The average Australian household is wealthier yet more indebted than the average German household, partly due to tax and retirement income policies.
New research conducted by CEPAR UNSW Sydney shows that German households can see significantly higher wealth and home ownership if Germany implements Australia’s policies on national tax, pension and superannuation.
“Gaps in wealth levels and home ownership patterns between Australia and Germany are partly due to differences in their public policies,” says George Kudrna, Senior Research Fellow at the ARC Centre of Excellence in Population Ageing Research (CEPAR).
Dr Kudrna says that while German households have a higher saving rate at 11 per cent of their disposable income (compare to less than 5 per cent in Australia), the average Australian household is significantly wealthier under Australia’s tax and pension system.
“We looked at the possibility of adopting Australian public policies in Germany and our modelling showed that in the long run, this would result in large increases in the country’s wealth, home ownership and welfare of future households.”
The findings published in the Wealth and Home ownership in Germany and Australia: The Role of Tax and Retirement Income Policy paper, compares Australia to Germany – two ageing societies at a very similar stage of economic development and with similar income levels.
What makes Australian households wealthier?
In 2018, the average household net wealth in Germany was approximately $680,000, while Australia’s net wealth was $1.022 million – more than 50 per cent higher. Dr Kudrna attributes the difference in net wealth to the following three pillars:
1. Age pension
The Australian government budget includes expenditures on the age pension, which represents the main income source for most retired Australians.
“In 2018, about 70 per cent of the age-eligible population in Australia received age pension, with the remaining 30 percent being fully self-funded. Out of the age pensioners, over 60 per cent received the maximum benefit (full pension) and the rest received a smaller benefit (part pension). Overall government expenditures on public pensions (including the age pension) stood at roughly 4.3 per cent of GDP in 2018,” Dr Kudrna says.
In contrast, the German public pension system covers more than 90 per cent of the population. It is pay-as-you-go financed, so contributions (payroll taxes) from workers are directly used to finance benefits of pensioners. Public pensions in Germany are also paid at a much higher replacement rate than in Australia.
The way that both countries approach superannuation (private pensions) also differs. In Australia, superannuation funds hold the largest financial assets, worth an estimated 20 per cent of total household wealth. In comparison, Germans hold less than five per cent of their wealth in retirement (private pension) accounts.
“We show that while capital income taxation and means-testing shift the asset structures towards residential properties, the superannuation system has also increased the overall wealth level,” Dr Kudrna says.
Superannuation is a mandatory employment-related and privately managed scheme that covers almost 95 per cent of employees in Australia. Employers are required by law to make contributions on behalf of their employees to their super funds.
“This is despite the effect of mandatory superannuation contributions on disposable income and the illiquid nature of superannuation assets (that you cannot access until you reach a certain age) which may initially reduce your ability to buy a house,” Dr Kudrna says.
“What we have found is that the impact on home ownership rate is very small. And the reason for this is that people borrow more in the economy with compulsory superannuation. If you look at the proportion of homeowners, the number of households with a mortgage has increased significantly. So, while we are a more asset-rich nation, we are also more indebted than the average German household.”
3. Home ownership
The way that people accumulate assets across both countries is also different.
“Only 44 per cent of German households own their place of residence compared to Australia where the home ownership rate reaches almost 70 per cent and the owner-occupied housing is the largest component of total household wealth,” Dr Kudrna says.
After calibrating the model to Germany’s economy, findings show that Australian tax and pension designs significantly impact on asset levels and home ownership rates, explaining nearly two thirds of the differences.
How can two developed countries have different wealth levels and patterns?
Germany operates a dual income tax system with a progressive tax on labour and pension income and a proportional, fairly low tax on capital income.
In comparison, in Australia, labour and capital (and age pension) incomes are aggregated and taxed under the progressive income tax schedule.
“This shows that the progressive capital income taxation in Australia favours home ownership and investment in owner-occupied housing, where the imputed returns on investment are not taxed at all.
“Even more importantly, Germany operates a pay-as-you-go financed public pension system, which absorbs almost 12 percent of GDP,” Dr Kudrna says.
In contrast, Australia combines tax-financed and means-tested old-age provisions with a funded retirement system financed by mandatory contributions.
“Australia’s system is much more affordable for taxpayers, which supports both wealth accumulation and home ownership.”
In addition, the age pension means test does not include owner-occupied properties, favouring home ownership in old age.
“Owner-occupied housing asset is not subject to the means-test. So, you can have a place of residence worth $5 million that will be exempted from your asset test. As a result, you may still qualify for the full age pension,” Dr Kudrna says.
Home ownership in Australia vs. Germany
The research isolated the main policy mechanics which drive the gaps in home ownership and wealth between Germany and Australia.
“At first thought, many would think that Australians have a lower home ownership rate due to a much younger demographic when compared to Germany. But we focus on the interplay between alternative policy settings and home ownership.
“On one hand, the higher (and progressive) taxation of capital income induces home ownership as does the non-contributory and means tested age pension system. But on the other hand, superannuation guarantee funds increase savings and contribute to larger household assets which are spent in retirement.
“While a strong connection between social security and tenure choice has been shown before, we’ve identified that different tax and pension systems can be main drivers of cross-country wealth and housing patterns.”
What does this mean for Australian policymakers?
That they are doing something right.
“The structure of current Australian tax, pension and superannuation system performs well, and it supports home ownership, wealth accumulation, overall economy and welfare across income distribution,” says Dr Kudrna.