Households save through purchasing assets and paying down debt. Superannuation is the largest (and fastest growing) financial asset on the household balance sheet, followed by deposits and equities. Housing is a significant savings vehicle for households, but also represents a significant use of funds in the economy. The Housing and household leverage section in this chapter explores this issue in further detail.
Taxation and the household balance sheet
The unequal tax treatment of savings vehicles distorts the asset composition of household balance sheets. This can affect the broader flow of funds in the economy. Many submissions support a more uniform tax treatment of household savings.6
Decisions related to asset allocation are based on the after-tax return and risk characteristics of different savings vehicles. The extent to which tax distorts relative after-tax returns affects both the composition of household assets and the amount of risk households are prepared to accept. Australia’s Future Tax System Review noted that:
There is considerable evidence that tax differences have large effects on which assets a household’s savings are invested in. Based on an examination of the literature and OECD data, the OECD concluded that while low-income individuals respond to tax incentives with more savings, for high-income individuals in particular savings are diverted from taxable to tax-preferred savings.7
For individuals on different marginal tax rates, no leverage
*For salary-sacrificed superannuation, the chart depicts individuals whose contributions do not exceed the prescribed contribution caps. For individuals earning income for surcharge purposes above $300,000, contributions may be subject to an additional 15 per cent tax, which reduces the superannuation concession. For individuals on the top marginal tax rate subject to this additional tax, the after-tax return would be 9.2 per cent.
Across savings vehicles, after-tax returns differ markedly in the stylised example presented in Chart 3.2. For most savings vehicles, taxation reduces the after-tax return. However, in some cases — particularly salary-sacrificed superannuation for higher income earners — taxation increases the after-tax return above the pre-tax return.
Of the savings vehicles depicted, bank deposits (and other interest-earning assets) are taxed relatively heavily because the interest earned on deposits is subject to the individuals’ marginal tax rate.
In general, returns on salary-sacrificed superannuation are either taxed concessionally or subsidised, except for very low–income earners. Salary-sacrificed superannuation contributions are taxed at a flat rate of 15 per cent, rather than the individual’s marginal rate — unless contributions exceed prescribed caps. Individuals with income, including contributions, above $300,000 may pay additional tax on contributions that reduce the attractiveness of salary-sacrificed superannuation.
For assets that generate capital gains, the asymmetric tax treatment of borrowing costs to purchase assets (and other expenses) and capital gains can result in a tax subsidy by raising the after-tax return above the pre-tax return. Individuals can deduct their full interest costs (and other expenses) from taxable income, but only half of capital gains are taxed when they are realised at a time chosen by the taxpayer. All else being equal, the increase in the after-tax return is larger for individuals on higher marginal tax rates.
The tax system encourages households to direct their savings into superannuation funds. Households’ allocation of assets towards superannuation as a preferred savings vehicle is reflected in their holdings of other assets. For example, since around 2002, households have tended to reduce their direct holdings of equities, instead opting to invest in equities through superannuation (Chart 3.3). This has been facilitated by changes to capital gains tax arrangements in 1999, which lowered the tax costs of selling equities and other assets.
Chart 3.3: Household investment in domestic equities (transactions, four-quarter moving average)
The distortions generated by the tax system affect the channels by which savings are allocated to the users of funds. This is particularly relevant to the superannuation sector, which is expected to grow rapidly over coming decades. The banking system and Superannuation sections in this chapter explore these issues further.
Households’ exposure to adverse market movements depends on the mix of savings vehicles; for example, if households choose to invest in a superannuation fund regulated by the Australian Prudential Regulation Authority (APRA) rather than in other savings vehicles. The asset allocations of APRA-regulated superannuation funds are more diversified than the asset allocations of self-managed superannuation funds (SMSFs) and the household balance sheet (excluding superannuation) (Chart 3.9). To some extent, SMSFs’ asset allocations also reflect the age composition, and thus particular investment preferences, of individuals within SMSFs. The Superannuation section in this chapter explores this issue in further detail.
6 For example, Westpac 2014, First round submission to the Financial System Inquiry, page 48.
7 Commonwealth of Australia 2009, Australia’s Future Tax System Review: Report to the Treasurer, Part Two — Detailed analysis, volume 1 of 2, Commonwealth of Australia, Canberra, page 68.
8 Chart 3.2 shows the nominal post-tax return for a range of savings vehicles, assuming a pre-tax nominal return (for each savings vehicle) of 6 per cent per annum. The analysis assumes that the assets are held for seven years. The chart draws on methodology used in Australia’s Future Tax System Review: Report to the Treasurer Part Two — Detailed analysis, volume 1 of 2, page 67. The marginal tax rates reflect the individual income tax thresholds plus the 1.5 per cent Medicare levy but excludes the Temporary Budget Repair levy and the recent increase in the Medicare levy.
9 Chart 3.2 shows the tax treatment of salary-sacrificed superannuation. The tax advantages for non-concessional contributions, which comprise the majority of superannuation fund assets, are less generous than for salary-sacrificed superannuation.
10 The relative tax treatment of assets is the same within superannuation as outside superannuation.
11 Australian Bureau of Statistics (ABS) 2014, Balance of Payments and International Investment Position, cat. no. 5302.0, ABS, Canberra.