Phil Gallagher, PSM Manager, Retirement and Intergenerational Modelling Unit

1. AUSTRALIAN POLICY APPROACH TOINTERGENERATIONAL ISSUESPresentation for NDRC & Australian Treasury Bilateral Seminar Program 22 December 2008 Phil Gallagher, PSM Manager, Retirement and Intergenerational Modelling Unit Tax Analysis Division, AUSTRALIAN TREASURY Phone +61 2 6263 3945 email phil.gallagher@ treasury.gov.au websites www.budget.gov.au http://rim.treasury.gov.au Views expressed in this presentation are those of the author and are not necessarily those of any Commonwealth Agency or of the Government

2. Objective of the presentation • To show how policy reports such as the Australian Intergenerational Report have been used to identify sustainability issues for: • Labour force growth and economic growth • Government spending • To introduce the policy framework used by the Australian Treasury to respond to these issues

3. Outline Part 1 – Identifying the problem • Origins of the IGR • Treasury long term modelling • Drivers of Intergenerational change - Demography, Labour Force, Productivity • Economic projections • Fiscal projections Part 2: Policy responses

4. Origins of the IGR 1996 Commission of Audit Report recommended a Charter of Budget Honesty Section 20(1) requires the Treasurer to publicly release and table intergenerational reports Section 21 outlines contents of intergenerational reports • Required to assess the long term sustainability of current Government policies over the 40 years following the release of the report, including by taking account of the financial implications of demographic change Two reports so far – 2002 and 2007

5. Treasury long term modelling • The aim of Treasury long term modelling is not to predict the future • The aim is to assess risks associated with current trends and current policies • The aim is also to model the effects of policy change and the threats to sustainability • Policies and trends will change

6. Drivers of intergenerational change DEMOGRAPHY

7. Treasury fertility projectionsTotal fertility per woman

8. Net migration • IGR1 assumed net migration of 90,000 per year • IGR2 assumes 110,000 per year which was the average of the last ten years • We would now assume between 160,000 and 180,000

9. Mortality – IGR2survival probabilities

10. Life expectancy is increasing

11. Life expectancy is increasing

12. Australia - changing age structure 1972 2047 2006

13. Changing age structure 2

14. Drivers of intergenerational change LABOUR FORCE TRENDS AND PROJECTIONS

15. Approach to labour force projections

16. Overall participation rates

17. Male total participation rates

18. Female total participation rates

19. Unemployment rate • The long term unemployment rate assumption is 5% as it was for IGR1

20. Drivers - productivity

21. Projecting GDP using the 3P’s In words GDP=Labour productivity * Average hours * Employment ratio * participation rate * Population 15+

22. Growth in economic aggregates

23. Selected expense projections • Age Pension • Health – particularly Pharmaceutical Benefits

24. Population age groupgrowth indexes

25. Effect of Superannuationon Age Pension status

26. Results – age pensions

27. Some key IGR sensitivity analysisfor Age Pension • Longevity • Highly significant impact • Plausible higher LE increases cost by 0.50 % of GDP • Participation • Significant impact • Plausible higher participation decreases cost by 0.24 % of GDP • Migration • Higher migration decreases cost by about 0.14% • Productivity • Negligible impact as pension rises or falls in line with wages

28. Health • Drivers – age distribution and non-demographic growth rates • Results

29. Age distribution of Pharmaceutical benefits to males

30. Real age adjusted pharmaceuticalspending history - PBS, s100 and RPBS($ per person)

31. Pharmaceuticals spendingIGR1 v IGR2 per capita and % GDP

32. Health overall results

33. Ageing and non-ageing factorsaffect health spending • Non-demographic growth is the key driver of health spending in the past two decades • In the projections, ageing contributes only around ¼ of the increase in spending

34. Summary of Australian Government spending differences

35. Summary of Part 1 • The Australian population will age - largely because of a decline in fertility from 1961 • Although labour force participation of women and the population aged 15-64 is projected to rise, total labour force participation for all persons 15 and over declines • GDP per capita continues to rise over the whole projection period, and does not slow to the same extent as GDP growth. Productivity has an important effect on both projections • On current trends and policies, Commonwealth demographic expenditure could grow by 4.75 percentage points of GDP by 2046-47

36. Part 2 POLICY RESPONSES

37. Projection of spending pressure

38. Projected primary balances

39. IGR1 IGR2 Some improvement in fiscal pressure since IGR1 Per cent of GDP Per cent of GDP 2 2 1 1 0 0 -1 -1 -2 -2 -3 -3 -4 -4 -5 -5 2006-07 2011-12 2016-17 2021-22 2026-27 2031-32 2036-37 2041-42 2046-47

40. Broad policy options • Increase GDP • Reduce expenditure eg pharmaceuticals and disability pensions, but problems if reduce money to States • Increase tax or other revenue • Public pre-funding eg the Future fund and surpluses deposited at the reserve bank • Private pre-funding which offsets public funding eg Australia’s Private Pension System Superannuation Guarantee • Private insurance as a substitute for public insurance

41. Method 1: Increasing GDP

42. Population policy Participation policy Productivity policy Economic policy themes the ‘3Ps’ Total population Share of population 15+ Participation rate Unemployment rate Average hours worked Capital deepening Multifactor productivity

43. Policy responses Multi-factor productivity Immigration Capital deepening Average hours worked Unemployment rate Participation rates Share of population 15+ Total population

44. Policy responses Multi-factor productivity Immigration Capital deepening Taxation of capital Average hours worked Unemployment rate Participation rates Share of population 15+ Total population

45. Policy responses Multi-factor productivity Immigration Capital deepening Taxation of capital Foreign investment Average hours worked Unemployment rate Participation rates Share of population 15+ Total population

46. Policy responses Multi-factor productivity Immigration Capital deepening Taxation of capital Foreign investment Average hours worked Taxation of skilled labour Unemployment rate Participation rates Share of population 15+ Total population

47. Policy responses Multi-factor productivity Immigration Capital deepening Taxation of capital Foreign investment Average hours worked Taxation of skilled labour Unemployment rate Welfare reform Participation rates Share of population 15+ Total population

48. Policy responses Multi-factor productivity Immigration Capital deepening Taxation of capital Foreign investment Average hours worked Taxation of skilled labour Unemployment rate Welfare reform Participation rates Labour market/workplace relations Share of population 15+ Total population

49. Policy responses Multi-factor productivity Immigration Capital deepening Taxation of capital Foreign investment Average hours worked Taxation of skilled labour Unemployment rate Welfare reform Participation rates Labour market/workplace relations Share of population 15+ Education and training Total population

50. Policy responses Immigration Multi-factor productivity Taxation of capital Capital deepening Foreign investment Average hours worked Taxation of skilled labour Unemployment rate Welfare reform Labour market/workplace relations Participation rates Education and training Share of population 15+ Microeconomic reform and sound macroeconomic policy frameworks Total population