The real message of the Intergenerational Report should be: we won’t be worse off

Treasurer Joe Hockey will release the latest intergenerational report on Thursday. AAP/Lukas Coch

Today treasurer Joe Hockey will release the fourth Intergenerational Report. Like its predecessors, the government is likely to use the IGR to frame its economic and budget message. What past experience tells us is that behind the messaging, the numbers tell a consistent, and surprisingly optimistic, story. Whatever today’s headlines, remember to look at the numbers and ask one important question – will future generations be richer or poorer on average than today?

The IGRs are required to be produced at least every five years, and have become a normal part of Australian policy-making. This reflects a global trend, where policy makers have focused more attention on the implications of population ageing. The first report was released in 2002, however, the schedule was changed by the Rudd Government, which brought forward the last report to 2010.

The headline of each IGR tends to focus on the fiscal calamity that awaits us if urgent action is not taken to arrest a projected growth in government spending. That certainly seems to be the tone taken by Hockey, who has justified unpopular budget measures on the grounds of intergenerational equity. Yet, to date, there is surprisingly little evidence in these reports to suggest any significant problem.

We won’t be worse off in the future

It is important to differentiate between two issues often conflated in this debate – the impact of population ageing on our economy and average incomes, and its impact on the government and its budget. Our main interest as citizens is surely on the overall economic impact.

On that front, the news has been largely positive. None of the reports to date suggest the average Australian will be poorer in the future than they are now. That’s worth repeating: all the evidence is that material living standards will continue to rise. Indeed, the last report suggested the average person in 2050 would be 80% richer than the average person in 2010.

The one exception (included only in the last report) comes from climate change. This is a genuine economic and intergenerational challenge, with real potential to leave future generations worse off. However, it would be surprising if this issue led the discussion under the current government.

The most recent IGR suggests that the proportion of people of working age (those aged 15-64), will be about the same in 2040 as in 1970. And that sounds worse than it is, because the increase in the number of working women means more of us will likely be engaging in paid work in the future than in the past.

If we took the figure back even further to the 1950s or 1960s – when living standards were growing more rapidly than they are today – the comparison would be more favourable because war and depression had thinned the number of adults and a baby boom had substantially increased the proportion of dependent children. The gloomy predictions of large numbers of dependents tend only to focus on those aged over 65.

We’ll be working longer

Of course its not only how many people might be willing to work, but how long they work. And here is another surprising finding. According to the 2010 IGR (Chart 1.11), the average worker in 2049/50 will be working more hours per week than did their grandparents in the early 1980s. The long historic trend to enjoy the gains of productivity as time, rather than money, has been in reverse as hours increased over the past 30 years.

It is difficult to suggest that making future generations much richer than past generations should be seen as either an economic problem, or as a source of inequity on the part of the young. The concern, then, is not really “economic”, but “fiscal”, its about the budget.

Each IGR has predicted future deficits. However, those predictions have been far from stable. The first IGR estimated that by 2041/2 the federal budget would have an annual deficit of about 5% of GDP. By 2007 this had fall to about 3%, and in 2010 it was just over 1% (Chart 3.2).

Estimating the future is always difficult. And it seems this year selecting the assumptions for the model might be more political. It is normal for annual budget numbers to be significantly different to predictions, let alone predictions decades into the future. But the scale of revisions suggests significant caution is needed in making any policy change now based on what might happen in decades to come.

Tax revenues are the untold story

Perhaps more importantly, the IGR has to date only told half the story. Discussion of the budget has only included public spending. Tax revenues are presumed to be stable as a proportion of GDP. This has two important implications. First, it conceals an implicit assumption that tax rates will be cut in the future. Our tax rates are progressive, so as incomes rise, the proportion of tax paid also rises. Given incomes are predicted to rise, it would require real tax cuts to keep tax revenues stable.

Second, inattention to taxation can lead to perverse outcomes. In response to earlier IGRs, the Howard government introduced new tax concessions for superannuation and investments designed to encourage people to finance their own retirement, reducing pressure on the public pension. But we now know that the cost of these tax concessions likely exceed the revenue saved. In effect, the changes made future deficits worse, while also reducing equity.

It is true that government spending is likely to rise given current settings. But this is only partly due to population ageing. The biggest expected increase is in health, and most of this is unrelated to ageing. Instead it reflects rising expectations and better health outcomes. But because healthcare is primarily a government responsibility, it also implies rising government spending.

As with pensions, the narrow focus on government spending can distort broader economic judgments. One response to growing health costs has been to shift these costs to the individual. Yet this may only increase total health spending, and increase inequality.

Governments have proven more effective at constraining costs in health by using their significant buying power. For example, the US spends more per person on health than any other country, but receives less in services and health outcomes than most European countries. The same appears to be happening here. The fastest growing component of government health spending is for the private health insurance rebate, reflecting the higher inflation rate in the private sector.

It will be interesting to see how the latest IGR responds to these issues. To be of real benefit the IGR will need to look to taxes as well as spending; focus on living standards, not just the budget; and look to real intergenerational risks like a changing climate.