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Some policy suggestions to improve the affordability of retirement

By Peter Costello - posted Friday, 5 March 2004


The starting point for thinking about our long-term, future is the Intergenerational Report released with the 2002-03 Budget. This was the first time any attempt had been made by an Australian government to look across the generations and identify the challenges that demographic change will bring to our society and our government.

The Intergenerational Report looked ahead 40 years. Our society, the way we live, the opportunities available to us, and indeed our own aspirations, will change dramatically over the next 40 years, just as it has over the past 40 years.

In 1962, only 35 per cent of women participated in the labour force. Now more than 55 per cent do. In the early 1960s the average family consisted of a single (usually male) breadwinner supporting a wife and two or three children. Today around 44 per cent of families have two incomes; around 23 per cent of families have a single parent; and we are having far fewer children. Our fertility rate has fallen to around 1.75 - well below the replacement rate.

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Our society has aged significantly over the last 40 years. For example, in 1962 just over 30 per cent of the population was less than 15 years old. Today it is around 20 per cent, and by 2042 it is projected to fall to under 15 per cent.

In contrast, the proportion of the population aged 65 and over increased relatively slowly over the last 40 years, from around 8.5 per cent in 1962 to 12.7 per cent in 2002. Over the next 40 years, however, we are projecting that this will nearly double, and in 2042 almost one in every four Australians will be aged 65 or over (with the largest increase being in the number of Australians aged 85 and over). At the same time, growth in the potential labour force (that is, people of workforce age) is expected to fall from around 1.2 per cent per annum over the past decade to zero in 40 years time.

We have a number of choices as to how we address these issues. The decisions we make today will affect the kind of Australia our children and grandchildren will live in. The time to start thinking about these issues is now. There is no need for panic measures. But there is a need for careful and determined policy. What we decide in the next few years will have a significant bearing on our quality of life and our children's future.

Among OECD countries, Australia's total labour force participation rate ranked 12th in 2002, suggesting there is significant potential to improve participation both in the short and medium term.

The new paper, Australia's Demographic Challenges, canvasses a number of opportunities, on which we are asking for community comment, to improve participation. The paper sets out three complementary policy areas which could lift labour-force participation: improvements in the capacity for work, through better health and education; better incentives for work; and improved flexibility in the workplace.

Education and training needs a strong foundation of skills learned in schools. Recent OECD studies confirm Australian students rate highly in international comparisons of reading, scientific and mathematical literacy. However, we can improve further. For example, an estimated 12 per cent of 15-year-old Australian students, and around 20 per cent of the adult population, continue to have very poor literacy skills.

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We need to ensure existing literacy and numeracy programs continue to deliver results. We need to help people improve their foundation skills. We need to ensure that transition and employment services better help people in their moves between jobs, from training to jobs, or from periods out of the labour force back into employment.

Health is another key aspect of our capacity to work. Poor health often leads to early retirement, spells out of work, and lost productivity through sickness or injury. Thirty per cent of 50-to-65-year-olds who retire in Australia do so because of illness or disability.

Over the past 40 years deaths from infectious diseases have fallen. Deaths due to cardiovascular/heart diseases, cancer and diabetes have all increased in relative terms, with deaths resulting from cancer roughly doubling to 28 per cent of all deaths. Today the Australian government funds programs aimed at preventing cancer, such as the National Tobacco Strategy and early detection programs like the BreastScreen Australia and the National Cervical Screening programs jointly funded with the States and Territories. Funding for these detection programs is in the order of $100 million per annum.

The traditional focus of governments is on those who have become ill but preventative medicine would take some pressure off the doctors and hospitals who treat the sick, and mean the sustainability of the system as a whole would be enhanced. Most importantly, it would bring benefits in terms of improved quality of life for individuals, with consequent benefits for workforce participation and productivity.

Labour force participation largely results from choices by individuals and families. These choices, however, are influenced by tax arrangements, provision of income support and retirement-incomes policies.

Our income-support system provides people with assistance during times when they are finding it hard to support themselves. The current system was set up at a time when full-time work was the norm for men but many groups, such as women and people with disabilities, were not expected to have a job. Today, opportunities and expectations are different.

Around 2.7 million working-age Australians are on income support - over one in five adults of working age. Forty years ago just under one per cent of the population was on an Invalid Pension. In 2002 we had over three per cent of the population on the Disability Support Pension (DSP). Many remain on income support for long periods of time, and we have one of the lowest rates of employment for disability pensioners and lone parents in the developed world. We now have more than 225,000, about one in every eight, men aged between 50 and 64 receiving DSP.

Forty years ago, the workforce was dominated by men who started work when they turned 15 or 16 and worked till they retired at 65 onto the Age Pension. Many spent 50 years in the workforce. Some full-time workers now spend as little as 30 years in the workforce, yet life expectancy is increasing rapidly. In 1964, the average 65-year-old man could expect to live for a further 12 years. For women, the corresponding figure was 16 years. By 2004, life expectancy for a 65 year old man had increased by 50 per cent, to 18 years. Women today can expect to live for a further 21 years after reaching age 65.

Preservation rules that allow access to superannuation as a lump sum before Age Pension age can encourage people to prematurely retire. They can send the signal that this is the de-facto retirement age. We need to guard against this. In 1997 the government decided to increase the preservation age to 60 years by 2024. However, even these changes still allow many of the babyboomer generation to access superannuation lump sums before Age Pension age.

Looking forward, the retirement-income system also needs to consider changing preferences for work by older Australians. The government has already made it easier for people over age pension age to continue to work if they wish to. The Senior Australians Tax Offset and the reduction in the age pension income test taper rate from 50 per cent to 40 per cent mean that people who continue to work will pay less tax while retaining more of their age pension.

However, the superannuation system is still largely built on historical principles that a person must be in the workforce to make superannuation contributions and retire from the workforce to receive their benefits. The concept of a set retirement age must change in line with the demographic changes occurring in Australia.

The opportunities for older Australians to remain in the workforce are likely to grow as the population ages. Older workers are also expected to want to retain a connection with the workforce but gradually wind down their hours of work. The superannuation system needs to cater for these changing workplace arrangements. To this end, the government will amend the superannuation laws to allow people to access their superannuation from preservation age as an income stream. This will allow people to take advantage of opportunities to work part time and supplement their income with their superannuation.

To broaden the choices for financing retirement, the government will extend complying status (thus allowing generous tax and social security concessions) to new market-linked income stream products which require an orderly draw down of capital over a person’s life expectancy. These products will be non-commutable and will restrict payments to a set proportion of the account balance.

At the same time, a 50 per cent social security assets test exemption for particular income stream products will apply so that it is more consistent with the intended role of the age pension as a safety net for people who have not been able to fully save for their retirement. The higher pension reasonable benefit limit and a 50 per cent assets test exemption will apply to these products purchased on or after 20 September 2004. This will allow industry time to develop and have these products on the market.

The combination of age pension, superannuation and associated tax concessions provides a firm base for most people’s retirement incomes. This year, taxpayers will provide almost $19 billion to fund age pensions and a further $11 billion for superannuation tax concessions. These arrangements provide Australians with higher levels of retirement incomes than ever before.

With much-reduced growth in the working-age population in the future, it will be essential that we generate flexible work opportunities for all those who want them - including those who are currently unable to find a job at all, or who are looking to increase the hours that they work. Reducing the amount of regulation imposed on those seeking to negotiate mutually beneficial wages and conditions is the key to this flexibility.

The government has already legislated to remove any age discrimination that exists for employment by the Australian government, and provides leadership in promoting community understanding of the economic and social imperatives of greater participation by mature-age people. The Business Council of Australia has recently issued a guide for supporting older workers, which is aimed at encouraging big business to keep more older Australians in the workforce.

The prime minister has also asked the Community Business Partnership to suggest practical ways to encourage the private sector to employ more mature workers. The Partnership is expected to report back around the middle of this year.

Increased flexibility in the workplace-relations system would allow older workers to choose whether to remain in the workforce for longer in part time work as they approach retirement. A flexible workplace-relations system will also enable older workers to balance caring responsibilities by allowing employees and employers to negotiate mutually beneficial family friendly work arrangements.

A number of further workplace relations reforms are currently proposed: reform of unfair dismissal laws to minimise the impact on employment, particularly for small business; simplification of procedures for agreement-making; improvements to the remedies and sanctions against unprotected action; improvements to bargaining processes; and improvements to the processes for union right of entry to the workplace. These reforms have been blocked in the Senate.

Wage-setting processes also are complicated by cross-jurisdictional issues arising from workplace relations issues being covered by state and Australian government legislation. This can create significant issues for businesses operating in a number of states. Some currently proposed legislation seeks to broaden the federal jurisdiction in workplace relations matters.

Some people argue that we don't need to take steps now to address the ageing of the population. After all, some of these demographic changes have a long way to go before they fully work out.

But just as a demographic change takes a long time to take effect, so too does the policy response. The people who will be carrying the tax system in 40 years time have already been born. There are long lead times in implementing change in the area of their retirement incomes. To achieve worthwhile change in 30 or 40 years time requires action now.

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This is an edited version of an address delivered on 25 February, 2004.



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About the Author

Peter Costello AO is a former, and longest serving, Commonwealth Treasurer. He is a company director and a corporate advisor with the boutique firm ECG Financial Pty Ltd which advises on mergers and acquisitions, foreign investment, competition and regulatory issues.

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