Posted 16/04/2014 by Michael Klapdor
In the lead-up to the Coalition Government’s first Budget, speculation has focused on possible changes to the age pension, including adjusting the way pension rates are indexed. Indexation is a complex and important component of the Australian social security system but one that is often misunderstood. The following provides an explanation and brief history of indexation.
How pension rates are adjusted
Currently, pensions (including the Age Pension, Service Pension, Disability Support Pension and Carer Payment) are indexed twice each year by the greater of the movement in the Consumer Price Index (CPI) or the Pensioner and Beneficiary Living Cost Index (PBLCI). They are then ‘benchmarked’ against a percentage of Male Total Average Weekly Earnings (MTAWE). The combined couple rate is benchmarked to 41.76% of MTAWE; the single rate of pension is set at 66.33% of the combined couple rate (which is equal to around 27.7% of MTAWE). ‘Benchmarked’ means that after it has been indexed, the combined couple rate is checked to see whether it is equal to or higher than 41.76% of MTAWE. If the rate is lower than this percentage, the rates are increased to the appropriate benchmark level.
The CPI is a measure of changes in the prices paid by households for a fixed basket of goods and services. Indexing pension rates to CPI maintains the real value of pensions over time. The PBLCI measures the effect of changes in prices of the out-of-pocket living expenses experienced by age pensioner and other households whose main source of income is a government payment. The PBLCI is designed to check whether their disposable incomes have kept pace with price changes.
The MTAWE benchmark is not intended to maintain the value of the pension relative to costs; it is seen as ensuring pensioners maintain a certain standard of living, relative to the rest of the population.
Brief history of indexation
Prior to 1976, pensions were generally not automatically indexed to movements in prices. Instead, rates were adjusted on an ad hoc basis, typically reflecting upward movements in the CPI.
In the early 1970s, the Labor Party under Whitlam announced a commitment to maintain the rate of pension at 25% of Average Weekly Earnings (AWE). The Whitlam Government’s policy was that pensions should rise until they reached 25% of AWE.
The Fraser Government, in October 1976, introduced automatic increases twice yearly, according to movements in the CPI (though this was briefly reduced to an annual increase in 1978–79).
Benchmarking single pension rates to 25% of MTAWE was a policy of the Hawke and Keating governments. From 1983, aside from the twice yearly CPI indexation adjustments, Labor governments made four increases to pension rates (in November 1984, April 1990, September 1990 and January 1993).
Automatic benchmarking of the single rate of age pension to 25% of MTAWE was legislated by the Howard Government and took effect from September 1997. This was despite the 1996 National Commission of Audit stating its opposition to automatic benchmarking.
Following the Harmer Review of Pensions in 2009, the Rudd Government introduced the current indexation method and increased the single pension rate by $30 to improve its relativity to the couple rate. The Review had found that single pensioners living by themselves were finding it much more difficult to meet their living costs compared to couple pensioners.
Wage growth versus inflation
Other income support payments such as Newstart Allowance are also adjusted twice a year but only in line with movements in the CPI.
In recent decades, wages have tended to increase at a faster rate than prices, meaning that pension rates have increased much more than allowances. There have, however, been times when CPI has increased at a higher rate than wages, for example between 1985–86 and 1989–90 and in the first half of 2013–14. There have also been times when the CPI has decreased (for example in 1991 and 1992), but during such periods pension rates have typically remained at the level set by the previous adjustment. Movements in the PBLCI have driven three of the ten pension increases since this method began to be used in 2009 (the most recent was driven by a rise in the CPI).
Changing pension indexation
Any changes to the way pension rates are adjusted will be controversial, not only because of how it might impact on a wide range of recipients, but also because the issue is intertwined with others. For example, the growing gap between pensions and allowance payments has raised concerns about the adequacy of Newstart Allowance and seen calls to apply the MTAWE benchmark to other payments.
The Government recently passed legislation applying the current pension indexation arrangements to some military superannuation benefits. The Coalition has long described this as applying ‘fair indexation’ to these military superannuation benefits. Any adjustment to pension indexation may see these recent changes to military superannuation called into question.
Indexation is only one factor influencing the sustainability of pensions and the Government could look to a range of other options to reduce expenditure, including changes to means testing or to superannuation arrangements.