Speech to CEDA ‘2015 Economic and Political Overview’:
Structural Impacts on Commonwealth Expenditure in Australia
13 February 2015, Sydney
Thank you for inviting me to speak today. I welcome this opportunity to participate in CEDA’s annual event. CEDA’s continuing contribution to debate and understanding of important public policy issues is commendable.
There is wide recognition of the need to return the Commonwealth budget to surplus and to a structurally sound and sustainable position. This is a challenging but necessary task.
It is inevitable that this task requires a slowing in growth of government spending, which is growing at a faster rate than the economy and – without corrective action – will continue to grow at a rapid rate due to an ageing population and the increasing cost of and demand for government funded services.
Spending growth needs to be curtailed because the real economy and national income will not grow strongly enough to generate the revenue growth required to fund the projected increasing levels of spending, and the significant increase in tax receipts as a proportion of GDP that would be required to close the ‘fiscal gap’ is unlikely to be socially and economically desirable.
The outlook for real economic and national income growth is constrained by a number of factors, including in particular global economic headwinds (for example, those associated with continuing weakness in the Euro zone economy and Japan); the Australian economy’s continuing transition from mining investment led growth to more broadly based growth; an expected continuing decline in Australia’s terms of trade (albeit from the recent historic peak of the mineral commodity prices boom); and an ageing population, which will tend to reduce the aggregate workforce participation rate and, hence, economic growth. This of course also raises issues about the need for reform to increase productivity and workforce participation in order to support living standards, which will otherwise be eroded as a result of the decline in the terms of trade.
To continue with persistent budget deficits would mean growing levels of public debt and increasing levels of debt interest payments. Ongoing increases in interest payments as a share of total spending are not sustainable.
The 2014-15 Budget is a useful starting point for me to illustrate structural impacts on Commonwealth expenditure. I will therefore briefly outline projected growth in Australian Government spending as at the 2014-15 Budget compared with projected growth in the absence of the Budget measures. I will then present a sketch of the key structural drivers of spending growth.
Spending and budget balance projections
The 2014-15 Budget announced a range of measures to achieve a structural reduction in the growth of government spending and put the budget on a path to a sustainable and responsible budget position.
(See Slide 1) Projections in the 2014-15 Budget show that, before the measures announced in the Budget, even with taxation receipts allowed to increase as a proportion of GDP through fiscal drag (including bracket creep) the budget would remain in deficit through the next decade. If taxation receipts were capped, the deficits would increase over time from 2019-20.
The Parliamentary Budget Office (PBO) report Projections of Government spending over the medium term (August 2014) reinforced this view noting that, without action, government spending is unsustainable.
With the 2014-15 Budget measures, the budget is projected to be in balance in 2018-19 and turn to surplus in 2019-20, with the surplus then increasing to 1.4 per cent of GDP by 2024-25. This budget trajectory reflects a significant fall in total government expenditure as a proportion of GDP as a result of the announced measures, from 25.3 per cent in 2014-15 to 24.2 per cent in 2024-25 – in contrast to a rise projected at the 2013-14 MYEFO (in December 2013), from 25.9 per cent to 26.5 per cent over the comparable decade (2013-14 to 2023-24).
(See Slide 2) The projected budget balance trajectory to 2024-25, as updated in the 2014-15 MYEFO, is affected by a slightly weaker economic outlook since the Budget last May, but the budget is still projected to turn to surplus in 2019-20.
Commonwealth spending drivers
The key drivers of government spending growth (in the absence of corrective action) are primarily: an ageing population – due to the baby boomer effect, a lower fertility rate and people living longer; other non-demographic drivers such as the cost of medical technology; existing policies that govern eligibility conditions and indexation of government payments; and new and increasing demand for government support and services.
An ageing population (see Slide 3)
Over the last decade, the average annual growth rate for the population cohort aged 65 and over was significantly higher than the average annual growth of the total population, and this trend will continue.
This in turn raises the rate of growth of government spending as per capita government spending increases sharply for the age cohort of 60 years and older – reflecting largely spending on the Age Pension, but also health care and aged care.
In addition, as the population ages, proportionally more people move into age groups where participation in the labour force is lower, in turn lowering economic and national income growth and growth in tax revenue. While older Australians are likely to work for longer due to growing educational attainment, greater attachment of women to the workforce and deferred retirement, this will not be sufficient to offset the downward impact of ageing on the aggregate participation rate.
Structure and growth of Commonwealth spending (see Slide 4)
As at the 2014-15 Budget, around 58 per cent of total Commonwealth expenditure (which is $415 billion) was on social security and welfare, health and education. The proportion is significantly higher at around 70 per cent if GST payments to the States and public debt interest payments, which do not relate to direct Commonwealth government provision of services, are excluded from total spending.
Several major demand-driven programmes – which are predominantly in the social security and welfare, health and education areas – have been among the fastest growing expenditures over the last decade and, without corrective action, are expected to continue to grow rapidly in the future. New demand-driven programmes to meet growing community needs, in particular the National Disability Insurance Scheme, will also contribute to strong future spending growth.
(See Slide 5) As at the 2013-14 MYEFO, before the measures in the 2014-15 Budget, the share of demand-driven expenditures in total government spending was projected to rise from 59 per cent in 2013-14 to 62 per cent by 2023-24 in the absence of policy changes – and from 74 per cent to 80 per cent if GST and public debt interest payments are excluded from total spending.
(See Slide 6) The projections in the 2013-14 MYEFO imply that per capita spending on government services in real terms (that is, in 2013-14 dollars) would increase from $17,500 in 2013-14 to around $19,500 per person by 2023-24 – a real increase of around 11½ per cent. With the measures announced in the 2014-15 Budget, real per capita expenditure in 2023-24 is projected to reduce by around 5 per cent (at around $18,500 per capita).
Spending pressures – health (see Slide 7)
The ageing of the population is having a direct impact on health expenditure due to both the increasing proportion of older people (including through increasing life expectancy) and the higher level of health needs of older people. For example, per-capita health expenditure for people aged over 85 is around 20 times higher than for children aged 5-14.
Non-demographic factors are also driving the increase in health spending. These include: advancements in medical technology, which have tended to target diseases that have a higher prevalence among older people; rising costs of health services, including the rising cost of medical technological equipment and related services; and rising community expectations regarding the quality and capability of healthcare services.
Health expenditure is dominated by three key programmes: the Pharmaceutical Benefits Scheme (PBS), the Medicare Benefits Schedule (MBS) and Commonwealth assistance to the States for public hospitals – which together account for around 80 per cent of total health spending and around 13 per cent of total government expenditure.
Expenditure on the PBS has grown as a result of the increasing cost of new medicines, but also due to increases in the volume of prescriptions – which has been partially ameliorated by the effect of price falls for some drugs covered by the PBS as a result of previous pricing reforms, as well as drugs that go ‘off-patent’ and are substituted for generic brands.
Predictions of rising rates of cancer and chronic disease suggest that spending on more expensive medications will rise in the coming years. The fastest growing component of the PBS is medication for chemotherapy, and expenditure on highly specialised and high cost drugs for the treatment of chronic conditions is growing faster than many other components of the PBS.
Spending pressures – social security and welfare (see Slide 8)
Social security and welfare is the largest expenditure function, comprising 35 per cent of total government expenditure in 2014-15 (or 42 per cent if GST and public debt interest payments are excluded from total expenditure). Of this, income support for seniors (largely the Age Pension) accounts for around 10 per cent of total government spending.
Expenditure on the Age Pension is projected to grow at an average annual rate of 4.0 per cent in real terms, well above the projected growth in GDP.
The key drivers of growth in spending on the Age Pension, in addition to the ageing population, are current indexation arrangements for the pension (which over time tends to grow at the rate of growth of male average weekly earnings) and generous means test arrangements.
The Government announced in the 2014-15 Budget that it will index a range of pension-type payments only by the CPI, including the Age Pension, Disability Pension, Carer Payment, Veterans’ Affairs pensions, and Bereavement Allowance from 1 September 2017, and the Parenting Payment Single from July 2014.
Spending on new programmes – the National Disability Insurance Scheme
Additional or new government spending that adds to budget pressures can stem from a need to address anomalies in the provision of existing services. A particular case is the introduction of the National Disability Insurance Scheme (NDIS) which was announced in the 2012-13 Budget and is to be fully operational by 1 July 2019, and which established a consistent national scheme for those experiencing severe and permanent disabilities. Commonwealth expenditure on the NDIS is projected to grow rapidly and it accounts for 16 per cent of the projected real increase in total government spending over the decade to 2024-25, and 4 per cent of the level of total spending in 2024-25.
The Government has aimed to manage some of this additional expenditure pressure through an increase in the Medicare levy of 0.5 of a percentage point from 1 July 2014.
Spending on public administration and public sector efficiency measures
It is sometimes suggested that growth in Commonwealth spending at least partly reflects increasing public service costs in delivering existing functions. The evidence shows this is not the case.
As a proportion of total gross expenses in the general government sector (GGS), in nominal terms, departmental expenses excluding Defence operations have declined over the past five years – from around 9 per cent in 2009-10 to around 8 per cent in 2014-15.
While the proportion of total departmental spending is estimated to increase to around 14 per cent in 2017-18 and projected to increase further beyond that, this reflects new activities – largely by the agency set up to administer the NDIS, noting that disability support services received by the scheme participants are classified as departmental spending due to the nature of the legislation under which the National Disability Insurance Agency (NDIA) is constituted. Excluding the NDIA (as well as Defence operations), departmental expenses are expected to fall significantly further to around 6 per cent of total gross GGS expenses in 2017-18– well below the proportion in 2009-10 of 9 per cent.
Since 2011-12, there has been around $5.8 billion in savings achieved through a series of departmental efficiency measures. These include around $3.4 billion from increases in the Efficiency Dividend rate, in addition to the standard annual rate, that is applied to departmental expenses; $0.6 billion (over 4 years) from ‘Smaller Government’ reforms introduced in 2014-15; and $1.8 billion from a broad range of other measures in the preceding three years.
Restraining spending growth – an inevitable challenge (see Slide 9)
In summary, it is clear that in order to ensure fiscal sustainability over the medium term, it is necessary to restrain spending growth by addressing the structural drivers – including policy/programme settings. It is a challenging task the Government is pursuing and on which the Government is engaging the community.
Dealing with the structural budget deficit cannot rely simply on a strategy for stronger economic growth. Given declining terms of trade and the adverse impact of an ageing population on labour force participation, even returning to and sustaining the historical trend rate of economic growth is itself a challenge that requires reform.
Similarly, increasing tax receipts as a proportion of GDP would involve challenges the community needs to understand, and there are also structural impacts on taxation revenue that need to be tackled to strengthen public finances.
Reducing spending growth ultimately requires choices to be made through government engagement with the community in terms of prioritising future spending. It is not possible to materially reduce spending growth without looking at the largest and fast-growing demand-driven spending areas – and this includes looking at better targeting of government support and the level of government support in some areas. Several measures in the 2014-15 Budget move in that direction.
Public sector reform also needs to be ongoing and to build on efficiency gains already made and initiatives being currently pursued.
Last updated: 31 August 2015