Inheritance: the major life event no politician wants to mention

When I was growing up, my family didn’t have much. We lived rent-free in a succession of down-at-heel manses (the Salvos called them “quarters”), but my father’s stipend was a small one on which to support four kids.

Mum worried about where my parents would live after they retired but, with much scrimping and saving (including making my sisters hand over almost all their wages), they built and paid off a small cottage at Lake Macquarie, near Newcastle.

After my father died, Mum spent many impatient years in God’s waiting room, longing to be “promoted to Glory” and thus reunited with my Dad.

That was in 2004 but, though all she had was the cottage and a thousand or two in the bank, that was enough for the four of us to receive one or two hundred thousand each. By then, we were middle-aged and well established. It was nice to add it to the pile, but we didn’t desperately need it.

More people are receiving significant inheritances these days. They’re getting bigger and will get bigger still.

We worry that houses are becoming unaffordable, but the other side of ever-rising house prices is that inheritance has become an important event in most people’s lives. Many people look forward to it, and family disputes or unhappiness over wills is not uncommon.

But here’s a funny thing. When was the last time you heard a politician talking about inheritances? You didn’t. They never do. I’m sure they think about their own inheritance, but they never want to mention yours or anyone else’s.

In the 1970s, Australia became one of the few rich countries to abolish death duties (state and federal). People were so happy to see the end of them that death duties have become one of the bogeymen of federal politics.

Want to start a scare campaign? Spread a rumour that the other side has a secret plan to reintroduce death duties. Want to oppose limits on share franking credits? Claim it’s a form of death duties.

This is why, compared with other countries, we have little information – and even less reliable figures – on the size and dispersion of inheritances. The pollies fear that if they let the bureau of statistics ask people questions about their wealth, their opponents would jump to conclusions.

This explains why last week’s report from the Productivity Commission was “the first comprehensive research report on wealth transfers” and was initiated by the commission, not requested by the government.

The report explains that rising house prices are just the main reason inheritances are getting bigger. Another is that, with superannuation having been compulsory for about 30 years, more people are dying with unspent super balances. And, of course, family sizes are getting smaller.

The report finds that each generation has been wealthier than the previous one, though Baby Boomers have done particularly well. It found that $120 billion was transferred in 2018 – 90 per cent as inheritances and 10 per cent as earlier gifts – which was more than double that in 2002.

The average inheritance, we’re told, was $125,000. But that included a few large inheritances plus many much smaller ones. The average inheritance received by the wealthiest 20 per cent of recipients was $121,000, and by the poorest 20 per cent was about $35,000. Or so we’re told.

Not surprisingly, the children of rich parents received much bigger inheritances than the children of poor parents. Nor is it very surprising that the children of rich parents tend also to be rich, while the children of poor parents tend also to be poor.

But this may surprise: if you switch from focusing on absolute dollars to looking at relative size, you find that the smaller inheritances received by people without much wealth increase that wealth by a much higher percentage than the larger inheritances increase the wealth of already-rich recipients. The same thing can be seen in other countries’ figures for wealth transfers.

So, to a small extent, the growing prevalence of inheritance is reducing the gap between rich and poor. And, as the report’s authors stress, inheritance isn’t the main reason the children of the rich are also rich and the children of the poor also poor.

No, monetary inheritances explain only about a third. The rest is explained by “all the other things parents give their children – education, networks, values and other opportunities”. And remember, IQ is mainly genetic. Luck is another factor.

Did you notice how little of the wealth transfers gifts accounted for? The authors say they couldn’t find strong evidence of larger transfers from the Bank of Mum and Dad “despite popular belief”.

Sorry, not convinced. By their own admission, the data they’ve been using are “somewhat limited”. My guess is that more people receive inheritances than their figures show. The size of inherited amounts seems very low. As for parents having to cough up to help their kids buy a home, it’s become a big deal relatively recently.

So if the statisticians can’t find much evidence of it, that’s probably because they haven’t been asking the right questions.

Read more >>

Why the super tax changes mustn't be watered down

Everyone wants to know what achievements Malcolm Turnbull can point to after his first year as Prime Minister. Well, I can think of something: his reform of the tax breaks on superannuation – provided he gets it through without major watering down.

Why is it such a big deal? Because it ticks so many boxes. Because it makes the taxation of super much less unfair.

Note, I didn't say much fairer. It will still be an arrangement that gives the least incentive to save to those who find saving hardest, and the greatest to those whose income so far exceeds their immediate needs that they'd save a lot of it anyway.

A report by John Daley and others at the Grattan Institute, A Better Super System: Assessing the 2016 tax reforms, independently confirms the government's claim that the changes will adversely affect only about the top 4 per cent of people in super schemes.

That still leaves a lot of well-off people – including the top 4 per cent – doing very nicely out of super.

Remember this when Turnbull's backbenchers embarrass their leader and add to their government's signs of disarray by pressing for the changes, announced in this year's budget, to be watered down.

Whose interests did you say the Liberal Party represents? Why exactly does it claim ordinary middle-income voters can trust the party to look after their interests?

But back to the reform's many attractions. It would cut back one of the major loopholes that make tax paying optional for the well-placed but compulsory for everyone else; that allow very high income-earners to end up paying a lot less tax than they're supposed to.

A lot of the savings from reducing concessions to the high fliers (who, you should know, include me) would be used to improve the bad deal given to low income-earners and to make other changes but, even so, would produce a net saving to the budget of $770 million in 2019-20.

This saving would get a lot bigger over time.

So the super reforms would contribute significantly to reducing the government's deficits and debt, but do so in a way that spread the burden more fairly between rich and poor than the Coalition's previous emphasis on cutting welfare benefits.

A lot of well-off people have been using super tax concessions to ensure they leave as much of their wealth as possible to their children – a practice lawyers refer to euphemistically as "estate planning".

Wanting to pass your wealth on to your children is a human motivation as old as time. The question is whether it should be subsidised by other taxpayers.

If it is, rest assured it's a great way to have ever-widening disparity between rich and poor. In the meantime, it adds to (recurrent) deficits and debt.

The rationale for Turnbull's changes is the decision that superannuation's sole purpose is to provide income in retirement to substitute for, or to supplement, the age pension.

They fall well short of eliminating the use of super tax concessions to boost inheritance, but they make a good start.

This is the goal of the three main measures Turnbull wants. Reducing the cap on before-tax contributions to $25,000 a year will save almost $1 billion in 2019-20.

Capping at $1.6 million per person the amount that can be held in a retirement account paying no tax on the annual earnings. Any excess balance will have its earnings taxed at the absolutely onerous rate of 15 per cent – less dividend imputation credits. This will save $750 million a year.

Introducing a $500,000 per person lifetime cap on after-tax contributions, counting contributions since 2007, will save $250 million a year.

If those caps strike you as low, you're just showing how well-off you are. The huge majority of people will never have anything like those amounts.

They're set at levels sufficient to allow a comfortable retirement even for those anxious to maintain a high standard of living. Anything more and you're in estate planning territory – or you just want every tax break you can get because you're greedy.

The claim that starting to count contributions towards the $500,000 cap in 2007 (the time from which good records became available) makes it "retrospective" is mistaken.

The measure is prospective in that it applies to income earned after the day it was announced, not before.

Where contributions in excess of the cap have been made already, they won't be affected by the measure.

Any tax change is likely to affect the future tax consequences of actions taken in the past. That doesn't make it retrospective.

To say "I had planned to do things in the future to reduce my tax which now won't be effective" is not to say the changes are retrospective.

Sometimes politicians announce changes well before they take effect, to allow people to "get set". But it's common for them to make tax changes that take effect from the day of announcement, precisely to stop people getting set. That doesn't make the change retrospective, either.

As Daley says, "the proposed changes to super tax are built on principle, supported by the electorate, and largely supported by all three main political parties.

"If common ground can't be found in this situation, then our system of government is irredeemably flawed."

Read more >>

Why inequality is bad for growth

As any economist will tell you, it's all very well to care about "fairness" – whatever that is – but efforts to reduce the inequality of incomes in the economy usually come at the cost of lower economic efficiency.

So if you insist in reducing inequality you'll have to settle for slower economic growth. Much better to put up with inequality and enjoy a faster rise in our average material standard of living.

For decades that's been the economics profession's conventional wisdom on the question of inequality. But, next time some economist assures you of all that, it will be safe to assume they're not keeping up with the research.

Either that or they prefer sticking to their long-standing political preferences rather than changing their views in line with the empirical evidence.

That's the point: the economists' age-old assumption that "equity" (fairness) and efficiency are in conflict – that more of one means less of the other – fits with their theories, but is now being contradicted by empirical studies, many of them coming from such authoritative institutions as the Organisation for Economic Co-operation and Development and the International Monetary Fund.

Last year staff at the fund published a study finding that income inequality between households, as shown by an overall measure such as the "Gini coefficient" – which is zero when everyone has the same income, rising to 1 when one person has all the income – adversely affects economic growth.

Last week the fund's staff published a new study building on this analysis by looking at the experience of people in different positions at the bottom, middle and top of the distribution of incomes, in almost 100 advanced and developing countries over the 22 years to 2012.

The new study confirms that a high Gini coefficient for net income (income earned in the market, less taxes and plus government cash benefits) is associated with lower growth in real gross domestic product over the medium term.

But it also finds an inverse relationship between the size of the income share going to the rich (defined here as the top 20 per cent of households) and the speed at which the economy grows.

If the income share of the top 20 per cent increases by 1 percentage point, GDP growth is 0.08 percentage points lower in the following five years, suggesting that the benefits do not "trickle down" to the rest of us.

By contrast, if the income share going to the poor (the bottom 20 per cent) increases by 1 percentage point, GDP growth is 0.38 percentage points higher in the following five years.

This positive relationship between shares of disposable income and higher growth continues to hold for the second and third quintiles (blocks of 20 per cent) which, following American practice, the authors refer to as the middle class. (This must mean that people in the second top quintile are the upper middle.)

The paper's authors quote other studies to help explain why higher income shares for the poor and middle class are growth-enhancing.

They note research showing that higher inequality lowers growth by depriving lower-income households of the ability to stay healthy and accumulate physical capital (a home, a car, a heating system) and human capital (education and training).

"For instance, it can lead to underinvestment in education as poor children end up in lower-quality schools and are less able to go on to college," they say. "As a result, labour productivity could be lower than it would have been in a more equitable world."

Other research finds that countries with higher levels of income inequality tend to have lower levels of mobility between generations, with parents' earnings being a more important determinant of children's earnings.

As well, increasing concentration of income at the top could reduce total demand (spending), and so undermine growth, because the wealthy spend a lower fraction of their incomes than middle and lower-income groups do.

"Extreme inequality may damage trust and social cohesion and thus is also associated with conflicts, which discourage investment," the authors say.

Inequality affects the economics of conflict as it may intensify the grievances felt by certain groups or reduce the opportunity cost of initiating and joining a violent conflict. If you're poor you've got less to lose.

So what should governments that want faster economic growth be doing to promote it?

"Redistribution through the tax and transfer [welfare benefits] system is found to be positively related to growth for most countries, and is negatively related to growth only for the most strongly redistributive countries," they say.

"This suggests that the effect of stability could potentially outweigh any negative effects on growth through a dampening of incentives."

The redistributive role of the budget "could be reinforced by greater reliance on wealth and property taxes, more progressive income taxation, removing opportunities for tax avoidance and evasion, and better targeting of social benefits while also minimising efficiency costs in terms of incentives to work and save".

"In addition, reducing tax expenditures [tax breaks] that benefit high-income groups most and removing tax relief – such as reduced taxation of capital gains, stock options and carried interest – would increase equity and allow a growth-enhancing cut in marginal labour income tax rates in some countries."

Then there's the reform of the labour market. "Appropriately set minimum wages, spending on well-designed active labour market policies aimed at supporting job search and skill matching can be important."

"Moreover, policies that reduce labour market dualism, such as gaps in employment protection between permanent and temporary workers – especially young workers and immigrants – can help to reduce inequality, while fostering greater market flexibility.

"Labour market rules that are very weak or programs that are non-existent can leave problems of poor information, unequal power and inadequate risk management untreated, penalising the poor and the middle class,' they say.

Sounds like our economists have a lot to learn.

Read more >>

We've become a nation of graspers

Did you see an older bloke with a goatee beard ask Joe Hockey a question about the budget's changes to the assets test for the age pension on the ABC's Q&A program a few weeks back?

He was Dante Crisante, a retired chemist, according to a subsequent interview he did with the Financial Review.

A lot of relatively well-off retirees have been complaining about the changes, which could reduce or eliminate their entitlement to the pension. They've been wondering what changes they could make to their finances to get around the new rules.

Hockey probably assumed Crisante was asking on his own behalf. He replied that he wasn't an investment adviser. But Crisante was asking a policy question, aimed at highlighting the long-standing anomaly that someone's home is excluded from the value of their assets for the purposes of the assets test. (Bad luck for people who've rented all their lives.)

Turns out Crisante doesn't receive the pension and says he never wants to get it. Which means that the man who wanted to "end the age of entitlement", and who drew invidious distinctions between lifters and leaners, missed a golden opportunity to congratulate Crisante and hold him up as an example for other comfortably off old people to follow. Maybe put him up for a gong on Australia Day.

It's possible, however, that even had Hockey known Crisante didn't have his hand out for a handout, he wouldn't have been game to praise him for his self-reliance. He might have been afraid of offending too many people; too many of his own supporters (not that a Labor politician would have been any braver).

The point is, something bad has happened to Australians over the years: we've become a nation of graspers. There was a time when the comfortably off were too proud to put their hand out for the pension. "The pension is for those people who need it. I don't need it, so I won't be joining the queue at Centrelink, thanks."

But those days are long gone. These days we display our wealth by the suburb we live in, the flash house we live in, the flash car we drive and the flash clothes we wear. But none of that stops us arranging our affairs so as to claim a pittance more from the taxpayer.

I suppose it's a good thing there's now no shame attached to being an age pensioner. But it's gone too far when it means there's no shame in claiming a pension or part-pension you don't really need.

And, as I've experienced myself in recent years, there's a whole industry of financial advisers out there these days making their living – a lucrative one, by all accounts – advising older people on how to maximise their call on other taxpayers.

Not just how to minimise the amount of tax you pay on your superannuation – how to put as little as possible into the community kitty – but also how to maximise the pension and associated benefits you receive; how to get as much as possible out of the kitty.

We do all that, most other people do all that, then we wonder why our governments have so much trouble getting their budgets to balance. We even tell ourselves how worried we are about these governments leaving so much debt to be picked up by our grandkids.

Notice how it's always those terrible politicians doing terrible things to our grandchildren. It's never the collective consequences of their grandparents being selfish.

Actually, it's funny. An important part of our motive in using our last years to pay as little tax as possible and make the biggest claim on other taxpayers as possible is our desire to maximise our children's inheritance.

It's a form of selfishness we see as unselfish. Ripping off the system to help our children. Rip off your fellow taxpayers before they rip you off, a great philosophy of life to pass on. Surprisingly, selfishness is catching. Some people find their children even more anxious than they are to maximise their inheritance.

In vain do politicians protest – quietly, and only occasionally – that the billions lost in tax breaks on super every year are sacrificed to help people with their living costs in retirement, not to help the old maximise their kids' inheritance.

In the popular reaction to the latest changes to the assets test, angry oldies are talking of finding ways to prevent the government from cutting their pension. Move to a more expensive house, one far bigger than you need or want to look after?

Give a lot away to your kids in advance? The government has low limits on how much you can give away each year without reducing your pension entitlement, but that's OK, just lie to the government. Lying to governments isn't really lying, is it?

This wouldn't be the first time old people, in their mania for extracting the last dollar of supposed entitlement from the government, have done crazy things. Years ago people would keep thousands in non-interest-bearing cheque accounts so as to avoid reducing their pension.

Rather than losing one dollar of pension they preferred to lose two dollars of interest. Volunteer for the big banks to rip you off? Sure.

The government had to introduce "deeming" to stop pensioners from self-harming. We've become a nation of graspers.

Read more >>

Growing signs young won't do as well as their olds

Will today's young people end up better off than their parents? That used to be a stupid question. Of course they will. But these days, it's much less certain.

We've come to expect that each generation will be better off than its parents, with more income, better housing and better healthcare.

But many young adults have begun to doubt it. According to one opinion poll, only 22 per cent of respondents under 30 considered they would have a better life than their parents.

And now a report by the Grattan Institute think tank, The Wealth of Generations, has found evidence to support the fear that today's generation of young Australians may have lower standards of living than their parents at a similar age.

It's a question of what's likely to happen to their incomes and what's happening to their wealth.

Our wealth is our assets (property, superannuation and other financial investments, and money in the bank) less our liabilities (mainly debts).

Wealth is like congealed income. We can usually turn it back into money should we need to. Some of it produces income (rental properties, financial investments) and some reduces our need for income, such as when we live in our own homes rather than renting.

We add to our wealth when we save some of our annual income. Most of us save more than we think we do, by paying off a mortgage over 20 or 30 years, or by having our employer fulfil the government's requirement to put 9.5 per cent of our wage into super.

We also add to our wealth when the market value of the assets we own rises – "capital gain". And, of course, when we inherit the wealth of our relatives or receive a gift of money from them.

The wealth of Australian households has grown a lot over the years, even after allowing for inflation, as all the figures I'll quote do. But the report, by John Daley and Danielle Wood, finds that over the past decade, older households captured most of the growth in the nation's wealth.

Despite the global financial crisis, households aged between 65 and 74 in 2011-12 were, on average, $215,000 better off than households of that age range were eight years earlier. Those aged 55 to 64 were $173,000 richer, on average.

But the average household in the 35 to 44 age group was only $80,000 richer. And get this: those aged 25 to 34 actually had less wealth than people of the same age 8 years earlier.

Why? Various developments have conspired to bring this disparity about. Probably the biggest is what's happened to house prices and home ownership.

Rates of home ownership have fallen over the past two decades for all but the oldest households, the report finds. Going further back to 1981, more than 60 per cent of 25 to 34-year-olds were home owners. Thirty years later only 48 per cent of people in that age group were owners.

An increasing proportion of those born after 1970 will never get on the property ladder, according to the authors. If increasing education debts aren't already discouraging younger households from taking out mortgages, it sounds like it won't be long before they will be.

This means a higher proportion of the younger generation missed out on rising housing wealth as house prices boomed. Between 1995 and 2012, house prices increased by an average of 4.3 per cent a year faster than inflation. This was much faster than the rise in full-time wages.

The boom was caused by the greater availability of home loans, the return to low inflation in the mid-1990s and by our failure to build enough new dwellings to keep up with population growth.

The later you were to get in on it, the less the boom's capacity to increase your wealth, particularly because you had to borrow so much to join. But the worst of it for young people is that, though house prices are likely to stay high (making it hard to afford the entry fee), they can't possibly keep rising at the same rate (meaning the prize for getting in won't be as big as it used to be).

There's more to the problem than housing, however. Incomes also grew fastest for older people, allowing them to add more to their wealth through saving. In 2004, households aged 55 to 64 were net spenders; by 2010, with average annual incomes $4600 higher, their net annual saving was $2700.

Although households aged 25 to 34 kept their spending controlled, their average incomes increased by $3100 and their saving by $1500.

A big part of the reason for this is that, over the years, government spending and taxation policies have become more favourable to the elderly than they were. The age pension's been made more generous while income from super is now tax-free.

Who has gained most from the big budget deficits we've been running since 2009? The old. Who will eventually have to pick up most of the tab? The young.

All this wouldn't be such a worry if we could be confident that incomes will keep growing as strongly in the future as they have been for 70 years. They may.

But it isn't hard to think of reasons why they may not – including the thing none of us is allowed even to think about: climate change.

Read more >>