The Pension

A big sticking point for many in this year's budget was the proposed "cuts" to the pension. Since 1972, the age pension has been pegged to male total average weekly earnings. This means that the pension increases every year (twice a year, in fact, in March and September) at the rate of growth of average male earnings, to keep it around 25% of said earnings. What the government has proposed is to peg the pension to consumer price indexation (CPI). This means that the dollar amount of the pension will be increased biannually in line with inflation. This is not a real increase; it is simply updating the current rate of the pension, at each point in time, into today's dollars (that is, adjusting for inflation).

Are the proposed changes really a cut, as we've been hearing in the news? Tony Abbott says no. He says that increasing something at a lower rate than previously agreed is not really a cut. And there is some truth to this, although it is still a decrease (i.e. "cut") from what would otherwise have been business as usual.

The other factor is that the pension supplements introduced in 2010 (currently worth more than $1,500 per annum) are also set to be scrapped. This is unequivocally a cut.

The key question here is: why should the pension increase in the first place? Why can't it be set at a fair rate (based, for example, on a study of the average weekly cost of living for a retiree) and then simply be adjusted each year for inflation? This is a question that has been asked (and answered) on numerous occasions.

For example, the 1996 Commission of Audit report, for the incoming Howard Government found that:

Social security benefits are not currently based on any concept of adequacy in terms of enabling recipients to achieve a defined standard of living. The main benchmark currently used is a policy target for the age pension of 25 per cent of Male Total Average Weekly Earnings (MTAWE). Linkage between the single rate of age pension and other pensions and allowances effectively gives the MTAWE benchmark wide influence over the social security system, and hence over costs to government.

Changes to the composition of the labour force and income tax scales since the introduction of the MTAWE benchmark in 1972 have weakened any relevance of this indicator for measuring relative poverty. For this and other reasons, MTAWE is no longer an appropriate indicator on which to benchmark the base rates of pensions and allowances.

The Commission of Audit, accordingly, recommended a review of pension indexation, with a view that increases should be tied to CPI or, at the least, median incomes to be used as a better measure than average incomes.

The more recent 2014 Commission of Audit, for the incoming Abbott Government also commented on the inappropriateness of continual increases to pensions. Unsustainable expenditure and all that.

Commissions of Audit too political for you? The 2010 Henry Review also made (albeit oblique) recommendations about indexation of the age pension:

Recommendation 84: Payments and income test parameters should be indexed in a consistent way to maintain relativities across the three payment categories and to reflect changes in community standards. Governments should regularly review indexation as community standards are likely to be affected by significant changes in the composition of the workforce and household incomes in coming decades. The current community standard for pensions is set by reference to Male Total Average Weekly Earnings. Indexing all payments to this standard has been projected to involve a significant increase in budgetary outlays over the coming decades so it will be necessary for governments to regularly review the appropriateness of this measure and the level of the benchmark.

I've been meaning, for the last week or so, to post my two cents on this, with some illustrative graphs, and this morning found that Matt Cowgill had already beaten me to it. But I wasn't going to let all of my research go to waste, so here it is.

The government is certainly in a bind on this, because it has been increasing the pension for years, with the view that average male earnings are a good yardstick for a decent social wage. Meanwhile, the unemployment benefit (the Newstart Allowance) has been sitting at the same level for years, dropping each year in relation to average male earnings (see graph below).

Weekly amounts for average male earnings, Age Pension and Newstart Allowance ($AUD)

It looks like everything is increasing, although the welfare payments not nearly as much as male earnings. The below graph shows the rates paid in 2013 dollars (that is, adjusted for inflation).

Weekly amounts for average male earnings, Age Pension and Newstart Allowance (2013 $AUD)

What is abundantly clear from these graphs is that pensions have grown quite a lot compared with Newstart, especially after the pensions supplements were introduced in 2010. The supplements essentially saw the pension rise from around 25% to around 29% of average male earnings. Newstart is currently a little under 18% of average male earnings.

If the government's proposed changes take effect, the blue line in the above graph will drop when the pension supplement is cut, and will then flat-line. There are no changes to the Newstart rate, so the red line will also remain flat.

Is this a problem? Well, it's not a problem if you think that the current rates for the Age Pension and Newstart are fair, and if you think that adjusting for inflation is adequate to keep pace with costs of living. But how good a measure is CPI (the general measure for inflation) of cost of living increases for pensioners? Thankfully, the Australian Bureau of Statistics produces a Living Cost Indexes dataset, which includes a specific measure for changes to the cost of living for age pensioners1. The graph below shows how it compares with CPI.

Consumer price index and age pensioner LCI (December quarter)

So, going back to 1999 (when the LCI data begins), we can see that the cost of living for age pensioners has actually increased more than the general rate of inflation. If this trend were to continue, and the pension was to be indexed with CPI, we would find pensioners losing out over time. Surely, this is enough to consider the changes a "cut" to pensions.

But, what if CPI was a good enough measure of cost of living changes (and the above graph shows it's pretty close)? Would it be a reasonable way to treat the pension? Well, ultimately, that depends on your view of what the pension is and what the government's role is in supporting retired persons. On one level, it is fair, in that the rate will remain constant over time, relative to the value of our dollar. But are we content, as a society, to see a growing divide between the working wage and the social wage? If we seek a fair and equitable society, is it OK for average earnings to completely dwarf the pension over time? I guess we will find out, to some extent, at the next election.

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1 NATSEM also publishes reports on costs of living. Here is the 2013 report, if you're interested enough.

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