The intergenerational gap

When Federal Treasurer Peter Costello handed down the first intergenerational report in 2002, only a very few people could have imagined the way in which it was going to impact on the formulation of Government policy over the succeeding five years.

Perhaps more importantly, very few people within the Australian financial services industry could have conceived of the manner in which the first intergenerational report would give rise to a stream of policy initiatives that would fundamentally alter the advice they give clients.

It is on that basis that it is worth reflecting on the changes that flowed from the first intergenerational report:

~ transition to retirement;

~ contributions splitting;

~ removal of defined benefits limits; and

~ simpler super.

Of course, underpinning every one of those ‘headline’ policy issues flowing from the first intergenerational report were a raft of smaller but no less significant changes to Australia’s superannuation and retirement incomes regime.

From a political perspective, it is fair to say that the first intergenerational report allowed the Howard Government to wrest the superannuation debate from the hands of the Australian Labor Party (ALP).

The ALP may still lay claim to being the authors of the Superannuation Guarantee in Australia, but it is arguably the Howard Government that has created the policy fundamentals that make superannuation a highly attractive investment destination.

While five years may separate the first and second intergenerational reports, they share the one key element in terms of Government policy: the encouragement of Australians to remain in the workforce for as long as possible.

However, there is another key message contained in the second intergenerational report — that Australians will be facing higher taxes and tougher times unless there is an upturn in the future working age population by way of either an increased birth rate or increased immigration.

But it was the necessity for higher levels of workforce participation in the face of an ageing population that was made abundantly clear by Costello when he launched the second report in early April and said that the biggest problem confronting Australia remained its ageing population.

However, Costello made clear that the nation had made progress in the five years since the first report, including marginally improving the nation’s fertility rate and measures such as extended workplace participation and the Future Fund.

“But demographic changes are still working against us,” he said.

“The fact is that the lower fertility rates of the 70s, 80s and 90s are still winding their way through the system. The large population bulge caused by the post-war baby boom is moving through the population and heading towards retirement.

“The updated projections show that Australia’s population continues to age, that is, that larger and larger proportions of our population will be in the older age cohorts. And this will lead to slower economic growth,” Costello said.

While people working within the financial services industry will be interested in the findings of the second intergenerational report, most will be seeking to determine whether it will have any significant impact on the Government’s Budget strategy.

The Treasurer gave few hints about what might flow from the report, but made clear that health and ageing and the age pension were clearly the areas that would generate the ongoing spending pressures that would need to be addressed by the Government.

However, the Government seems more likely to refine its existing policy initiatives rather than launch any major new projects.

Costello said, for instance, that the Government would continue to work at encouraging people to remain in the workforce longer — a view that was strongly supported by the Prime Minster.

Costello said Australia was already achieving great results with respect to participation and that Australia’s labour force participation rates were increasing, with the trend towards increasing participation for women and older workers continuing.

“Moreover, in the past five years, there has been a significant reversal in the long-term decline in the participation rates for men aged 55 to 64,” he said.

“I think an excellent example of policy for the future is the recent Simplified Superannuation reforms,” Costello said.

“These reforms are the most significant reforms to the taxation of Australia’s superannuation system in decades.”

Analysis of the second intergenerational report has resulted in some mixed reviews for the Government, with companies such as RussellInvestment Group suggesting that the Government may have overstated the impact of an ageing population while being somewhat conservative with respect to participation rate projections.

The Russell analysis pointed out that the intergenerational report had presented a baseline set of projections for demographic and economic developments over the next 40 years, based on the actual historical experience over the past 40 years.

“Due to the uncertainties which surround making projections into the future, the Government regards the baseline projections as plausible central estimates, more than forecasts,” it said.

What the Government will find uncomfortable about the Russell analysis is that it suggests that a future Government might be forced to undo some of the Howard Government’s most recent changes to superannuation.

Looking at the assumptions contained in the intergenerational report, the Russell analysis said that, in practice, the “projected deficits would be funded in some way”.

“That will lead to changes in some of the variable discussed above, until a new equilibrium is found,” it said.

“One possibility is that the deficit could be funded by increasing taxes. However, there will be a narrowing of the tax base with fewer Australians of working age. Older Australians that are paying little or no taxes could be asked to contribute. It is possible that a future government could be forced to consider undoing some of the recent superannuation changes,” the Russell analysis said.

It said that a larger and younger population could help to reduce the predicted challenges of the Australian demography.

“Australians could start to have larger families, but all the empirical evidence leads us to believe that this is not going to happen to any significant extent,” the analysis said.

“The other approach to increasing the working age population is to accept additional migrants in that age band.”