Saving through spending for retirement: can it be done?

A new way to structure superannuation contributions could become standard practice in some developed countries

For several decades, economists and tax experts have favoured consumption taxes over income taxes for economic growth. But some experts say it is also possible to use individual consumption as a base to collect contributions (through taxation) to a pension plan, which could help address some of the sector’s affordability and coverage challenges.

Indeed, a consumption tax could be more efficient for saving into pensions in the developed world, according to John Piggott, Scientia Professor of Economics and Director of the Australian Research Council Centre of Excellence in Population Ageing Research (CEPAR) at UNSW Sydney. Prof. Piggott recently spoke about his vision for retirement savings over the next 30 years at the 7th International Pension Research Association (IPRA) Conference at the OECD in Paris, France.

Understanding retirement contributions in the OECD

For a century-and-a-half, contribution-based retirement income systems, which are widespread across the developed countries of the OECD, have relied on wages as a natural base for collecting contributions. And one way or another, these contributions translate into benefits when workers reach retirement age, Prof. Piggott explained.

While it is natural to think of labour earnings as the base for retirement savings, this approach has drawbacks. “People move into and out of the labour force – through spells of unemployment, sickness, or raising children. And even if they don’t stop work completely, they will likely be less engaged, working fewer hours or for lower compensation,” said Prof. Piggott.

A break in employment reduces contributions and retirement savings in arbitrary and probably inequitable ways, according to Prof. Piggott. And there is plenty of evidence to support this. For example, lower-paid workers are more likely to face lengthy unemployment spells. Women, generally, also suffer as a result of this. Due to the gender pay gap and being more likely to have a career break to raise children, women end up with roughly 25 per cent less in retirement savings than men over their careers.

How retirement contributions could change over the next 30 years

Is there a better alternative base on which to levy retirement contributions? Until recently, the answer was no, said Prof. Piggott. But this could all change in the next 30 years as we see more innovation across financial services.

“Pension contributions have to count a long way into the future. To make them work, they must be recorded, so the transactions on which they are based must be visible and certifiable. Formal wage payments meet these criteria,” Prof. Piggott explained.

“Increasingly, however, consumption expenditures are satisfying these criteria: as people use electronic transfers, through bank debits or credit cards, more consumption activity is becoming more visible, and it is easier to keep records,” he said.

And some countries have already started experimenting with this new approach. “Over the last few years, several countries have developed public or private structures that direct a proportion of consumption expenditure into retirement savings accounts. Examples include Mexico, which saw a private firm develop a mechanism for additional pension contributions known as ‘miles for retirement’,” said Prof. Piggott.

Read more: How to really engage young people with superannuation

Miles is an app that connects to every user’s credit or debit card and encourages people to build their savings by allowing them to automatically save from their accounts based on how much they spend. Customers are also exposed to promotions from stores and brands that contribute to their retirement accounts when they purchase a product.

So some consumers are already saving through spending. While these are still very fragile structures, as innovation paves the way for a cashless economy, we might find that consumption becomes a more feasible tax base for saving for retirement than income.

“Broadly similar structures have been introduced in China, Spain, and Australia. For example, in Chile, the government is contemplating an arrangement through which saving through spending might be matched by a VAT (or GST) adjustment, thus providing a government subsidy to saving of this kind,” he said.

Could saving through spending work in Australia?

Could this approach work for a national plan, like Australia’s superannuation guarantee, which is still one of the best retirement systems in the world? According to Prof. Piggott, in a world where cash no longer figures as a medium of exchange, then maybe. And while it’s not feasible yet, who knows what might be possible by 2050?

And there are two very good reasons why this might be the case. “First, while labour earnings go up and down with employment and wages, consumption is much more even. The unemployed have to spend, as do those on parenting or sick leave. So the contribution base is much more evenly spread through the course of their life,” Prof. Piggott explained.

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“And second, consumption taxes distort prices less than labour taxes; the same logic applies to pension contributions. We would enjoy a more efficient use of resources in the economy overall if retirement savings could be linked to consumption rather than labour earnings,” he said. 

“It is an idea for the future. But as the entrepreneurs who have already set up saving through spending structures have demonstrated, maybe not as far into the future as you might think.”

John Piggott AO FASSA is a Scientia Professor of Economics and Director of the Australian Research Council Centre of Excellence in Population Ageing Research (CEPAR) at UNSW Sydney. For more information, listen to Prof. Piggott's full presentation at the 7th International Pension Research Association (IPRA) Conference, or contact him directly.