Treasurer Jim Chalmers describes the new tax setting he wants to introduce as “a modest change”, but a growing chorus of critics say the plan to increase tax on super balances over $3 million will hurt investment and punish younger Australians working towards their nest egg.

One of Labor’s key policies, Chalmers’ super tax changes will be put to the parliament in coming months, affecting thousands with contributions to Australia’s $3.9 trillion superannuation sector.

The new tax setting for super balances of more than $3 million will apply from July 1.

Labor says it expects to raise about $2.7 billion in revenue in the first full year after the changes are made.

But how will it affect you?

And what are some of the tweaks that could be made before the final laws come into effect?

For about one in 200 Australian taxpayers with super balances higher than $3 million, there will effectively be a new tax bracket for money they earn on their super.

Currently, earnings from super in the accumulation phase (the time when people are still working and contributing to their balance) are taxed at a discounted rate of up to 15 per cent. This will be unchanged for superannuation accounts with balances of less than $3 million.

But people with superannuation funds of more than $3 million will face an additional 15 per cent tax on any investment returns (including interest, dividends or capital gains) they earn on the amount above this threshold.

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For example, someone with a $3.5 million super balance will continue to be taxed the discounted rate of 15 per cent on everything they earn on the first $3 million of their balance. Investment returns on the additional $500,000 will be taxed at 30 per cent.

A controversial element of Labor’s tax reform is that the super tax would also apply to “unrealised gains”, which refers to the growth in the value of an asset or investment that an investor holds but hasn’t yet cashed in.

For example, an investor could hold property or shares that increase (and decrease) in value over time. However, unless they sell these assets, any rise or fall in their value is seen as “paper profits” because they have not yet been converted into cash and locked in.

Generally, earnings are not taxed until they hit your pocket. But Labor’s tax on unrealised gains would mean Australians with superannuation balances of more than $3 million – while relatively wealthy – would receive a tax bill even if they hadn’t actually earned any income (potentially forcing them to sell assets to pay that bill, and reduce the total amount of money in the nation’s super pool, affecting returns for all super members).

If a person records an unrealised loss one year – where their super balance falls due, for example, to a market downturn – that unrealised loss will be used to offset the tax on earnings from their super balance in future years.

The final tax bill is generally paid directly by your super fund to the Australian Tax Office. For self-managed super funds, the tax amount is usually paid through BPAY or using a debit or credit card.

Indexation of the super tax – or lack thereof – is another aspect that some people have criticised.

Indexing refers to the practice of increasing a threshold or entitlement to change in line with another measure such as inflation, wages or tax.

In the case of the super tax, Labor has not promised to tie the threshold for the 30 per cent tax rate to changes in price growth. This is a problem because $3 million this year will not have the same purchasing power as the same amount in 20 years’ time.

Assuming an inflation rate of 2.5 per cent, an indexed threshold would capture funds with more than $5 million in 2045.

While the proposed tax only affects about one in 200 Australians now, it would apply to many more if not indexed. Independent MP Monique Ryan, for example, has criticised the lack of indexation, saying it means the tax could affect all of Gen Z by the time they turn 60.

Treasurer Jim Chalmers has stood by the new tax, first announced by Labor in early 2023.

Chalmers, speaking on a podcast with Michelle Grattan this week, maintained it was a “modest change” that still gave concessional treatment – although slightly less so – to people with large super balances.

“This will help us fund our priorities, whether it’s Medicare, the tax cuts and other priorities in our budget repair,” he said, noting he had consulted widely on the changes and that the controversial inclusion of unrealised gains was “the best, simplest way to go about it” according to advice from Treasury.

Chalmers also said it was wrong to assume the $3 million threshold would never change.

“There are so many instances in the tax system where thresholds aren’t indexed, and from time to time, governments take decisions to raise those thresholds,” he said. “I’m anticipating that that’s what would happen here.”

Several prominent figures have chipped into the conversation around the super change: among them, former treasury secretary (and author of the Henry Tax Review) Ken Henry and former RBA governor Phil Lowe.

In an article in The Australian, Lowe said the change was not an example of good public policy design, saying the government should explore alternatives.

In the same article, Henry said the system needed to be more equitable. “To do that, you do not need to tax unrealised capital gains,” he said, pointing to suggestions in his more-than-decade-old review.

Chalmers told The Conversation in a podcast that he was yet to start talks with the Senate crossbench. Labor will likely need support from the Greens to get the proposal turned into law.

Chalmers said he was not considering the Greens’ demand for a $2 million threshold but suggested there could be talks about indexing the $3 million threshold.

Parliament is due to resume on July 22.