ARPA:Death is inevitable, why aren’t taxes?

In the 2002–03 Budget papers was a new publication, the Intergenerational Report, a forty year projection of budgetary revenues and outlays. While most projections imply little change in the composition of Commonwealth budgets, it draws particular attention to rising budgetary costs of health and aged care.

The document exposes the narrowness of Commonwealth budgetary policy. It is concerned with budget expenditures only, rather than the community’s total health care costs. It considers financial matters only, without even a mention of the real economic re-allocations we may need to make to cope with an ageing population. And it completely overlooks important intergenerational issues such as the state of our physical, human, and environmental capital.

The 2002–03 Budget in context

Public debate on the 2002– 03 Commonwealth Budget has understandably been focused on areas of political conflict—in particular the Pharmaceutical Benefits Scheme, disability pensions and the superannuation surcharge. This focus on short-term and politically salient issues has tended to distract public debate from what, at first sight, appears to be a bold project—a forty year budgetary outlook.

Budgets are primarily about collecting and allocating revenues for the coming year. That function remains central, but over the last twenty years budgets have become more concerned with the longer term; the 1989–90 Budget, for example, was the first to include three years of forward estimates, and the 2002–03 Budget documentation includes for the first time an Intergenerational Report, with forty year projections of revenue and expenditure. Like the forward estimates, this document is a projection based on an assumption that there will be no change in policies over the period under consideration.

While budgeting has been changing, so too has Commonwealth economic policy, with the Commonwealth withdrawing somewhat from its traditional role in economic resource allocation. Expenditure control has become the hallmark of sound economic management, even if it is to be achieved by neglecting other important functions of government, such as ensuring that limited health care resources are allocated efficiently and equitably.

This means that the Commonwealth Budget has become more an instrument in financial management rather than economic management; the Budget papers reveal the authorship of financiers and bankers rather than economists. As budget documents have expanded in financial detail, they have contracted in program and policy detail. A similar financial emphasis is also reflected in the Intergenerational Report.

The Intergenerational Report

‘Never make predictions—particularly about the future’ was George Bernard Shaw’s advice. But it would be wise for governments to identify some of the economic issues emerging over the longer term. Such consideration is not without precedent; the 1965 Report of the Committee of Economic Enquiry (the Vernon Report) presented to the Commonwealth a ten year economic outlook. The Vernon Report examined demographic issues, education, public health, physical infrastructure, natural resources, and industry productivity.

A scan of forty years is more ambitious, but we might expect such a scan to cover the same range of issues as the Vernon Report. Environmental sustainability perhaps should have a higher priority than it did thirty-seven years ago. Likewise structural issues deserve more attention than they did in 1965; it is now clear that Australia’s long term living standards will not be sustained on the basis of exports of high bulk/low value commodities. Are we making the appropriate investments in human and physical capital to sustain our living standards in a world where we have to compete on our wits rather than our natural resources? And, of course, we need to consider demographic projections in light of falling fertility, lower immigration and longer life expectancy.

Those expecting to find in the Intergenerational Report an updated and expanded Vernon Report, however, will be disappointed. Its concern is limited to the last of these issues—the impact of an ageing population.

Even within this ambit, however, there are many questions to be considered. What will be the effects of various rates of immigration? Will our labour force have the right set of skills to provide the services required by an ageing population? (A shortage of nurses is already emerging as a workforce problem.) Will people go on working longer? Will they require re-training? There will be a significant growth in the number of healthy and fit people aged over sixty five; will they be available to provide services for the frail old? Will there be disproportionate regional consequences of ageing, for example in South Australia, Tasmania and many country regions? Are our sprawling dispersed cities suitable for an ageing population?

These and similar questions are all economic issues, concerned with real resource allocation. When it comes to long lead-time decisions on issues such as nursing education and urban infrastructure, forty years isn’t long into the future. But these issues are outside the authors’ brief. Production of the Intergenerational Report is a requirement of the 1998 Charter of Budget Honesty Act, which calls for an assessment of ‘the long-term sustainability of current policies, taking account of the financial implications of demographic change’. It is prepared on the same basis as the forward estimates, but over a much longer period. Three year forward estimates, when introduced, were designed to provide some protection against bureaucratic ‘wedging’—that is, obtaining approval for a program with a rapidly escalating financial requirement. It is not clear, however, what policy purpose is served by taking the ‘current policy’ assumption out for forty years.

A financial perspective

These legislative constraints result in the report being no more than a series of fiscal projections, and those projections are limited to Commonwealth finances. While there is some sensitivity analysis, there is no assumption of any policy change. Immigration, for example, is assumed to remain at 90,000 people a year, with the same age-gender profile as at present. The main health and aged care programs are assumed to operate under the same policy parameters as at present. When we consider the changes in health, immigration and welfare policies which have occurred over the last forty years we can see just how unlikely it is that we will enjoy a stable policy environment over the next forty years.

The projections show steep rises in health and aged care expenditure, rising from around 4.7 per cent of GDP at present to around 9.9 per cent of GDP in 2041–42. By contrast, personal transfer payments are projected to rise only slightly, in part because of optimistic assumptions about unemployment, and because superannuation will slow the rise in age pension outlays. Education expenditure as a percentage of GDP will fall; there is no assumption that an ageing healthy population may seek retraining and mature age degrees. These outlay projections are summarised in Table 1.

These outlays, increasing faster than economic growth or public revenue, would drive the Commonwealth Budget into deficit in around 2015—a deficit which rises to around 5 per cent of GDP by 2041–42.

Projections, of course, are not forecasts. They are often used to indicate the unsustainability of certain trends. In this case they do little more than point to the obvious: if Commonwealth outlays on health and aged care grow faster than GDP and if revenues and other outlays retain a constant proportion of GDP, then at some time the Budget will go into deficit. As Galbraith said,‘all pessimism has an air of authority’; this document is clearly written with a pessimistic bias.

Options

In a clear statement of policy implications, the Intergenerational Report states that ‘The projections in this report suggest that, if policies are not adjusted, the current generation of taxpayers is likely to impose a higher tax burden on the next generation’ (p. 1).

Within the assumptions of the document, this statement is incontestable. If the document were designed to stimulate debate and to encourage the community to focus on these hard issues, one would expect this statement to be followed by an exhaustive list of possible policy adjustments and arguments for and against certain courses of action. The options are higher taxes, more control of total health outlays, or shifting more costs off budget.

There is no such discussion, however. After all, this document is constrained to be a mere technical projection. But the authors cannot resist hinting at their preferences; tax increases are unthinkable and costs will have to be shifted off budget. I will briefly try to provide here the case for considering the other two options.

The extent of tax increase to fund these outlays can be inferred from the report—at about $87 billion in constant prices, spread over a population of 25.3 million. That’s an extra $3,400 in per capita taxes—a high burden until one puts in the context of a growth in real GDP per capita of ninety per cent over the same period (obtained by compounding the growth projections in Table 4 of the Report).

A 90 per cent increase in per capita GDP is about $30,000 per capita; is it unreasonable to devote 11 per cent of that to taxation to provide for the needs of an ageing population? Another way to frame the question is to ask whether a five per cent tax rise over forty years is unreasonable; such a rise would put us into the mid league of where other OECD countries are now, and there is a reasonable body of evidence showing that Australians are willing to pay more in taxation to fund health care.

But the document closes off the option of tax increases: ‘Major policy priorities should continue to include both those that increase the economy’s capacity to generate revenue, and those that reduce the growth in government spending’ (p. 1).

The second option is to try to control health care costs. But the report does not mention this option. In fact, because of its narrow fiscal brief, it does not mention of total health care costs at all, its concern is only with budgetary outlays. It is not that this information is unavailable; the Australian Institute of Health and Welfare collects detailed data on health care outlays by governments and individuals. The focus of the Intergenerational Report is government outlays only.

The steepest growth identified in the projections is in the Pharmaceutical Benefits Scheme (PBS), outlays for which are projected to rise from 0.6 per cent of GDP at present to 3.4 per cent of GDP in 2041–42. The Commonwealth’s response revealed in this Budget has simply been to propose increasing patient co-payments.

Now there may be an economic case for increasing patient co-payments, but it isn’t canvassed in the report. If there is no demand response to higher co-payments all they do is to re-distribute the burden of health care payments. If there is a demand response there can be perverse consequences on the health care system if people fail to take important medication and have to be admitted to hospital. The Commonwealth’s obsession with specific high growth programs fails to consider the wider economic consequences of cost-shifting.

There are alternatives to cost-shifting. One reason for the high growth in PBS outlays has been the greater than expected uptake of new, expensive pharmaceuticals. Because pharmaceutical production and distribution involves high fixed costs and low variable costs, there is a strong incentive for firms to promote expensive drugs; each extra prescription is almost pure profit. One way to control such cost blow-outs is to institute price-volume agreements with firms, with one price up to a certain volume, and a lower price for higher volumes.

But, as pointed out in Ken Harvey’s contribution to this symposium, the Commonwealth has shown little interest in price–volume relationships. Similarly, the Commonwealth has shown little interest in reducing pharmaceutical dispensing costs; pharmaceuticals are still dispensed through high cost retail pharmacies.

Shifting expenditures off budget doesn’t relieve the financial burden of an ageing population; at best all it does is to redistribute the burden, often to those who are least able to pay. If co-payments resulted in a more efficient allocation of health care resources they may have some justification, but there is no evidence that the Commonwealth has such an economic objective in mind. Why, for example, increase co-payments on the PBS while maintaining free public hospitals? If the Commonwealth wants more rational resource allocation through markets why retain restrictions on pharmacy ownership and prohibition of price advertising?

The inference to be drawn from the Budget—the Intergenerational Report and the specific budget proposals on the PBS—is that the Commonwealth’s concern is purely with budgetary outlays in certain high growth categories, without considering how these relate to other government programs or to general issues in resource allocation. The issue of total health care costs and the way they are distributed does not warrant a mention—just so long as the growth occurs off-budget.

The consequences of cost-shifting

When health care costs are shifted off-budget there are two consequences. The first is that the benefit of distribution of costs through the taxation system is lost. The second is that cost control is lost.

In most countries people choose to share some or all of their health care costs through pooled funds—generally through national health insurance schemes. In Australia most sharing has been through governments; less than ten per cent of outlays have been through direct patient payments.

In a series of measures in recent years—a thirty per cent subsidy and ‘lifetime rating’—the present Government has made it clear that they expect some of the pooling to be through private health insurance. Indeed, such a commitment is reaffirmed in the Intergenerational Report. While private health insurance is mainly concerned with hospital and auxiliary services at present, it is possible that as patient co-payments increase in pharmaceuticals and ambulatory services (with the fall in medical practitioner bulk billing) private insurance will move into these areas.

Private health insurance achieves at high cost what official taxes achieve at low cost. It pools and redistributes health care expenses, but with much high administrative costs than the Tax Office and Medicare. Being akin to a flat tax it lacks the progressive equity of official taxes. And, as overseas experience shows, a fragmented private insurance system lacks the capacity to control health care costs; single national insurers, by contrast, have the market power of strong monopsonies.

Nor does private insurance bring any improvement in allocative efficiency, for it still suppresses price signals at the time of transactions. The notion ‘HCF or MBF will pay for it’ is no different to the notion ‘Medicare will pay for it’. This phenomenon, known in the insurance trade as moral hazard, is common to all insurance arrangements, be they public or private.

In effect private health insurance is a privatised tax, with all the disadvantages and none of the benefits of a tax. If the Commonwealth envisages that private insurance will displace some of the growth in health care outlays, then a report of this nature should at least acknowledge that it is merely substituting one form of taxation for another.

If, on the other hand, the Commonwealth wants to see more market signals in health care, then it needs to give careful thought to how co-payments might fit into such a vision. How may they be rationalised across different hospital, pharmaceutical, and ambulatory programs? Should they be capped in dollar amounts or proportional to outlays? What other market reforms should accompany co-payments; on this last point governments often liberalise markets only to the advantage of producers, while ignoring the legitimate needs of consumers.

Conclusion

The Intergenerational Report contributes little to our appreciation of our needs and options over the next forty years. Its main contribution has been to reveal the poverty of economic thinking in government. Even if we lay aside finances for an ageing population there is no guarantee that real resources will follow; the most likely consequence of a mismatch between finances and resources is a continuation of high rates of inflation in health care costs.

Ian McAuley lectures in public sector administration and finance in the School of Management and Policy at the University of Canberra. His research has specialised on health and ageing issues, and he has served on the Pharmaceutical Benefits Remuneration Tribunal and the Pharmaceutical Benefits Pricing Authority.

View other articles in this symposium:

Disabling Employment Policy David Abelló and Jenny Chalmers
Safe but not Secure Graeme Cheeseman
Securing The Future of the PBS? Ken Harvey

View other articles by Ian McAuley:

Whatever Happened to Microeconomic Reform? (Digest, 5 Dec 2005)
Public Debt: Another Perspective (Digest, 10 Jun 2003)
Obsessed with Size (Digest, 2 Nov 2001)
Fiscal Guardians (Digest, 12 Apr 2001)