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National Affairs

Two indexes, two very different impacts on pensions

17 April 2014

If the rumours are correct, the federal government is considering a complex but far-reaching change to pension payments, writes Daniel Nethery


Outstripping the CPI: Joe Hockey, pictured here with Reserve Bank governor Glenn Stevens at an IMF/ World Bank meeting in Washington last Friday. International Monetary Fund

Outstripping the CPI: Joe Hockey, pictured here with Reserve Bank governor Glenn Stevens at an IMF/ World Bank meeting in Washington last Friday. International Monetary Fund

WITH THE federal budget looming, Joe Hockey has flagged two possible changes to pensions. The first, raising the age at which individuals become eligible for the age pension to seventy years, has attracted widespread media coverage, in part because its impact is easy to grasp. The second, modifying the indexation of pensions, has received relatively little scrutiny, yet represents a profound structural reform. It would affect not only senior citizens, but also those receiving a disability support pension or the carer payment.

In the 2012–13 financial year, there were 2.36 million age pensioners, 822,000 disability support pensioners and 220,000 people receiving the carer payment; taken together, these pensions account for around half of all government expenditure on benefits. But the complicated rules governing indexation make it very difficult for recipients to work out what the changes would mean for them.

Pension base rates are currently indexed on two indexation days in March and September. The pension increases in line with prices or wages, whichever have increased the most over the preceding period. Two measures of prices are used. In addition to the usual Consumer Price Index, or CPI, the Rudd government’s pension reforms, which came into effect in September 2009, established the Pensioner and Beneficiary Cost of Living Index, or PBLCI. The two indices are related, but the PBLCI more closely reflects the spending patterns of individuals on government benefits. Whereas the basket of goods used to calculate the CPI includes house purchases, the PBLCI instead considers mortgage repayments – age pensioners may still be paying off their home, but are unlikely to buy a new one.

Since its introduction, the PBLCI has resulted in a better outcome for pensioners on three out of ten indexation days, reflecting that the cost of living for those on government benefits has been increasing in real terms. Indeed, it has outstripped the CPI on five of the ten indexation days, so its effect on current pension rates of payment would be even more pronounced were it not usually masked by wage indexation.

Because wages tend to grow faster than prices, wage indexation has determined six of the last ten pension increases. Under current arrangements, single pensioners cannot receive less than 27.70 per cent of what the Australian Bureau of Statistics refers to as male total average weekly earnings; the corresponding benchmark for pensioner couples stands at 41.76 per cent. This is the mechanism of pension indexation which Hockey has suggested may need to go.

Making sense of all the moving parts becomes simpler with a few numbers. In September 2009, the single pension basic rate stood at $615.80 per fortnight. Since then, it has increased to $766.00 per fortnight. Now suppose that as part of its 2009 pension reforms, the Rudd government had abolished wage indexation. Under this scenario, the pension would have only increased to $701.80. After four and a half years, a single pensioner would have forgone indexation increases of $64.20 per fortnight; pensioner couples would be $96.80 per fortnight worse off. The chart shows that wage indexation has contributed 43 per cent of the increase in the single pension basic rate since September 2009.

Indexation of the single basic pension rate (per fortnight)

Abolishing wage indexation of pensions would constrain them to increase in line with other government benefits like Newstart Allowance, the basic unemployment benefit. Pensions would no longer keep pace with wages for those who provide care or who cannot participate in the workforce due to age or disability; the pension would instead provide for a fixed standard of living based on what the government, at one point in time, considered to be an adequate level of consumption for these groups of people.

In 2009, the Rudd government offset part of the cost of providing more generous pensions by tightening the income test and increasing the age pension age from sixty-five to sixty-seven years. This time around, the Abbott government is preparing voters for a rise in the eligibility age and lower indexation increases. And while it seems highly unlikely that any government would risk alienating pensioner voters with such a harsh reform – even if the full effect of abolishing wage indexation would not be felt for some years – the complexity of the pension and its indexation rules leaves plenty of opportunities for governments to leave their stamp. That same complexity also makes it very difficult for those who depend on the pension for their livelihood, rather than for their legacy as responsible fiscal managers, to interpret rumours in the lead-up to the budget. •

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Information, analysis and rhetorical verve: economist Joseph Stiglitz. Abhisit Vejjajiva/Flickr

Information, analysis and rhetorical verve: economist Joseph Stiglitz. Abhisit Vejjajiva/Flickr