Gazing into the fiscal crystal ball: the first Intergenerational Report

The 92 page intergenerational report which accompanied the 2002 federal Budget is an attempt to stare into the fiscal crystal ball and make predictions about Australia’s future as an aid to policy development. This is a worthwhile pursuit in the context of immediate and future budgetary directions. However, the report and the Budget response to it are lacking in several fundamental ways.

The report argues that present levels of spending on health, aged care and pensions will be unsustainable as the baby boomer generation retires, and that without changes to policies social spending will increase by 5 per cent of GDP by 2030. Spending on areas like defence and the environment is assumed to remain constant while spending on areas like education and childcare is expected to fall, in line with the fact that there will be fewer young people.

The first problem is that the forward projections on government outlays are based on current government policy, carrying into the future many wasteful, poorly targeted and badly designed measures that have been largely offered to the better-off as election sweeteners. In doing this it is also based on a scenario that cements in place a lack of action in relation to revenue raising, in particular, a crackdown on the profitable business of tax avoidance. Some of the wasteful measures we can’t afford over the long haul include:

• Failure to reintroduce petrol tax indexation (at a cost of $4.6 billion over four years);
• The 30% private health insurance rebate, which costs the taxpayer more than $2 billion per year;
• The reduction in the superannuation surcharge for the less than 5 per cent of taxpayers on incomes above $85,000 per annum at a cost of $200 million per year;
• The extension of pensioner fringe benefits and tax rebates to well-off retirees (including couples on up to $80,000) at a cost of $300 million per annum – ironically this includes the pharmaceutical benefits the government now argues are unsustainable;
• The baby bonus, which offers up to $12,500 over five years to mothers on incomes of $50,000 or more costing $500 million per year; and
• Withdrawal of trusts legislation ($700 million per year).

A second issue is that the report’s analysis is based on a number of arguable assumptions that fail to address many other likely developments such as changes in the patterns of labour market participation and the benefits of improved health technology.

The report shows the strain on federal finances starting at around 2008, pushing out to a deficit in 2018 and plateauing out at 2042. Health spending, welfare and aged care benefits are seen as the main culprits.

While the picture painted is of an increasing number of retirees supported by a smaller number of taxpayers, changes in the structure of the labour market are likely to mean that there are greater numbers of taxpayers in good health continuing to work past 65. In addition, the report assumes no increase in participation by mothers, also likely to occur as the population ages and employers seek alternative sources of labour supply. The impact of a healthier Australia – where more people will be able to work at all ages – is also not factored in. Access to affordable health and other services will be especially important for people who are less well-off in this context.

The largest single driver of rising costs relates to the costs of new medical interventions and drugs to improve health, as well as more generous subsidies for health care. This needs to be separated from the effects of population ageing and population growth. Once this is done, focusing on these effects only, the increase in health expenditure over the next 40 years is more likely to be around 0.8 per cent of GDP (not 4.8 per cent) expenditure.

Australia’s population is projected to grow to 25 million by 2042, with the number of people over 55 rising most quickly. By 2042, the proportion of people over 65 will rise by just under a quarter. Federal spending on health is projected to double from 4 per cent of GDP to 8 per cent. The report predicts aged care spending will rise from 0.7 per cent of GDP to 1.8 per cent. Aged and disability pensions are also set to rise from 2.9 per cent to 4.6 per cent.

The fertility rate is assumed to fall from 1.75 per cent to 1.6 per cent in 2042. During this time Australia’s labour force growth is seen to shrink from 1.2 per cent to 0.2 per cent by 2042. Despite this, the report assumes no policy action to boost population growth by encouraging an increase in the birth rate or increasing immigration.

However, this is not all bad news, especially for jobless people for whom the market will be forced to compete, resulting in a much reduced unemployment bill – provided the rate of economic growth does not fall too low (growth is much slower in ‘older’ European countries than in Australia).

In part four, the report attempts to model alternative scenarios, including higher immigration and higher workforce participation. However the base case on which the report ultimately relies makes a number of "no change" assumptions based on the patterns of expenditure over the last 30 years, a continuation of current policies, a low economic growth rate of 1.75 per cent, and no change in workforce participation. In this way, it paints a pessimistic fiscal scenario. A different set of assumptions can be readily applied that sharply reduce the predicted cost increases.