Australia’s choice: keep hiking taxes, or grapple with our spending on health and the aged

How to deal with our demographic future of an ageing population? One was is the status quo - hike taxes - but the other requires the courage to grapple funding to health and the elderly. AAP

More than a decade ago the federal treasury produced the first Intergenerational Report (IGR), warning of the challenges facing the Australian economy due to demographic change.

The IGR warned that the living standards of future generations would depend on the decisions made at that time. Unfortunately budgetary decisions made in the past decade have not begun to meet the challenges of an ageing population, and in most cases have taken us backwards.

We are not, on the current trajectory, headed for a smart, productive workforce enjoying high living standards. Instead we are headed toward the European style long-term malaise, though I would hope that we do not fall so far.

The challenges outlined in the IGR and subsequent updates are pretty simple. With an ageing population, the burden of higher aged care and health costs will be borne by a smaller workforce.

While demographic forecasts are subject to errors, the general trend will be impossible to reverse. The first IGR projected that the ratio of adults not in employment to those in employment would rise from approximately 0.7 to 0.9 by 2042, and continue to rise thereafter.

What can be done about this problem? One option is the status quo. Assuming that GDP continues to grow, a rising welfare and health burden can be dealt with through increasing tax revenues and government expenditure, with living standards still continuing to rise.

In my view this option will see living standards decline dramatically in the coming decades relative to where they ought to be and to our regional peers, so that the opportunities for our children will be far less extensive than they should be. Rising tax burdens stifle innovation and entrepreneurship, and our new competitors in Asia will increasingly occupy spaces that Australians should also enjoy.

Let me first spell out the general directions taken in the past ten budgets, then spell out some different options and directions to be considered.

In the 2003-04 financial year a small budget surplus was projected, with spending of around $177 billion. Social security and welfare accounted for $76 billion (or 42%) of total spending, with health comprising a further A$31 billion (18%) of total spending. Defence, and education spending were each around A$13 billion, or 7% of the budget. If one looks at the budget aggregates it is very clear that in order to limit spending increases, rising health care and social welfare payments are the major issue, with an ageing population leading to increasing pressures in these areas.

If one looks into the details of the social welfare payments, aged care payments are the largest single spending item in the budget. In 2003-04 A$26 billion were payments to the aged, while families with children received A$21 billion. While health spending is not broken down by spending on the health of the aged, the Productivity Commission has reported total health costs of those aged over 75 are more than four times the costs of those aged 35-54.

The 2013-14 budget reports accrual expenses of A$398 billion, and revenue of A$388 billion. Over the past ten years that is an average rise in tax revenue and expenditure of around 15% per year. During the same period nominal GDP grew by 8.5%.

Some of the increase in expenditure and tax revenue is due to different treatment in the budget of GST revenues and associated transfers, but even after taking this out of the budget, spending rises by more than 12% per year, much faster than nominal GDP.

Treasurer Wayne Swan has blamed some of the current deficit on slower than expected nominal GDP growth – one could alternately argue that Australian governments have become far to used to relatively high nominal and real GDP growth, and in particular company tax revenues, and have spent the windfall before they earned it.

Social security and welfare spending accounted for A$138 billion in the latest budget, a rise of nearly 14% per year over the past decade. Assistance to the aged has risen to almost A$55 billion, a rise of 22% per year since 2003-04. Over this same period health care spending has risen to A$65 billion, an increase per year only slightly slower than spending on assistance to the aged.

Despite the warnings in the IGR, we have not gotten close to controlling the two main costs associated with an ageing population. This is perhaps not surprising in a world where the aged vote, our voters are getting older, and our politicians pander relentlessly to the median voter, but this mix is a recipe for an impoverished Australia.

What can be done to control these costs? In regard to both health and aged care spending, government spending must be provided only to those who are in need of assistance. Pension tests are still far too lenient, with many pensioners who receive some assistance clearly capable of caring for themselves.

Anyone who receives any pension also receives very substantial health benefits and other subsidies. Over the past decade the governments share of total health spending has risen. Private contributions to health need to be increasing, not decreasing, in the future.

A further factor is the lack of savings of older Australians. The government is to be commended for increasing the compulsory superannuation contributions over time. However, the government should resist changes to superannuation that make it less attractive, and also ensure that withdrawals from superannuation are managed so that balances are sufficient to the end of what will be very long lives for most people.

Further, it is well to remember that when the government pension was introduced, the average life expectancy for men was still below the pension age of 65. While increases in the pension age to 67 are a good start, the current reality is that the right pension age is probably closer to 75, or even 80, and ought to be increased well above 67.

In this Asian century it is interesting to look at some developments in our Asian neighbours. In most countries in Asia spending on health, on pensions, and on education is a fraction of our spending. Of course it is often the case that we do not want to emulate our neighbours, however there are many cases where we have a lot to learn.

At Narayana Hospital in Bangalore, heart surgery is performed at a fraction of the cost of the same procedure in an Australian or US hospital, with outcomes at least as good in terms of mortality and other indicators. The focus at this hospital is on high scale, efficiency, and low cost. In OECD economies it is this last point that is usually lost.

In education the government has the ambition for our education system to produce students who are top five in the world. Currently Shanghai has the top ranked students in maths and science outcomes according to the OECDs PISA tests. There are some things we would not want to replicate from the Shanghai system, such as the high levels of homework and discipline, but Shanghai has also implemented many effective reforms that have improved weaker performing schools – mentoring, training of teachers, and experimentation with different teaching methods have been very successful. Interestingly, the approach in Shanghai is very decentralised and experimental, which seems to be the opposite direction to the one Australia is taking.

It is telling that we still compare our economy with the mostly weak OECD economies in our budget papers, rather than the more dynamic and diverse economies in our region. In the Asian century we have a lot more to learn from our Asian neighbours than from OECD economies. German Chancellor Angela Merkel was recently quoted in the Financial Times as saying that Europe has 7% of the global population, 25% of global GDP, and 50% of global welfare spending. Welfare spending is far from the only problem in Europe, but the habits of dependence, rather than work, are a major issue.

Fifty years ago Donald Horne referred to Australia as the lucky country. But he also pointed to the fact that we were run by second rate people who shared its luck. Unfortunately luck will not be enough to get us through the next 50 years.