By Matthew Taylor Thursday 19 March 2015

Photo: There is a strong argument to be made for tightening eligibility for the age pension. (AAP: Alan Porritt)

If Scott Morrison is willing to grasp the nettle of pension reform, he would be better off looking at ways to move those with greater means off the payment altogether - that's where the real savings are, writes Matthew Taylor.

The Prime Minister's assurance that the May budget will be "pretty dull and pretty routine" is meant to assuage the fears of a restless electorate and an increasingly nervous back bench. However, with the government locked into a battle with cross bench senators to freeze pensions from 2017, it could be anything but dull for pensioners.

The early signs don't look good for Social Services Minister Scott Morrison's pension reforms. Senators Zhenya Wang, Glenn Lazarus and Jacqui Lambie say they are opposed, while Senator Nick Xenophon says the plan is "problematic".

As Judith Ireland wrote for the Sydney Morning Herald this morning:

While fellow crossbenchers John Madigan and Ricky Muir are yet to state their positions and senators Bob Day and David Leyonhjelm have been more receptive to the Social Services Minister's proposal, even if all four agreed this would not provide the six votes the Coalition needs to pass legislation.

There are only two ways to reduce the structural burden of the age pension on the federal budget. The Government can lower the rate, by permanently changing the level of indexation, or it can reduce the number of people eligible for the pension by tightening the means test and pushing higher income pensioners off altogether.

For all the political deftness of Scott Morrison's proposal to freeze the pension in return for regular reviews of pension adequacy, the Government risks significant political pain for little fiscal gain. Without shifting community expectations, such a change is unlikely to deliver a permanent reduction in the level of pension payments.

If the Government is willing to grasp the nettle of pension reform, it would be better off looking at ways to move those with greater means off the pension altogether. Not only will this deliver greater - and longer term - budget savings, it is also the fairer of the two options.

Pensioners, whatever their level of private income, have become accustomed to their pensions increasing in line with 27.7 per cent of Male Total Average Weekly Earnings (MTAWE) when the Consumer Price Index increases fail to deliver this amount.

This benchmarking to MTAWE is responsible for an increase in the single rate of the pension of over $9,000 since 2002. This amounts to 5.4 per cent annual growth in the single rate, outpacing prices by 2.7 per cent over the period.

This MTAWE benchmarking has been in place since the Whitlam years. It will be extremely difficult to convince pensioners that current policy is unsustainable and that they should accept lower payments.

Even if the government were able to do this, it will only benefit the budget bottom line if the Minister's proposal does in fact reduce pension expenditure - which is far from certain.

Much rests on the recommendations of the independent panel tasked to undertake the triennial adequacy reviews. There is a strong possibility this panel will be captured by those who would recommend even higher pension levels, regardless of whether they were affordable or what tax burden that would impose on Australia's wage earners.

For example, if the panel were to recommend that the pension should be set above a relative poverty line - half of median disposable household income adjusted for family size - it is probable that age pension expenditure will increase.

Had the single rate of the age pension been benchmarked to such a measure in March 2002, it would be 14.1 per cent higher by March 2012 compared to current policy. This increase would be even greater if one assumes that pensioners would have received the September 2009 one-off pension increase of $1,560 on top.

The newly minted independent Senator Lazarus is worried that "pensioners will be at the mercy of a review every three years". However, in the absence of a change in community expectations on pension benchmarking, it is more likely the budget will be at the mercy of a large - and growing - constituency that will demand the return of any income lost over the preceding three years.

Of course, the government could choose to ignore the advice of the independent panel and keep the pension tied to prices increases, but this would defeat the purpose of creating the panel in the first place and merely add another new bureaucracy.

Even if this approach was successful in constraining growth in pension payments, it will do so at the expense of all pensioners - some of whom are completely reliant upon it.

There is a case to be made for pensioners to shoulder some of the burden of budget repair, but the government's focus on pension indexation is, at best, a distraction from the more substantial reform required.

If the government is serious about returning sustainability to the age pension it should look at some of the inequities in the pension means tests, especially those created by excluding the family home from the assets test. This ignores the higher living standards pensioners could achieve by converting this asset into income, and provides the same pension payment to those with small amounts of home equity as to those with million dollar homes. It directs taxpayer's dollars - including those with lower lifetime earnings - towards those who have over-capitalised in their homes, allowing them to draw a larger pension and preserve this asset for their children.

Beyond this, there is a strong argument to be made for tightening eligibility for the age pension. A single pensioner with $40,000 in private income, and nearly a million dollars in assets, can still receive a part pension.

There are better uses for taxpayer's dollars than providing support to those who do not need it. Fixing the pension requires action, not review.

Matthew Taylor is a research fellow at The Centre for Independent Studies.

Pension plan: political pain for little fiscal gain - The Drum (Australian Broadcasting Corporation)