TONY JONES, PRESENTER: It's been called the coming silver tsunami and a demographic time bomb. As the swelling numbers of elderly make up an increasingly proportion of the population, how will Australia and other developed countries like ours pay for them? Will raising the pension age to 70 be enough? Well, the former Prime Minister and Treasurer Paul Keating was the chief architect of the superannuation system. He joins us now in the studio.

Thanks for being here.

PAUL KEATING, FORMER PRIME MINISTER: Pleasure, Tony.

TONY JONES: Now, is the fundamental flaw in Australia's superannuation system that people are now living much longer than you planned for when the original people sat down and thought about this?

PAUL KEATING: Well, when we started - when we began thinking about this about 1984, thinking how life would be and the circumstances of people 30 years away - that's now, 2014 - most people retired at 55 to 60 and lived till 78, 80, 81, and that was about it. But in the 30 years since, people are now living eight to nine years longer, so we now have ...

TONY JONES: That's happened in that relatively short space of time?

PAUL KEATING: In that relatively short space of time. If you take my children, both of their grandmothers are in their early to mid-90s, so there's a very good chance, for instance - women tend to live a bit longer - my girls are likely to live till 96 or 97, they may even make 100 and my son perhaps a little earlier. So, we've now got two cohorts in superannuation. We have the 60 to 80 cohort and we have the 80 to 100 cohort we've got to think about. The point - the fact is, Tony, no superannuation accumulation save between 35 years of work - you join the workforce at 25, say, start saving till, say, 60 or 65. You can't save under super for 30 years or 35 years and then live another 30 years off from it. In other words, the pool can never be big enough to sustain you till your 90s. So, we have superannuation mach one, the one I set up, which is 60 to 80, and we have now nothing in respect of superannuation mach two, which is 80 to 100. At the moment, nearly all of those people would rely on the pension because their superannuation lump sum will have well and truly expired by the time they touch 80.

TONY JONES: I've got to ask you the obvious question: I mean, there was six years of Labor government, the Rudd-Gillard governments; did they drop the baton here. I mean, if this was seen coming by people, that superannuation mach two should have been part of their agenda.

PAUL KEATING: Well, the fact is, you see - look, the Government is the default insurer with the pension and only the Government can insure across generations and pool resources. So, the 80 to 100, where people no longer can earn income, are either living on some sort of government support or in a nursing home and their confidence goes, their nerves go, their ability to manage money goes, unable to work to add to money. It means that we have to start thinking constructively about how we manage a lot of people, very big numbers of people in the 80 to 100 cohort. Now, that requires a completely new basis of thinking than anything we've been doing now by the former Labor government, as you mentioned, or the Coalition.

TONY JONES: OK. Well, you were one of the architects, as we said at the beginning, of the superannuation system mach one, the one that we're talking about effectively. If you were in government now, if you had the reins of power, what would be the first thing you would do?

PAUL KEATING: Well the key thing is adequacy. Nine per cent is not enough to give you a replacement rate, that is, to - when you leave work and start living off your superannuation capital sum and income, nine per cent is not enough to get you a replacement rate of 70 to 75 per cent. It has to be 12 per cent - at least 12. You remember in the 1995 Budget, I had it going to 15. But the former Labor government announced 12 and the current government said they will put a hold on two years of it and let it go to 12. So adequacy is the first big issue. I mean, we can't be speaking about a retirement income system which is inadequate, you know? So we've got to get to 12, and at the same time we've got to reduce the number of people on the pension. And what happened was I was heading for a pension system where 50 per cent of retirees over 65 were on the pension and the rest were on self-provision under superannuation. That's now basically 81 or 82 per cent, because in John Howard's day, he reduced the tapers or the withdrawal rates on the pension, so he halved what I had; in other words, he let people keep more pension in the face of more private income.

TONY JONES: Well, it's already the case that by 75 years of age at the moment, 80 per cent of the population receive - the population of that age group receive a full or a part pension.

PAUL KEATING: Yeah, and if you get a dollar of pension, you get all the PBS, the pensioner benefit card and the subsidies to pharmaceuticals and the rest.

TONY JONES: And one theory about this is that people are seeing this as actually a worthwhile thing and spending whatever lump sum that they've got relatively quickly so that it's not available to them.

PAUL KEATING: Well I don't think they do. I think people are very abstemious with their money. I think - look, Tony, for people who've just lived on an ordinary income all their lives, having $80,000, $100,000, $120,000 or $200,000 or even a little bit more in a lump sum gives them that little bit of comfort in retirement that there's something to rely on, there's something to get them out of trouble if they get really sick, to support their kids if they have to - all the things that they do. But we can't try and pretend that like a piece of Indian rubber, we can stretch the accumulation from 65 to 95. It can't - there's not enough of it now and it can't go for 30 years. So, we have to have, I believe, a Commonwealth insurance scheme for the 80 to 100s with a calibrated, precise product which guarantees people income support, aged care and aged accommodation. And it's possible to do. It's a classic insurance thing. It's like the houses in the street: you pay your insurance, but only one house burns down. What happens? One person dies earlier, but their work and savings subsidises other people who last into their late 90s. So, it's a classic model for an insurance scheme, but it's got to be done in the 80 to 100 cohort while we continue to build the accumulations between 60 and 80.

TONY JONES: OK. but how do you pay for something like that? Because - I mean, Medicare Gold was an idea the Latham Opposition had. It was going to cost a huge amount of money. How much would a national elderly insurance scheme cost?

PAUL KEATING: Well a longevity levy of a kind - well, at two or three per cent of wages and you put it in, but the Commonwealth guarantees you a calibrated, precise product - income support, aged care - all of the time when you can't help yourself. So that's what has to happen. Now on the 60 to 80s, the current scheme, the accumulations are not large enough - that is the biggest problem. And partly because we're only now at 9.25 per cent and we should be at least at 12, you know? But we have arguably the best retirement income system in the world because the compulsion means that people have put the money away where by discretion they wouldn't have, most of them, and they have something in retirement and this has built not only better retirement incomes, but a massive pool of capital which is underwritten and lowered the cost of Australian capital for capital formation in Australia.

TONY JONES: But in the past in terms of how you pay for something like this, you've suggested several means of doing that, including one where you actually take a proportion of people's lump sum and put it aside until they're 80. That's another method of doing it, isn't it?

PAUL KEATING: Another method of doing it would be to quarantine, say, 25 per cent of it where preservation rules would apply where they can't touch it till 80. But I think a better scheme is really for - because no commercial insurer can insure across generations and no insurer can pool this like the Commonwealth. The Commonwealth is in the box seat to provide the coverage from 80 to 100 and it's in the box seat because it has to pay the pension anyway. Right? So we should be working now, like I did 30 years ago for now, for the people who are going to be in the 80 to 100 cohort and we can do it with a classic insurance model.

TONY JONES: I've got to say, are your Labor colleagues listening to this? Because it sounds like the kind of narrative that you often said that the previous Labor governments, the recent Labor governments were lacking.

PAUL KEATING: Well, Kevin Rudd and Wayne Swan did kick super from nine to 12 per cent and I'm hoping that Joe Hockey and Tony Abbott will after their two-year interregnum move on to 12 because this is the basis of our - and the other thing - look, Tony, not many countries - in my case a Labor government comes along and secures the agreement of the workforce to, say, between 12 and 15 per cent of their wages as savings and then that is all privately managed - not a big government fund, all privately managed and all going into the private economy. So, you show me an economy - a society which saves and I'll show you a prosperous one.

TONY JONES: Briefly, just go back to your national elderly insurance scheme. Your plan would be for a three per cent levy, your main theory as to how to actually pay for this. That's effectively a three per cent tax on everyone, is it?

PAUL KEATING: Well two to three per cent. But you see, you do it from - you pay it from an early age and it simply goes into the pool and over time - people say, "Oh, well, look, we can't have another levy. We've got levies and levies and levies."

TONY JONES: People will say it's a tax. That's precisely as they are doing with this deficit levy that Tony Abbott is talking about.

PAUL KEATING: But they all know they're heading for the old stove round-up: 80 to 100. Right? They're heading there. And you see, this - we've got to think about now. I mean - and this is the problem we have with the Treasury. The Treasury hate tax expenditures. The Treasury's a great department of state, but it has not a scintilla of imagination. If you asked them to have established our existing scheme, they opposed it all along the way, right? Yet they believe people will just fork out for the pension and live on a lower, less valuable aged pension as they go to their 80s and their 90s with geriatric care, geriatric assessment - assistance, hospitalisation and all the rest. It's not going to happen. We're going to have to provide for it now.

TONY JONES: But you're not saying that there's still antagonism in the Treasury to the superannuation system because it's actually money they can't get hold of, are you?

PAUL KEATING: There's antagonism in the Treasury to every tax expenditure that exists, including superannuation.

TONY JONES: Let's go to this equity question. You've said that the Super Guarantee - you've said this in the past - was principally designed for middle Australia, for people earning one or two times average weekly earnings and that was the principle behind the Labor government, creating a system with where better off Australians effectively will get the most benefit from it. Now, why did you do it like that to start with? What was the - why middle Australia?

PAUL KEATING: Well this is where most people - this is where the base of most people are. I mean, people - people who were never having enough income, people on, say, 100 per cent of average weekly earnings, $60-odd thousand a year, to $200,000, $120,000 a year, never having enough spare change to actually do the second rental property, to be able to develop the second - or buy shares or margin loans to buy shares. They're never going to have enough spare money. So, as a consequence, we've set up a scheme where they can compulsorily save and they get - I mean, what is the key to all wealth, Tony? I'll tell you what it is: compound earnings. Compound earnings. And by forcing people to put the money aside, they end up with a pool of money to use later in life. And that's basically what we proposed and that's what's happened.

TONY JONES: Did you know now there are being serious - or there are serious equity questions that are being raised about the superannuation tax concessions?

PAUL KEATING: Let me just make this point: there is a view amongst the ACOSSes of this world that it's not doing enough down the bottom, as if super was a welfare scheme. Super was never a welfare scheme. It was always for people on one to two times average weekly earnings. And I notice when the Household Expenditure Survey came out recently, the claims of these lobbies were basically found to be false, because when you look at the transfer payments, family assistance, support for kids at school and the rest, we've got a very - a much more even society in Australia than, say, the United States, than, say, Great Britain or any of these countries. So, these sort of mealy-mouthed claims by the welfare lobby about superannuation are fundamentally false.

TONY JONES: What about the other claims that there are serious equity questions about the superannuation tax concessions, essentially that they benefit wealthy people and they benefit wealthy people in a way to the detriment of poorer people in the society because that's foregone tax revenue in the budget that could be spent on other things?

PAUL KEATING: Well Tony, I think there is a very good case to be made about someone who joins the workforce at 25 and puts their now 9.25 per cent away every week for 35 years, and wealthy people who come in at the end with a self-managed super fund who have wealth outside of super and then shelter it right in the last four or five years of their working life, that's not right. That is not right. And you've got all ...

TONY JONES: Well that's what's happening though. I mean, you've actually got self-managed super funds with $100 million (inaudible) ... four or five of them.

PAUL KEATING: Yeah, you've got all the people out there with - you know, flogging these self-managed super fund seminars. I see a few people I know in journalism these days are out there advertising every day, flogging seminars to sort of suck people into self-managed super. So, we've got to be careful. The people who've done the right thing, who save every week and every month for 35 years, they're the people we've got to look after.

TONY JONES: But the Treasury's own modelling is fuelling this debate, the equity debate. The figures they put out in the MYEFO statement in December show that super tax concessions cost the budget, according to them, this year, more than $34 billion, rising to well over $50 billion in 2016-'17.

PAUL KEATING: Yeah, well of course they realise now that they've overdone it and the Treasury's now walking away from those estimates with all speed. They're in reverse gear and backwards. It's like one of those films you see on fast time - they're walking backwards in fast time, because in the January, 2014 Tax Expenditure Statement we have this little phrase that says, "Previous additions of the Tax Expenditure Statement have stated that tax expenditure estimates are not strictly additive, for example, because the removal of one tax provision will affect the utilisation and use of other concessions for behavioural reasons."

TONY JONES: Well you're going to have to put that in common parlance.

PAUL KEATING: What they do is they've constructed the straw man phony case. So let's say someone's got - make it simple: $100,000. The Treasury says, "Now, if we didn't have to cover tax concessions for that $100,000 super and the fact that we are costs X, what would that $100,000 be doing? Oh, it would be in a bank account." Now in a bank account, let's say it's you, Tony. You're talking about $100,000. Tony Jones pays his PAYG - PAYE tax on his monthly income and out of your after-tax income, you then put money in a bank account and you leave it there and the interest is taxed at full marginal rates. So you get taxed at full marginal rates on the way in and you leave your $100,000 or $200,000 sitting in a bank account. The fact is, no-one will leave it in a bank account. If the tax concessions weren't there for super, they would negatively gearing a house, they'd be buying margin loans in shares in Westpac or BHP or the Commonwealth Bank or doing tax-preferred things. So this sort of simplistic nonsense notion the Treasury have had that the yardstick with which you compare the tax concessions is the simplicity of people simply leaving their money in a bank and paying full marginal tax rates on it is a complete nonsense. So now they're ...

TONY JONES: Look, I'll just interrupt you there for one minute, 'cause I've got - 'cause you actually did send me these tables before. There is a table that appears in the MYEFO statement that talks about the $50 billion figure being the figure in a couple of years time, cost to the Treasury. Then, there are the other document that they've put out which seems to undermine that completely. What is actually going on here?

PAUL KEATING: What they've done: they've built the straw man and a lot of people are now running - see, you've got journos in the (inaudible) and people in the (inaudible) say, "Well, look, there's $30 or $50 billion here of tax expenditure we could use for something else." This is completely false. Completely false. So, this is the - I mean, look, "An experimental estimates of superannuation tax expenditures". I mean, the Treasury's even driven to put out an appendix, "Experimental estimates". They can't even estimate it. They cannot even estimate it.

TONY JONES: These documents, I've got to say, they're quite hard for a layman to understand. But does the Treasury to come to a conclusion with how much foregone revenue actually is there because of the superannuation tax concessions?

PAUL KEATING: Well, I'll just read this little bit for the record. It says, "This likely change in taxpayer behaviour, the revenue foregone approach does not do this. As a result, it is important to note - important to note - that revenue foregone," - that's a loss to the budget, "tax expenditure estimates should not be interpreted - not be interpreted - as the budget impact or benefit of removing a tax expenditure, i.e. for superannuation."

TONY JONES: OK. So did they come up with any figures?

PAUL KEATING: In other words, the Treasury finally is debunking its own myth about the cost of superannuation. They've massively overestimated the cost of superannuation because if people weren't using the superannuation tax concessions, they'd be negatively gearing a second apartment, a flat, a house, buying shares with margin loans and doing all the things that clever people do.

TONY JONES: OK. But do they come to any conclusions at all as to how much is actually foregone ...

PAUL KEATING: Yeah, they have.

TONY JONES: ... in terms of tax revenue because the figures of $34 billion this year or $50 billion in a couple of years' time, they're pretty dramatic figures.

PAUL KEATING: They are. I'll find it for you. I've got it here. They say on one basis it's a cost to revenue of $15 billion on a revenue foregone basis, and on an expenditure basis, it's a gain to revenue of $6 billion. So, they've got a minus $15 billion cost to revenue and a plus $6 billion gain to revenue. That's the new estimate.

TONY JONES: Yeah. Alright. Briefly, what do you say ...

PAUL KEATING: That's the new estimate.

TONY JONES: What do you say has gone on? Are you alleging some kind of conspiracy here or has the Treasury made a mistake and they're now correcting it? What do you think is going on?

PAUL KEATING: Well, look, the Treasury's a one-trick pony, fundamentally. They're always berating tax expenditures and they've sold the Government. The Treasurer produced in the MYEFO statement a $50 billion cost by 2017 of these tax expenditures in December, and in January, the Treasury walk away from their own statement that they've given the Treasurer to publish.

TONY JONES: Let's ...

PAUL KEATING: I mean, look, if I was still around, I would have massacred them for this. Massacred them for it.

TONY JONES: You mean actual massacre? (Laughs)

PAUL KEATING: No, I mean, you just wouldn't cop this stuff. You wouldn't cop this sort of sleight-of-hand behaviour.

TONY JONES: Alright. Just we've got a couple of minutes left and I just want to quickly move on to broader budget issues. How can governments make really any significant reforms to the sort of things you're talking about when the budget is in such serious deficit? I mean, we see what the current government is proposing to do. They're thinking about raising the pension age to 70, they're imposing tax definite levies or tax deficit levies, they're putting up new taxes. I mean, how can anyone actually do the things you hope to happen when the budget is in deficit?

PAUL KEATING: Well, the answer is, Tony, you've got to affect the way in which the outlay sides of the budget is shaped for the longer run. Like, for instance, one of the first things Bob Hawke and I did in 1984 was to put an assets test on the pension to sit beside the income test. In those days, the pension was only income tested. You could have a house worth $3 or $5 million and you still got a full pension. So we put an assets test. It's those kind of structural changes which produce a medium term change in the budget trajectory and that's what is needed now; that is, we're not going to remedy this in 12 months; we're going to remedy it over time, but these changes which induce behavioural change - structural changes which induce behavioural changes is the way to change the spending side of the budget. And hopefully if the economy grows a bit faster and a bit stronger, the revenue starts to pick up, so you start to see the outlay slow down and the revenue pick up and the budget start to turn back towards surplus.

TONY JONES: OK. I've just got to - we've got little time left, but Jeff Kennett, former Victorian Premier, was on this program a little over a week ago and he said, "Well, you can actually fix the whole problem really quickly in fact by Tony Abbott breaking a promise and just raising the GST or broadening the base of the GST," and he gave the figures which he indicated would actually fix up the budget deficit within a year or two years.

PAUL KEATING: Yeah, well I don't agree with that. I like Jeff, he's a good fellow, but I don't agree. Look, I'll tell you why, Tony: the average person, their income and their expenditure are one and the same. So when you hit their expenditure with a 10 per cent tax or a 15 per cent tax, then they're carrying another 15 per cent tax burden, whereas a wealthier person and many more wealthier people who don't spend all of their income and save a large proportion of it, they're not taxed by the GST. You can't build a society where the low to middle income people carry the greater burden of the tax system.

TONY JONES: Margaret Thatcher did it, of course. She doubled her sales tax and brought down income tax. That was the kind of model for how to actually do it in Thatcher ...

PAUL KEATING: Yeah, but we did it - look, I had outlays growing at one to two per cent less than the inflation rate for five years up to 1990. I mean, it can be done by a studious attention, and also, in a growth economy, the revenue starts to pick up. We don't need to do these kind of very nasty things in the tax system.

TONY JONES: Paul Keating, it's always very interesting to talk to you. I suspect a few Treasury officials will be reaching for their documents to defend themselves.

PAUL KEATING: Well they know what they've done. Don't worry about that.

TONY JONES: Thank you very much.

PAUL KEATING: (Laughs)