Retirees tilt the generational bargain in their favour

Pension spending is rapidly becoming unsustainable. Not only because the ageing population will place too much pressure on our tax system but because it is shifting the bargain between the generations too much towards retirees at the expense of workers.

Over the past 40 years the proportion of average wages dedicated to paying old age pensions has doubled. Each generation has demanded more from the next generation than they were willing to give the previous one.

In part this increasing cost has been driven by life expectancy. When the pension was first introduced, the retirement age was set above the average male life expectancy. Since then, life expectancy has increased by one year every three to four years, far outstripping recent increases in the retirement age.

Yet this is not the whole story. Between 1880 and the early 1970s, male life expectancy at 65 (that is, the number of years people were expected to live in retirement) had barely moved. Life expectancy at birth had increased 21 years but life expectancy at 65 had increased just one year. More people were making it to pension age, but the length of time they had in retirement was largely the same.

Since then life expectancy in retirement has increased seven years for men and more than six years for women, and all indicators suggest this trend will continue.

This massive increase in time in retirement has had a profound impact on the budget because both sides of politics have expanded the value and scope of the age pension. In real terms, the full rate of the pension increased seven-fold between 1911 and 2011 — and the means tests have also been made more generous.

So more people are eligible for the pension and are receiving it for longer.

Meanwhile, the value of the pension has been increasing much faster than wages. Not only has more wealth been accumulated by older generations, they are also taking an increasing share of national income.

As the population ages and retirees’ political power increases, it is easy to imagine a scenario in 2055 where workers are expected to pay a greater proportion of their salaries to pay for the retirement of others than they pay for their own retirement. Even under current policy settings, these figures will almost converge.

The Intergenerational Reports predict the ageing of the population could add 4% of GDP or more to government spending by 2055, even before discretionary increases in pensions are factored in (there have been three such increases since the GST was introduced). This is far beyond the scope of our current taxation envelope, which for 40 years has fluctuated around a mean of 23.8% of GDP.

Beyond the question of whether we can afford this is another issue: will future taxpayers tolerate a massive increase in taxation to fund a retirement lifestyle they themselves may never achieve?

This is especially pertinent when pensioners are not using their significant wealth to support themselves in retirement. The unused savings stored in pensioners’ homes now exceed $700 billion. One third of retirees also voluntarily leave work before retirement age — diminishing their retirement nest egg — and many of those also go on to receive an age pension.

Rebalancing the generational bargain requires twin streams of reforms.

First, the retirement age should be increased by six months every four years to ensure it keeps pace with increases in life expectancy. When coupled with reforms that include the value of the primary residence in the pension means test, this should ensure the pension is focused on alleviating poverty of those who really need it, not just enabling pensioners to amass a store of wealth.

Second, the age at which superannuation can be accessed should be increased. At a minimum, it should increase in line with pension age. Flexibility in accessing superannuation is important — for example, it may be better to require people accessing their super before retirement age to purchase a deferred annuity — but the system currently incentivises people to leave work early and rely on the pension.

The broader superannuation system needs review to ensure it boosts older worker participation but also focuses primarily on encouraging self-sufficiency in retirement. Far too much focus has been placed on the cost of superannuation tax concessions, and we have lost sight of their failure to substantially increase self-funded retirement.

We cannot ignore the imbalance between the generations simply because it is politically difficult. Already younger workers feel the system is rigged against them, they arelocked out of the housing market and discouraged at the seeming inevitable tightening of superannuation laws. The generational bargain must be fair to both sides to be sustainable.

Simon Cowan is a Research Fellow at the Centre for Independent Studies. He is the author of the research report The Myths of the Generational Bargain.