4.3 Fiscal projections

Medium-term outlook to 2023-24

Revenue and spending is inherently difficult to project accurately – both in the near term and over the longer term.

Nonetheless projections can serve a useful purpose, increasing transparency and assisting prudent policy decisions in matters which have material longer term impacts.

Notwithstanding the inherent uncertainties, it is possible to obtain an approximation of likely trends in payment growth on the basis of what we know about likely population growth, demographic changes, indexation factors and likely take up rates for certain programmes.

Projecting revenue is more difficult and at best an approximation can be made based on historical relationships between tax collections and with assumed rates of nominal GDP growth.

Growth in spending

Growth in payments (in real terms) is expected to be 0.6 per cent per year from 2013-14 to 2016-17 and payments as a share of GDP are projected to fall from 25.9 per cent to 25 per cent over this period.

However, the Commission expects real growth in payments to increase materially from 2016-17 to 2023-24 to an average rate of 3.7 per cent per year. On this trajectory spending would grow as a share of GDP from 25 per cent to 26.5 per cent.

The strong growth in payments beyond 2016-17 reflects the impact of recent initiatives in areas such as the National Disability Insurance Scheme and schools funding, as well as continued strong growth in health spending and underlying growth in other programmes such as Australia’s foreign aid programme.

Chart 4.6: Projected Commonwealth spending

This chart shows the projected growth in large and fast growing programmes from around $200 billion in 2013-14 to around $400 billion in 2023-24 and other programmes growing from around $200 billion in 2013-14 to around $300 billion in 2023-24.

Source: National Commission of Audit.

Strong growth in spending is in part driven by the ageing population. The Intergenerational Report 2010 highlighted the impact demographic change has on the Commonwealth Budget. An ageing population places pressure on government expenditure while the portion of working-age taxpayers is falling.

Over the next 10 years, combined growth in spending on social security and welfare, health and education is projected to contribute the most to growth in total expenses.

For the period 2013-14 to 2023-24 the Commission has focused on the 15 largest and fastest growing programmes. They are, in almost all cases, projected to grow faster than average growth in total government expenditure. Most are also expected to grow considerably faster than GDP.

These 15 policy areas will account for around 70 per cent of the total growth in payments over the next 10 years. (As outlined in Table 4.2 below.)

In addition to the growth in payments included in this table, the Government has made commitments on increasing Defence spending (to reach 2 per cent of GDP within a decade) and on the Private Health Insurance Rebate (to remove means testing when appropriate to do so). As no firm decision has been taken on these matters they were not included in the Mid-Year Economic and Fiscal Outlook Update and are not considered in the Commission’s assessment.

If these commitments were implemented, the Commission estimates that they would add an additional $17 billion to total Commonwealth government spending in the medium term.

Table 4.2: Large and fast growing programmes
  2013-14
($ billion)
2014-15
($ billion)
2015-16
($ billion)
2016-17
($ billion)
2017-18
($ billion)
2018-19
($ billion)
2019-20
($ billion)
2020-21
($ billion)
2021-22
($ billion)
2022-23
($ billion)
2023-24
($ billion)
Average annual growth
(per cent)
Age Pension 39.5 42.3 45.2 48.7 51.7 54.6 57.8 61.1 64.6 68.3 72.3 6.2
Defence 25.3 27 28.1 28.6 34.1 35.8 36.7 37.6 38.6 40.7 41.4 5.1
Family Tax Benefit 19.4 19.7 19.5 19.8 20.1 20.5 20.9 21.3 21.7 22.1 22.6 1.5
Medicare Benefits Schedule 19 20.4 21.7 23.1 24.8 26.6 28.6 30.7 32.9 35.2 37.7 7.1
Disability Support Pension 15.8 16.4 17 17.8 18.6 19.6 20.6 21.6 22.7 23.9 25.2 4.7
Hospitals 14 15.4 17 18.8 20.8 23.1 25.6 28.3 31.2 34.4 37.8 10.4
Schools 12.9 14.1 15.4 16.8 18.7 20.6 23.5 26.2 27.7 29.4 31 9.2
Aged Care and Population Ageing 12.8 13.8 14.8 16 17.3 18.6 20 21.9 23.7 25 26.4 7.5
Job Seeker Income Support 10.1 10.6 11.2 11.7 12.4 12.7 12.9 13.2 13.5 13.7 14 3.3
Pharmaceutical Benefits Scheme 9.3 9.3 9.6 10.2 10.8 11.5 12.3 13 13.8 14.7 15.6 5.4
Higher Education 7.1 7.4 7.8 8.2 8.5 9.1 9.7 10.3 11 11.8 12.6 5.8
Child Care and Paid Parental Leave 7 7.8 10.7 12.8 13.8 14.8 15.8 17 18.2 19.5 20.9 11.5
Income Support for Carers 6.8 7.5 8.1 8.9 9.8 10.8 11.9 13.1 14.3 15.7 17.1 9.6
Official Development Assistance 5 5.2 5.3 5.4 9 9.5 10 10.5 11.1 11.8 12.5 9.6
National Disability Insurance Scheme 0.3 0.4 0.5 1.8 4.5 7 8.6 9.4 10 10.7 11.3 46.2
Total listed programmes 204 217 232 248 275 295 315 335 355 377 398 6.9
Total Commonwealth payments 409 414 430 447 485 515 544 578 612 649 686 5.3
Nominal GDP 1,577 1,631 1,708 1,788 1,874 1,970 2,072 2,191 2,316 2,448 2,588 5.1

Source: National Commission of Audit.
Note: Programme projections are on an accrual basis, whilst payments are on a cash basis.

High level overview of major programmes

Of the 15 programmes the Commission has focussed on, Age Pension is the largest by a fair margin. Currently close to $40 billion, the Age Pension is forecast to rise by 6.2 per cent per year from 2013-14 to 2023-24, when spending is projected to be over $72 billion.

Of the projected $32 billion increase in the cost of funding the Age Pension, around 40 per cent is driven by current arrangements to index the payment, with most of the remainder due to increasing numbers of recipients. This is an important fact.

Three large programmes in health make up around $40 billion in Commonwealth spending.

Spending on hospitals (currently $14 billion) is expected to rise to around $38 billion by 2023-24. The Commonwealth contributes to the funding of public hospitals in the States through Australian Health Care agreements. With annual growth of 10.4 per cent between 2013-14 and 2023-24, spending on hospitals is one of the fastest growing and largest areas of government spending.

The Medicare Benefits Schedule currently costs around $19 billion and is expected to grow by 7.1 per cent per year to 2023-24. The increase in expenditure largely reflects population growth and increasing use of medical services, particularly with an ageing population.

Spending on the Pharmaceutical Benefits Scheme is projected to grow by 5.4 per cent per year from 2013-14 to 2023-24. At present, nearly 80 per cent of the Scheme’s expenditure is attributable to concessional recipients.

The National Disability Insurance Scheme commenced in 2013 and is expected to grow rapidly. From a very small starting point of less than $0.5 billion for the next three years, average annual growth is projected to be over 45 per cent, from 2013-14 to 2023-24. This means that by 2023-24, NDIS spending by the Commonwealth will be around $11 billion.

Payments to Carers are projected to increase by 9.6 per cent per year between 2013-14 and 2023-24. Rapidly rising beneficiary numbers are one of the main drivers, with annual increases in excess of 10 per cent for recipients of some payments.

Aged care is growing strongly and is forecast to double from its current level of around $13 billion to $26 billion in 2023-24. The increasing number of older Australians accessing aged care services is the main driver of this growth. Residential care is the largest component of aged care spending.

In 2013-14, nearly $16 billion is expected to be spent on the 820,000 recipients of the Disability Support Pension. Over the next 10 years spending on the Disability Support Pension is projected to increase by 4.7 per cent per year. Population ageing drives part of the growth but a significant portion is due to indexation. The Disability Support Pension is indexed in the same manner as the Age Pension.

Growth in child care fee assistance and Paid Parental Leave is expected to be around 11.5 per cent per year between 2013-14 and 2023-24. This reflects increased usage of formal care, for which the Commonwealth provides two major subsidies and the increased generosity of the proposed changes to the Paid Parental Leave scheme.

Family Tax Benefit is growing less strongly than other areas, but is still a substantial programme. At around $19 billion, it makes up close to 5 per cent of all Commonwealth Government spending, and is projected to be over $22 billion in 2023-24.

Commonwealth spending on job seekers is currently over $10 billion. Growth in expenditure in this area is not projected to be large as it is dependent on the unemployment rate, which, consistent with the medium-term projection methodology is assumed to be around 6 per cent.

Commonwealth spending on education is around $20 billion, with around $13 billion on schools and the remainder on higher education.

Schools funding is expected to grow by 9.2 per cent per year to 2023-24. This growth largely reflects indexation and per student funding goals under the Better Schools Plan.

Growth in higher education funding (5.8 per cent per year between 2013-14 and 2023-24) partly reflects the effect of uncapping the number of bachelor degree places in Australian universities.

In 2013-14 around $25 billion will be spent on Defence. This figure which excludes capital is forecast to increase to above $40 billion by 2023-24. The Government’s aspiration is to raise defence spending to 2 per cent of GDP. Defence spending is facing ongoing cost pressures, reflecting the increasing cost and complexity of military equipment (often associated with increased capability) and personnel.

Australia’s foreign aid programme (Official Development Assistance) is forecast to grow on average by 9.6 per cent per year between 2013-14 and 2023-24. The vast majority of this growth is attributable to the previous government’s commitment to Australia’s foreign aid programme reaching 0.5 per cent of Gross National Income.

It is important to note that while the Commission has focussed on the next 10 years the growth trend in the above major programmes is expected to continue unabated beyond 2023-24.

Fiscal scenarios

In order to guide its deliberations, the Commission has analysed the Commonwealth’s medium-term fiscal outlook.

For the purposes of simplicity, the Commission has identified two scenarios: a ‘Business as Usual’ Scenario and a ‘Reform’ scenario.

Although they provide high level guidance for the Commission’s work the scenarios do not provide detailed projections.

They involve assessments and judgements about future growth in receipts and payments at the Commonwealth level and are based on assumptions around economic growth and inflation that are reasonable and sensible.

Over the medium term, nominal GDP is projected to grow by around 5 per cent per year, with inflation growing by around 2.5 per cent per year (these and associated assumptions are outlined in further detail in Annex B).

Inevitably, the outlook is uncertain and the assumptions used may turn out to be overly pessimistic or unduly optimistic. However, we can only plan on the basis of what we know and can reasonably expect and the scenarios assist in this task.

Data on Commonwealth receipts and payments used has been sourced from the Mid-Year Economic and Fiscal Outlook update released in December 2013. This data is augmented with assumptions made by the Commission.

On the revenue side, it is assumed that tax receipts will rise in line with a strengthening economy, with the tax to GDP ratio recovering to normal levels. Once tax receipts reach 24 per cent of GDP — which is around the average level of tax receipts over the period from 2000 to the lead up to the global financial crisis — they are assumed to remain at that level.

This reflects a critical assumption that increased tax collections arising from bracket creep (as wages growth pushes taxpayers towards higher tax brackets) are partially returned by the government in the form of periodic income tax cuts. This is the established practice of Commonwealth governments over many decades.

If adjustments are not made for bracket creep, the Commission estimates that a person earning the average wage and currently facing a marginal tax rate of 32.5 per cent will be taxed at a 37 per cent marginal tax rate by 2023-24. The marginal tax rate for a person on the minimum wage would rise from 19 per cent now to 32.5 per cent well before 2023-24.

Both the ‘Business as Usual’ and ‘Reform’ scenarios assume tax receipts remain below 24 per cent of GDP. When non-taxation receipts, such as dividends and other income are included both scenarios assume total Commonwealth receipts will reach 25 per cent of GDP and remain at around that level.

The 'Business as Usual' Scenario

The Commission’s ‘Business as Usual’ Scenario assumes that Commonwealth spending follows the same path as outlined in the Mid-Year Economic and Fiscal Outlook. The pace of spending is expected to slow through the next three years before picking up considerably in 2017-18.

On the Commission’s projections, and as outlined in the previous section, spending growth will remain strong throughout the period to 2023-24.

Spending as a share of GDP is projected to reach 26.5 per cent of GDP at that time.

With total Commonwealth receipts at around 25 per cent of GDP this ‘Business as Usual’ scenario would produce a series of budget deficits over the coming decade. The deficit would be greater than 1 per cent of GDP each year throughout the period and beyond.

As a result of the continuing run of budget deficits, the level of the Commonwealth’s net debt would increase to around 17 per cent of GDP by 2023-24 (or $440 billion).

The table below outlines the underlying cash balance and real growth in payments under this scenario.

Table 4.3: Fiscal aggregates for the 'Business as Usual' Scenario
 

13-14

14-15

15-16

16-17

17-18

18-19

19-20

20-21

21-22

22-23

23-24

Underlying cash balance
(per cent of GDP)
-3.0 -2.1 -1.4 -1.0 -1.5 -1.5 -1.2 -1.3 -1.4 -1.5 -1.6
Real growth in spending
(per cent)
8.6 -0.9 1.4 1.4 5.9 3.6 3.0 3.6 3.5 3.7 3.4

Source: National Commission of Audit.

This is clearly unsustainable as we would be living beyond our means and incurring an ongoing annual interest bill on Government debt in excess of $30 billion.

Chart 4.7: 'Business as Usual' Scenario

Panel A: Receipts and payments
This chart shows payments as a per cent of GDP being greater than receipts as a per cent of GDP from 2013-14 to 2023-24.

Panel B: Underlying cash balance
This chart shows the underlying cash balance in deficit from 2013-14 to 2023-24.

Panel C: Net debt
This chart shows net debt increasing from around 12 per cent of GDP in 2013-14 to around 17 per cent of GDP in 2023-24.

Source: National Commission of Audit.

The 'Reform' scenario

The Commission’s ‘Reform’ Scenario assumes a more moderate pace of spending growth over the medium term. In particular, it assumes greater expenditure restraint starts in 2014-15 and is maintained through to 2023-24.

Under this scenario payments would decline from their current level of around 26 per cent of GDP to around 24 per cent of GDP by 2023-24.

Coupled with the revenue assumption that tax receipts do not exceed 24 per cent of GDP, under the ‘Reform’ scenario, the Budget returns to surplus in 2019-20 with the surplus growing to 1 per cent of GDP by 2023-24.

Under this scenario Commonwealth net debt peaks at 15.1 per cent in 2016-17 and then declines to just over 5 per cent of GDP.

The table below outlines the underlying cash balance and real growth in payments under the ‘Reform’ scenario.

Table 4.4: Fiscal aggregates for the 'Reform' scenario
 

13-14

14-15

15-16

16-17

17-18

18-19

19-20

20-21

21-22

22-23

23-24

Underlying cash balance
(per cent of GDP)
-3.0 -2.0 -1.2 -0.7 -0.4 0.0 0.4 0.5 0.7 0.9 1.0
Real growth in spending
(per cent)
8.6 -1.1 0.9 0.8 2.5 2.5 2.5 2.5 2.5 2.5 2.5

Source: National Commission of Audit.

Chart 4.8: 'Reform' scenario

Panel A: Receipts and payments
This chart shows receipts and payments as a per cent of GDP from 2013-14 to 2023-24, receipts exceed payments from 2019-20.

Panel B: Underlying cash balance
This chart shows the underlying cash balance improving from -3.0 per cent of GDP in 2013-14 to 1.0 per cent of GDP in 2023-24.

Panel C: Net debt
This chart shows net debt improving from 12 per cent of GDP in 2013-14 to over 5 per cent of GDP in 2023-24.

Source: National Commission of Audit.