The economics of ageing doesn’t have to be unfair

The most recent Intergenerational Report released by treasurer Joe Hockey last week is the first to offer up a policy solution in response to the fiscal challenge caused by Australia's ageing population.

The three previous intergenerational reports flagged a "problem", but did not propose explicit policies to eliminate the projected fiscal deficits.

It may be thought that it is "good government" to have an explicit policy. However, the actual policy proposed to deal with the fiscal challenge falls disproportionately on the less well-off and the less healthy.

Peter Whiteford estimates that old age pensions will fall from their present level of about 28% of male total average weekly earnings to just under 24% in 2029. Unemployment benefits will also fall relative to average weekly earnings. Furthermore, Commonwealth support for health services will be reduced.

Not only is a major burden to be borne by the less well-off but also this burden will be borne too soon.

The proposed policy has the Commonwealth primary balance moving into a surplus of 1.2% of GDP by 2024-25. This move is to the benefit of the future population in the decades after 2024-25 relative to those currently alive. And yet with productivity growth in the future, which the report assumes will be at its historic average of 1.5% per year, those people in the future will be better off than we are today.

Under the proposed policy, fiscal surpluses are projected to continue until 2054-55, leading to a projected net asset position of the government of 15% of GDP by 2054-55. This is a further indication of how the proposed policy benefits the better-off people in the future relative to the less well-off that precede them.

Hitting the vulnerable

It is "doubly inequitable", so to speak, that the less well-off of people living now are penalised in order to make future people even better off than they otherwise would have been.

Three aspects of the benefits people enjoy from government-provided old-age pensions and health services are relevant here. First, these government outlays redistribute wellbeing from the better-off to the less well-off, namely from the young to the old. This improves equity.

Second, some of the higher productivity of later generations is due to the efforts of the preceding generations; later generations will inherit an enlarged capital stock and an enlarged stock of knowledge. And those who are older now and in the near future have contributed to the support of earlier generations of old people. These considerations suggest that the old deserve some support from the young.

Third, government support through pensions and health care helps to insure the old from some of the risks associated with ageing, especially longevity risk and the risk of high health costs. Both of these risks are substantial.

While much discussion focuses on average life expectancy, there seems to be less recognition of the variation across people of actual lifetimes. One quarter of 65 year-olds will die some seven years or more before the 65 year-old who lives for the average life expectancy and another 25% will live some five years or more beyond the average person. One in ten will live for 10 years or more beyond the average person. Planning a consumption path for one's later years to allow for this variation is helped by the annuity-nature of a government pension.

Health expenditures also vary considerably across people. According to the 45 and Up survey of older people in NSW, of women aged 75, for example, 5% have health costs greater than A$21,000 and 5% have health costs less than A$1000. (These are total health costs, public plus private.)

Of course, continuing government support at current policy settings implies a probable increase in the cost of government support, which may cost as much as 6% of GDP. But that would still leave the working population in the future much better off than is the working population today. Productivity growth dominates the ageing effect.

Dealing with uncertainty

There is another argument for not acting in advance of future ageing in the way proposed by the government's Intergenerational Report policy. There is a case for a plan to be gradual, flexible and responsive to the challenge of the ageing population as it emerges. Fiscal adjustments should be made as circumstances develop. Policies should be assessed on the basis of their costs and benefits.

There is much uncertainty surrounding projections made for decades into the future. This uncertainty is especially large for projected health expenditures. The nature of future technological change in health care is unknown. New treatments may raise costs but new procedures may lower costs. How demand for health services will respond is not clear.

There is less uncertainty about projections of income support but there is still uncertainty. By how much will an increase in the age of eligibility for the old-age pension increase the number of people on disability pensions?

Government revenue projections are also uncertain. They are sensitive to the rate of unemployment and yet how robust is the assumption of a lower constraint on the feasible rate of unemployment equal to 5%, as assumed in the report, when the measurement of that constraint is notoriously inexact?

Ultimately, a policy that allows the overall tax share to increase with demographic pressures is preferable to one that relies on cutting benefits to the less well-off.

- Ian Martin McDonald  
Emeritus Professor at University of Melbourne

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