By Geoff Walker, June 2019

(on behalf of firstlinks)

The $64,000 question from the recent Federal election is, “Why did Labor lose?”. Many well-informed retirees will say we should be talking about the $67,000 question. Some of you may ask, “Why bother with this debunking now Labor has lost the election?” The answer is that many people who heard Chris Bowen’s favourite example about a nurse believe it is the truth, which is a clear risk for sensible future retirement income policy development.

Throughout the campaign, the then Labor Shadow Treasurer touted this $67,000 example at every opportunity. For instance, on ABC’s Q&A on 29 April:
“Let’s take an example. If you’ve got a nurse who’s earning around $67,000 we charge that nurse around $13,000 a year tax, roughly. Fair enough, that’s what we charge her. If you’ve got a retired shareholder who owns their shares in a self-managed super fund, who earns $67,000 in dividends, we don’t charge any tax. Fair enough. Then we send a tax cheque refund for around $27,000.

$13,000 we take from the nurse; $27,000 to the retired shareholder, through their self-managed super fund. Same income; different outcome. I can tell you it’s not fair.”
Sounds persuasive. That’s an unfair $40,000 difference in outcomes. Maybe to some, but let’s check the numbers.

The detail required for a fair analysis

As any taxpayer who has ever received a salary knows, wage and salary earners never receive their actual stated salary. They only receive what’s left after PAYG tax is taken out, with a final reckoning at the end of the financial year. So Mr Bowen’s nurse doesn’t receive $67,000. Before submitting her tax return, she probably receives $52,000 throughout the year, assuming $15,000 PAYG tax. In contrast, Mr Bowen’s retiree’s super fund is earning $67,000 after various taxes have already been taken out. Thus the comparison is false – the nurse and the retiree are not receiving the same income.

We’ll start with an informed investor who started his (or her) superannuation investing in 1988, just at the time that superannuation funds were first taxed. His aim, seemingly unachievable at that time, was to produce an income stream of $67,000 per annum in retirement from dividends on Australian shares, on which he expected to pay full income tax when received from his super fund.

Back in 1988, dividend imputation had only recently been introduced for individuals and in the press there was widespread speculation that, in addition to individuals’ personal portfolios, imputation would be extended to their retirement savings, i.e. superannuation funds. It was also widely believed that this extension would come at the cost of taxation of superannuation funds’ investment earnings.

If dividend imputation was so extended then our investor’s challenging task of producing $67,000 per annum in his retirement would be that much more achievable. Instead of having to generate $67,000 in cash dividends after company tax, his fund would need only generate that same amount in grossed-up dividends. For example, if when he retired, company tax was 30%, then his cash dividend target would be 70% of $67,000, i.e. $46,900.

And on cue, the government released its May 1988 Reform of the Taxation of Superannuation, which did in fact so extend dividend imputation, at the cost of 15% taxation on investment earnings.

And since he was in an employer superannuation fund, it didn’t matter that imputation credits were not refundable since they would be used by the fund to reduce its tax payable and then be apportioned back to him.

However, the May 1988 statement also contained an initiative that had not been contemplated in the run-up to its release. This was the taxation of employer and deductible employee contributions at the same rate as investment earnings, 15%. Fortunately for our investor, the Federal Treasurer, Paul Keating, explained that this initiative would not cost superannuation savers 1¢ in retirement benefits, as it was to be accompanied by a compensating reduction in income tax on superannuation benefits, be they lump sum or pension.

There is no difference in the end results between a given rate of tax taken out at the contribution stage and the same rate applied to the pension at the benefit stage. The amounts of tax are different, but that is of course simply the decades-long difference in the time value of money.

With 15% taken out of all the contributions that would finance our investor’s retirement pension, that would leave the investor’s contributions accumulating to generate a cash dividend of only 85% of $46,900, i.e. $39,865, which, including franking credits of $17,085, grosses up to $56,950 of taxable income in the fund.

Investor versus nurse

Let’s now assume that the investor reached his target and consider how his outcome compares against that of Mr Bowen’s nurse. The personal tax rates used are those applicable over 2018/19, ignoring Medicare and any other variations that might apply in individual cases.

Mr Bowen’s nurse’s tax on $67,000 would be assessed at $13,322, entitling her to a tax refund of $1,678 after allowing for $15,000 PAYG tax, leaving her with after-tax income of $53,678.

For our investor (on a level playing field) there have been two lots of tax taken out:

1. contributions tax equivalent to 15% on $67,000, i.e. $10,050
2. company tax of 30% on ($67,000 – $10,050), i.e. $17,085

Let us also assume that he has reached his preservation age so is eligible to start a pension from his fund, equal to the dividends and franking credits received by his fund, i.e. $56,950. His final after-tax position will depend on whether he has reached age 60 or not. We’ll look at both cases.

Aged under 60

Being under 60 he must pay full tax on his pension, less allowance for the effective pre-payment of income tax via contributions tax:

• marginal tax on $56,950 = $10,055.75
• less 15% tax on $56,950 (already paid within the fund) = $8,542.50
• gives tax payable = $1,513.25

This leaves our investor with after-tax income of $56,950 – $1,513.25 = $55,436.75.

Aged 60 or over

Being 60 or over he is no longer required to pay the under-60 tax bill of $1,513.25. This will leave him with after-tax income of $56,950.

A level playing field rather than a $40,000 question

Let’s put all these after-tax results side by side so that we can judge the validity of Mr Bowen’s conclusions:

Mr Bowen’s nurse	Actual nurse	Mr Bowen’s retiree	Actual retiree <60	Actual retiree >60
$54,000	$53,678	$94,000	$55,436	$56,950

In other words, a retiree truly comparable to Mr Bowen’s nurse is not $40,000 better off after tax, but rather a mere $3,000, of which just $1,500 can be attributed to over-60’s tax exemption.

If more people knew the history and studied the facts, they could better judge the sheer unfairness of the Labor proposal to eliminate the refund of franking credits. The only tax this retiree didn’t pay was the $1,513.25 he didn’t have to pay once he turned 60. And for this, Labor wanted to strip him of $17,085.

No wonder he and his numerous not-hugely-well-off ilk revolted at the election.

Geoff Walker is a former Chief Actuary at the State Bank of New South Wales and winner of the 1989 JASSA Prize for published research on the implications of the then relatively-new dividend imputation system. This article is general information and does not consider the circumstances of any investor.