Intergenerational Report lays uneven path for tough policy choices

The three scenarios in Joe Hockey’s Intergenerational Report present very different pictures of the future budget situation. AAP/Lukas Coch

The 2015 Intergenerational Report has been interpreted by some as presenting a gloomy picture of Australia’s future. However, the report delivers a range of very good news. Our children and grandchildren will be living longer than us and, on average, they will be much better off in material terms.

The report projects that a girl born in 2055 could expect to live 96.6 years compared to 93.6 years for a girl born in 2015. For boys, the corresponding increase in life expectancy at birth by 2055 is from 91.5 to 95.1 years.

Australia will be a much richer country than it is now. Productivity growth is assumed to be 1.5% per year on average, which would lift real Gross National Income (GNI) per person from around A$66,400 in 2014-15 to A$117,300 in 2054-55.

Using the assumption specified in the report, real Male Total Average Weekly Earnings (MTAWE) – the benchmark currently used to index Age and Disability Pensions and some other payments – would rise from around $71,500 now to close to $128,000 in 2054-55.

On average, then, Australians – particularly those employed – will be better off in real terms by more than 75%.

Nevertheless, the Intergenerational Report shows that Australia faces an extended period of difficult social policy choices.

The report presents three scenarios. One is said to be based on “previous policy” – although this is disputed by shadow treasurer Chris Bowen. A second scenario is based on “currently legislated” policies that have been passed by the federal parliament. A third scenario is based on “proposed policy”, which assumes full implementation of the 2014-15 budget, or “alternative measures of equivalent value”.

These three scenarios present very different pictures of the future budget situation.

In the first scenario, the underlying federal government cash deficit would reach 11.7% of GDP; net debt would reach 122% of GDP. In the second, the deficit would be around 6% of GDP; net debt would be close to 60% of GDP.

In the third scenario, there would be a surplus of 1.4% of GDP in 2039-40, falling somewhat thereafter. Net debt would be zero by 2031-32, before declining further (assets would exceed debt).

However, some of the necessary assumptions used to generate these scenarios have desirable budgetary outcomes but very unpleasant outcomes for the poor.

What does it mean for the Age Pension?

One of the biggest savings proposals in the 2014-15 budget was to change the indexation of the Age and other pensions to be only in line with increases in the Consumer Price Index (CPI) rather than the higher of MTAWE or the Pensioner and Beneficiary Price Index.

Interestingly, the report assumes that once the budget reaches a surplus of 1% of GDP in 2028-29, a future government will return to wage indexation of pensions. However, strictly speaking, this is what not the proposed budget policy would do since there was no “sunset clause” in it.

Following this assumption, the base rate of the Age Pension for a single person would fall from about 28% of MTAWE currently to just under 24% in 2029 and be stable thereafter. The total pension package including supplements is higher. But because these supplements are already only increased in line with the CPI or not indexed at all, the total payment would fall from 31% to 25% of MTAWE.

However, if a future government failed to change the indexation back to wage rates, by 2055 the single rate of Age Pension would fall to not much more than 16% of average wages. This is a level considerably lower than at any time in the last 50 years.

What for the unemployed?

Even more worryingly, all the scenarios – as in previous intergenerational reports – properly assume the continuation of existing policies for the indexation of working-age payments and family payments.

What this means is that while the average worker is projected to be 75% better off in real terms by the middle of the 21st century, the unemployed would be relatively worse off. A single person relying on Newstart would see their payment fall from just under 19% of MTAWE currently to around 10.5% in 2054-55.

Given that the current level of Newstart is already recognised as inadequate, we could ask whether these projected future levels of payments would be socially acceptable in the much richer country that Australia is likely to be.

It is also worth noting that the report assumes that the unemployment rate stays at around 5% over most of the projection period. According to the report, this rate is:

… the lowest sustained unemployment rate that does not cause inflation to increase.

In addition, the “proposed policy” scenario assumes the implementation of a six-month waiting period for Newstart for unemployed people under 30 years of age. As I have previously explained, unemployed people under 30 receive under 1% of total budget spending, but are the source of close to 10% of proposed expenditure savings in the 2014-15 budget.

So, the current and previous reports assume fairly constant unemployment, but with the ongoing impoverishment of those who experience it and the potential halving of support for some of the most vulnerable unemployed. This is the path the government sees as the way back to surplus.

The then-Labor government’s 2009-10 budget changed the indexation of Family Tax Benefits from wages to prices. Under the same assumptions shown above, Family Tax Benefit Part A for the lowest-income families would also nearly halve relative to wages over the period up to the middle of the century. This might lead to an increase in the depth of child poverty.

Under both the “previous policy” and the “currently legislated” scenarios, spending on working-age payments fall from 2.8% to 2.6% of GDP. Spending on families falls from 1.8% to 0.9% of GDP. But under the “proposed policy” scenario, the falls are larger – to 2.4% of GDP for working-age payments and to 0.8% of GDP for family payments.

If the implicit distributional outcomes of these spending trends are unacceptable in a society as rich as Australia, we need to recognise that these projected falls in expenditures may not happen. This means that the report may actually be underestimating the scale of the budgetary challenges ahead.

Australia has a very real dilemma in cutting spending on social security. Because the Australian social security system targets lower-income groups more effectively than any other rich country, cutting social security benefits would increase income inequality more than anywhere else in the OECD.

UNSW’s Rafal Chomik has pointed out that, in relative terms, the proposed changes to indexation of payments and the proposed increase in the Age Pension age to 70 would actually have the most negative impact on the poorest pensioners. Greater targeting of payments is always possible, but the scale of potential savings is unlikely to be as substantial.

Social sustainability is an essential part of the debate Australia needs to have about the future of spending and taxation. The projected deficits in the report also reflect the assumption that the projected Commonwealth tax-to-GDP ratio stays constant at 23.9% of GDP from 2020-21 onwards.

In addition to having an open and serious public discussion of how to target Australia’s social spending better, we need to look at the revenue requirements necessary to fund social and government spending more broadly. As my colleague Miranda Stewart has argued:

Since federation, the Australian community has made broad choices about government expenditures, redistribution and taxes. It’s time to do it again.

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