What is the difference between levying tax on the unrealised gains on an asset with a market value, and levying a tax on the imputed increase in the value of a promise for which there is no market?

Just over a year.

That is the time between Treasurer Chalmers’ claim on February 28, 2023, that if he could work out how to do it, Labor intended to increase tax on Defined Benefit (DB) superannuation schemes worth over $3 million, and the proposals to do so released on March 15, 2024. These proposals are allegedly to produce equitable treatment with Labor’s tax increase on Defined Contribution (DC) superannuation. (This is the so-called ‘Division 296’ tax. Industry super funds, commercial super funds, and SMSF are all DC schemes: you can’t get out of them more than you (plus your employer if relevant) contributed, plus market returns on those investments.)

Let’s explore the DB proposals using the cases of the two major public service DB schemes, the CSS and the PSS. They have been closed to new entrants for 35 and 20 years, respectively. They now have about 56,000 contributors and about 170,000 pensioners, both groups dwindling by the year. Pensioners in those schemes now have an average age of 71 for members and 80 for surviving spouses. Those still contributing to the schemes are in the last phase of their careers, with an average age of 53 years. There are no Commonwealth DB schemes open to new members.

These membership numbers may not be electorally or fiscally important, but the measures to tax them illuminate the taxation fantasy world Labor now inhabits. The measures set a new low in tax policy design in complexity, cost, and opacity.

The DB proposals impose double taxation of any increase in the estimated present value of the Commonwealth promise to pay DB unfunded pensions. This is, in effect, the imaginary capital actuarially estimated to be necessary to honour the promise. For those affected, this value would be re-estimated annually ‘unto death’ using annually the rules a divorcing couple may use once to estimate the value of one party’s DB entitlement. That estimate can be pooled with other matrimonial property and split between the divorced parties under Family Law. (See the Explanatory Statement, which tellingly avoids any examples showing a DB taxpayer how the proposal would work).

While the proposed DC tax increases notoriously bears on unrealised capital gains as well as realised capital gains and realised income, the proposed DB tax increases bear entirely on an ‘unrealised’ amount, the product of an actuary’s formula. That ‘value’ cannot be accessed by cashing out the pension entitlement. That is why the proposals allow a DB member who is still working to postpone the tax payment until retired and drawing a pension out of which the tax can be paid. (DC members reasonably ask why they can’t receive the same treatment for a Division 296 assessment of their unrealised gains.)

The proposals violate one of Adam Smith’s key precepts for good tax design:

The tax which each individual is bound to pay ought to be certain, and not arbitrary. The time of payment, the manner of payment, the quantity to be paid, ought all to be clear and plain to the contributor, and to every other person.

No revenue estimate for the DB measures has been presented. They will probably yield negligible revenue, because most DB pensioners are old, retired a decade, or more ago when final salaries were much lower than present (and therefore yielded lower pensions), and have limited remaining life expectancy over which their pension has to be paid. They will not breach the $3 million trigger.

But even if initially inflicted only on a few recently-retired, younger and richer public servants, bad policy ends up damaging everyone because bad precedents metastasise, just as the bad policy on DCs has metastasised to worse policy on DBs. As Bill Kelty remarked of the Division 296 tax, ‘bad policy is bad policy’.

The DB proposals are unfair in practice.

Any DB member rich enough to be affected by the $3 million trigger is already paying income tax on their whole DB pension, with the margin taxed at their top marginal rate plus the Medicare levy – almost certainly, the top 47 pe cent tax rate. They enjoy a 10 per cent tax offset, capped $11,875 (in 2024-25). Their fund also paid 15 per cent on their employee contributions, and on the compound earnings on those contributions over their working life.

Of course, the Commonwealth itself paid no employer contributions – that is the ‘original sin’ of how the old DB schemes came to be ‘unfunded’, dating back to the inaugural 1922 superannuation legislation. Redressing that historical Commonwealth error is why the Howard government created the Future Fund discussed in Dimitri Burshtein and Peter Swan’s Spectator Australia article. More below on what they aptly called ‘Frankenstein’s Future Fund’.

In contrast, a DC member drawing a complying allocated pension pays no income tax, unless the actual value of their super assets would exceed the indexed Transfer Balance Cap (now $2 million). Any excess must be placed into an accumulation phase fund, where it pays 15 per cent tax on its actual, realised income.

Double taxation

We can certainly imagine some hypothetical capital sum that could pay the DB pension. But it is double taxation to tax each year any increase in the hypothetical capital sum to pay a pension stream while simultaneously fully taxing the pension stream itself.

Taxing an imaginary base

Obviously, the DB pensioner cannot access any hypothetical actuarial increase in the Family Law value of their DB interest. They receive an inalterable fortnightly pension that extinguishes with their death or that of a surviving spouse (who receives a reduced reversionary pension under the old DB schemes). They cannot make a withdrawal from the Family Law value to pay the Division 296 tax bill. They cannot spend down the Family Law value to bring their TSB under $3 million.

In contrast, DC fund members can withdraw any amount above the regulated minimum from the fund paying their tax-free allocated pension, either to pay any Division 296 tax bill or reduce their TSB under $3 million.

But if it works for divorce, why not for tax assessment?

The Family Law value varies by year, increasing (other things being equal) with rising inflation or falling with lower inflation because of indexation by the CPI of the future stream of indexed pensions. It also varies by age and sex of the DB super member (falling with their dwindling remaining life expectancy). It is influenced too by whether the member has a spouse (who would get a reduced, reversionary pension if the member dies first).

In a divorce, the parties only have to agree once how to split a pool of matrimonial assets, including any actual DB income flow as it is paid in future. But Labor wants to simulate an ‘annual fiscal divorce’ for those close to or above the $3 million trigger.

It is practically impossible for a taxpayer to foresee what their tax liability might be, or verify an ATO assessment. For a DB pensioner, a Division 296 assessment is in effect ‘pay us this sum that we have dreamed up’. Bad policy is bad policy.

As an illustration of the complexity proposed, I am a retiree receiving a DB pension from a fund that I joined in 1972, so I was naturally curious as to whether the DB tax proposals might affect me. I don’t think they would (and I certainly don’t feel $3 million rich).

I went to the 156-page section of Family Law regulations, Volume 2 Part 1 that drive the valuation of a pension in my situation, and also consulted the Attorney-General’s Departmental website, which advises those contemplating divorce:

Valuation methods and factors for superannuation interests are complex, and parties should seek expert advice to value these types of interests.

To this advice, the Commonwealth Superannuation Corporation (the Administrator of the CSS and the PSS) adds 30-page booklets to members on how to apply for a Family Law valuation and split of super, using information that it will supply to members for a $150 fee as a ‘Form 6’ declaration. I could then use that information to pay an actuary $600 an hour to advise me how to fill in a complex valuation formula.

Such formulas and the tables supporting them contain the factors that adjust imputed DB value for age, sex, and whether the member has a spouse. But those values may be amended by regulation by the Attorney General. As Morgan Begg has noted, other parameters of the amended law can be changed through regulation by the Treasurer, using the s290-60 clause in the implementing law. The future tax is completely unpredictable.

This is the sort of complexity whose costs a DB taxpayer would need to address if they wanted to understand or dispute an ATO assessment of a Division 296 tax liability.

With complex new taxes proposed on imaginary amounts like this, taxpayers will soon catch on: don’t trust any government on superannuation. Put your life savings as far as possible out of government’s reach, say in the family home (or the kids’ homes, through the Bank of Mum and Dad). The super guarantee levy will become the de facto ceiling as well as the de jure floor on contributions into super. For a country with a weak national savings performance and almost continuous government dis-saving, that is not a good message to propagate. Bad policy is bad policy.

As the complexities and implications of the $3 million super tax surcharge on DC funds have become clearer, it has drawn heavy criticism, not only from tax and superannuation bodies, but from Bill Kelty and also (uncharacteristically subtly) from Paul Keating.

There is obviously a consensus: against taxing unrealised gains; against the abandonment of the CGT discount within the super system (which would perversely make capital gains taxed higher in super than in current income); and against the lack of indexation of the $3 million trigger. To this consensus I would add that the DB proposals should be dumped. Let nature take its course: a morbid version of ‘grandfathering’.

What happened to the Future Fund?

As Burshtein and Swan argue, it is well overdue to consider the fate of the Frankenstein Future Fund, which was created precisely to meet the unfunded liabilities of the long-closed DB schemes. The Fund is untaxed. It contains capital that in effect ought to have been paid by the Commonwealth as its employer super contributions for its employees. It was founded with seed funding by taxpayers. That seed funding has compounded within the Fund, tax free.

For want of serious policy attention, the Fund risks being wasted, according to Peter Costello, the former Treasurer who created the Fund and its Chair until May 2024. On June 17, 2025, Greg Combet, the current Chair of the Future Fund (and former Minister for Climate Change and Energy Efficiency and Chair of the Net Zero Economy Agency) noted:

‘Since my appointment the government has announced changes to the Future Fund Investment Mandate. These included deferring the first drawdown on the Future Fund to finance superannuation liabilities from 2026-27 to 2032-33.

‘This was a crucial change. Without that deferral of drawdowns we would soon have needed to start managing the portfolio for liquidity and restricting our ability to commit large amounts of capital to long-term investment themes. [That is to say, the Fund would have to have been used for its intended purpose!]

‘The deferral is not only significant for that reason but also because it means that the Fund can become an enduring sovereign wealth fund beyond the original purpose of meeting superannuation liabilities.’

This all looks very odd. Why is Labor proposing the double-taxing of imaginary growth in a hypothetical capital sum estimated by actuaries for unfunded DB liabilities, when there is an actual capital sum created for that purpose, sitting off-Budget, earning investment returns and paying no tax?

Is that a green hydrogen hub I see shimmering in the mirage on the horizon?