Michael Keating. The 2015 Intergenerational Report

Purpose of the Intergenerational Report

The Intergenerational Report (IGR) should be an important document.  It purports to tell us what the Australian population, economy and Budget could look like in forty years time.

Of course no-one really knows what the economy will look like in forty years time. Instead the IGR tells us how fast the economy could grow over the next four years if the drivers of economic growth – population, participation and productivity – continue to have the same future impact as in the past. So despite the declared optimism of the Treasurer about our economic future, and how much better off we will be, as far as the IGR is concerned that future has been established by definition and is certainly not proven.

But that is to miss the point of this IGR and its three predecessors.  Rather the IGR is a conditional projection designed to help us assess the sustainability of government policies impacting on expenditure and revenue, assuming that the economy continues to grow in much the same way as in the past.  That is a useful exercise, especially as each of the four IGRs so far have signalled a future long run Budget deficit, although the magnitude has varied substantially from one IGR to another (see Table below). This in itself reinforces the need for caution in interpreting the IGR projections as a basis for policy action.

Projected Fiscal Deficit in Successive Intergenerational Reports

Per cent of GDP

Report Projected deficit forty years later
2002 5.2
2007 3.5
2010 3.0
2015 6.0

 

Nevertheless the principal message in all the IGRs is that assuming no change in present policies, there are pressures for public expenditure to grow faster over time than the economy and revenue; principally because of:

  • the ageing of the population,
  • the disproportionate impact of more expensive technologies on the cost of health care, and
  • the relatively high demand for more health and education services as incomes rise.

Accordingly it would seem prudent to start taking action now to bring the budget back onto a more sustainable basis in the long run, especially when the present starting point is itself an unsustainable deficit. But given the inevitable uncertainties associated with these projections, the pace and extent of fiscal tightening should be subject to constant review as events unfold.

Although this message of the need for ongoing fiscal restraint is common to all of the four IGRs so far produced, this latest 2015 IGR is different in both tone and presentation.  In particular, the three previous IGRs had only one fiscal projection based on a continuation of present policies, whereas this 2015 IGR has three scenarios. In itself this introduction of scenarios might be a good innovation, as they could serve to further illustrate the relative significance of the uncertainties involved in these projections. Unfortunately, however, that does not seem to be the main purpose of the three scenarios in the 2015 IGR; rather their purpose seems mainly to make polemical points about the irresponsibility of the previous Labor Government and those who continue to oppose the Government’s budget measures in the Senate.

The fiscal scenarios

The three fiscal scenarios provided in the 2015 IGR are:

  1. A ‘previous policy’ scenario which purports to reflect the situation that the present Government inherited on its assumption of office along with a continuation of what would have allegedly been the previous Labor Government’s policies. Under this scenario an underlying cash deficit for the Budget is projected equivalent to 11.7 per cent of GDP in 2055, and net debt would reach almost 122 per cent of GDP.
  2. A ‘currently legislated’ scenario, which uses the Government’s savings measures that have actually been passed by the Parliament, and for 2055 it projects a Budget cash deficit of almost 6 per cent of GDP and a debt to GDP ratio of almost 60 per cent.
  3. A ‘proposed policy’ scenario, which is based on full implementation of the present Government’s policies as they had been announced – a couple of these policies have been reversed since the scenario was completed (namely the Medicare co-payment, the Defence Forces pay, and possibly additional expenditure on international and domestic security). According to this scenario the underlying cash balance of the Budget will improve to a surplus of 1.4 per cent of GDP in 2040, and then moderate to a surplus of around 0.5 per cent of GDP in 2055, with net debt projected to be fully paid off by 2032.

The second ‘currently legislated scenario’ has most in common with the way previous IGRs reported, and this projection of the size of the fiscal task is of much the same order as projected in the first IGR. However, in Peter Costello’s first IGR the projected fiscal gap was discussed in a much more measured way as an illustration of the future challenges, whereas in the latest IGR the presentation seems to be intended to scare us into accepting the Government’s ill-fated budget.

Furthermore, the so-called ‘previous policy’ scenario which the Government wants to hang around Labor’s neck is a pure concoction. The starting position chosen for this scenario is after the Government had been in office for some time and had made a number of decisions, such as abolition of the mining and carbon taxes. That effectively means that at its starting point the Budget deficit for this scenario was already much greater than when Labor left office.  In fact the only true statement of the fiscal situation that the present Government inherited is the Pre-Election Economic and Fiscal Outlook report, which the two Secretaries of Treasury and Finance signed off on just before election day, and that report showed that in the Secretaries’ opinion the Budget would return to surplus as soon as  2016-17. In addition to the extent that the Budget has deteriorated since Labor left office there is every reason to think that Labor would have taken action to restore the fiscal position, as Labor has in the past.

In short, this ‘previous policy’ scenario is quite disingenuous. Furthermore it is inconsistent with the Government’s professed desire to build the bi-partisan support which will almost certainly be required to restore a sustainable fiscal position.

Restoring a sustainable fiscal position

The Government’s ‘proposed policy’ scenario projects a return to a fiscal surplus by 2019-20, and this surplus continues to increase slowly to around 1.4 per cent of GDP in 2039-40. On what we presently know, the projected trajectory for that Budget balance seems reasonably in line with what is required to restore fiscal sustainability.  Again, however, the validity of this scenario depends upon the realism of the underlying assumptions, particularly as regards the policies required to achieve the projected Budget surpluses.

Indeed a key rationale for each of the four IGRs that have been produced to date has been to examine the fiscal consequences of the projected ageing of the population, and the extent of that projected ageing has increased through successive IGRs as the baby boomer generation continues to age. Thus this latest 2015 IGR projects that in forty years time there will be just 2.7 people working for every aged dependent whereas today there are 4.5 people in the workforce supporting every aged dependent. And by comparison, the first 2002 IGR projected that there would be about 4 people working for each aged dependent in another forty years, compared to a bit more than 5 working people at that time.

So, as expected, the projected aged dependency rate has increased as the time-period of the projections has been pushed out in successive IGRs, and other things being equal, the fiscal pressures expected from an ageing population should have also increased commensurately. But the preferred ‘proposed policy’ scenario in the latest 2015 Report projects much lower social spending on health, aged care and age pensions, and education than all the previous IGR Reports. Thus the latest IGR 4 projects increases of 3 percentage points for these social expenditures in the ‘preferred policy’ scenario, compared to around a 6 percentage point increase projected in IGRs 1 and 2, and a 4.5 percentage point increase in IGR 3.

This much lower social spending projected in the latest 2015 IGR essentially reflects the policies of the Government that the Senate has so far refused to pass and which are the key feature of this ‘proposed policy scenario’. But the realism of these proposed policies must surely be open to question.

First, health costs were projected to rise by 80 per cent over the following forty years to 7.1 per cent of GDP in IGR 3, but in the latest IGR 4 these costs are projected to only increase by 30 per cent to 5.5 per cent of GDP in 2055. The principal reason for this huge turnaround in projected health costs is the government’s plan to reduce the indexing of health payments to the States. Similarly changes to indexation arrangements are expected to bring big savings in education; especially in payments to State schools.

Even if the Government does succeed in limiting its payments to the States to this extent, it seems most unlikely that the States could then restrain the expenditures commensurately on health and education. Instead this policy is a form of cost shifting to the States, and if the States have to wear it, then they will almost certainly have to raise additional taxation revenue to cover their higher share of health and education expenditures. The most obvious tax for the States to increase would be the GST, but that is a Commonwealth tax and the 2015 IGR is premised on the assumption that the revenue from Commonwealth taxes will not be allowed to rise above a ceiling equivalent to 23.9 per cent of GDP. If that ceiling is adhered to then the Australian Government would then need to find further expenditure savings on its own account if the States were allowed to increase their GST revenue to meet their increased funding share of essential health and education services.

Second, another major source of savings critical to achieving the outcome of the ‘proposed policy’ scenario is the change in the indexation arrangements for various pensions and other social security payments so that they are indexed to consumer prices rather than to average weekly earnings[1]. Peter Whiteford of the Australian National University has shown that this will result in the single age pension falling from about 28 per cent to just under 24 per cent of average earnings by 2029. While if indexation back to wages were not restored then, by 2055 the single age pension would have fallen to around 16 per cent of average wages, a considerably lower level than any experienced in the last 50 years. The projected increases for many other social security payments, such as family allowances and Newstart, would lead to even more inequality, and this in an economy which already has a tendency to increasing inequality without the government withdrawing assistance to lower income people and their families.

In short, there must be considerable doubt about the realism of this ‘proposed policy’ scenario.  Wage earners would continue to experience increases in their living standards and no increase in their taxes, but people on welfare and those who are sick would fall behind.  The consequences for our society would seem to make it most unlikely that these policies would be maintained for the next forty years. Instead many would say, as the Senate is presently disposed, that the route back to fiscal sustainability must lie elsewhere.

Thus, unlike its predecessors, this latest 2015 IGR does not provide a useful basis for further planning and we all will need to consider alternative strategies.  There are other alternative ways of balancing the budget, and in addition the rate of economic growth could be enhanced modestly by further improvements to participation and productivity.

These alternative proposals for restoring fiscal sustainability over time and further improving living standards will be the posted as part of a series of policy articles being planned for this blog to appear over the next few months. In addition, some previous suggestions for an alternative budget strategy were canvassed in articles I posted on 21-23 July 2014.

Michael Keating AC was formerly Secretary of the Department of Finance and Secretary, Prime Minister and Cabinet.

 

[1] The IGR assumes that this policy will only be maintained until 2028-29, although the Government’s legislation has no such sunset clause.

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4 Responses to Michael Keating. The 2015 Intergenerational Report

  1. Ironic Hockey suing Fairfax about his integrity when this IGR shows a complete lack of it.

  2. KR says:

    How can one predict that wages will only increase from 66,000 to 117000 [about 80% over 40 yrs – about 1.3% per year when over past 40 years wages rose around 1000% from $7000 to $66.0000 now – an avge of 6% per yr Unless we are forced into many many years of recession or depression can this prediction be fulfilled.

  3. Wayne J McMillan says:

    KR is right, its very hard to predict what will happen in 15 to 30 odd years in regards to population increase, wages, the labour force participation rate, and taxation. I feel being preoccupied about reducing the deficit is short -sighted.

  4. Mark says:

    If the current population is 22 million, and is aging, and if it’s going to double by 2055, to say 44 million, where is the other 22 million going to come from? Are the old and aging people going to have the babies (since they will be working at Bunnings and living to 150)? Obviously not.
    The extra population will come where it’s already come from so far in Australia, and that’s from immigration. So, who’s going to pay to build the infrastructure for the new population (like hospitals, schools, shops, roads, sewage, water, electricity, phone cables etc)? You. No wonder the economy is not working when you expect the citizens to sustain themselves as well as another 20 million people. How is that fair? Is that why taxes are so high in Australia?
    The 2015 Intergenerational Report is nothing but rubbish designed to scaremonger people for political agendas.

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