The fiscal crunch is coming from rising pension, health and aged care costs
Australia’s economic model and social compact will be tested in coming decades as it searches for a policy consensus that can deliver quality service and not impoverish younger workers.
Our national anthem was changed in 2020 from rejoicing about being “young and free” to “one and free” because it was seen as ignoring the history of Indigenous Australians.
Still, there are also demographic and fiscal reasons to justify the tweak ahead of the coming transformation: Australia is becoming older and far more expensive to run.
Intergenerational strains will shape our politics and policy debates.
The nation’s future growth depends on making the most of the three defining Ps: population, participation and productivity.
Australia’s economic model and social compact will be tested in coming decades as it searches for a policy consensus that can deliver quality services off the toil of future generations, who will struggle to approach the material wealth and mobility of their forebears.
Most rich nations are experiencing the fiscal crunch, where rising costs for health, pensions and aged care are outstripping growth in revenue, as well as stagnation of living standards from a slowdown in productivity growth.
In its latest World Economic Outlook, published in October 2024, the International Monetary Fund says the global economy has endured a long period of structural weakness and across the coming decade “prospects under current policies remain bleak” because of ageing populations, weak investment and a lack of economic dynamism.
“In this context, policymakers are urged to advance structural reforms – that is, to update the rules and policies that shape how an economy operates – to boost productivity, employment and growth,” the IMF report says.
According to Treasury’s latest Intergenerational Report, demographic ageing is estimated to account for about 40 per cent of the increase in federal spending across the coming four decades, concentrated in health, Age Pension and aged-care spending.
The number of workers in the so-called care economy has more than doubled across the past 20 years and is estimated to double again across the next 40 years.
There is often a perception that the ageing of the population is a temporary episode, due to the greying of the baby boomers, those born between 1946 and 1964.
But that’s not the case according to Treasury secretary Steven Kennedy, who says as long as the fertility rate is below replacement, which is 2.1 babies per woman, successive generations will be smaller.
The latest figures on births from the Australian Bureau of Statistics show a record low total fertility rate of 1.5 in 2023. At the peak of the post-war boom it was 3.5 babies per woman.
“Combine this with Australians living longer lives, and the share of Australians aged 65 and over will just keep rising, albeit more slowly over time,” Kennedy said after the release of the IGR in 2024.
“A permanently higher share of older people underpins the importance of the design of aged-care services, and the tax and superannuation systems.”
Total government spending on aged care, including residential care and support at home, is expected to more than double across the coming decade.
The IGR, which tries to measure long-term fiscal sustainability, estimates that across the next 40 years real total health spending on those aged over 65 is expected to increase about sixfold and ninefold on those over 85.
People aged 65 or older currently account for about 40 per cent of health spending, despite being about 16 per cent of the population.
Across time, population ageing is projected to lead to a narrowing personal income tax base, meaning younger workers are likely to bear a greater burden.
The IGR projects that the old-age dependency ratio – which measures the number of people aged 65 and older for every 100 people of traditional working age (15 to 64) – will increase from 26.6 per cent to 38.2 per cent across the next 40 years.
Only 18 per cent of Australians aged 65 and older and 12 per cent aged 70 and older pay income tax, so there are likely to be more calls for the heavier taxation of consumption or wealth taxes, given the steady rise in the value of retirement nest eggs and housing.
The public cost of the Age Pension is actually going to fall as a share of the economy during coming decades (unlike in most OECD countries, where it is expected to keep growing) because of reforms and the growth in superannuation balances.
Although the gradual increase in the eligibility age and changes to Age Pension means testing have improved fiscal sustainability, there could still be a push to change the treatment of the family home in the assets test for benefits.
But Treasury warns that trends in life expectancy and home ownership could present risks to sustainability of the retirement incomes system. Simply, home ownership rates are falling among younger cohorts; owning a home or not is the great determiner of financial comfort in retirement.
Longevity risk – where retirees worry about running out of money – means many people draw on their savings at only a minimum rate and generally have a quarter of their savings at death.
Funds are modifying their product offerings to smooth out spending in retirement.
Treasury warns that the drop-off in home ownership among younger people is seen as a key risk for fiscal sustainability and may affect patterns of how superannuation is drawn down.
The Albanese government is targeting tax breaks on superannuation, especially for higher balances, and seeking to impose higher costs on those with the means to contribute more to their aged-care costs, with a set of far-reaching reforms put forward by Aged Care Minister Anika Wells in September 2024.
Two dozen OECD countries levy an inheritance or estate tax, although they raise, on average, less than 1 per cent of total revenue in those that do.
Former Treasury chief Ken Henry has highlighted how younger workers are confronted by higher education debt, accumulated public debt, the consequences of climate change and the diminishing prospects of ever being able to afford a home of their own.
Given the rising costs identified by the IGR and increased average tax rates, Henry, who chaired a tax review for the Rudd government, is calling for an overhaul of the tax system.
“The intergenerational tragedy confronting Australia is of our own making,” he said in April 2024, launching a book on the mixed history of tax reform.
“And it is of a magnitude that threatens the social compact. Somebody has to grab this thing and get on with it.”
Grattan Institute chief executive Aruna Sathanapally says the federal budget’s structural problem can be tackled by reducing spending, increasing revenue and growing the economy.
“Growing the economy is the easiest solution to sell but it is the hardest to achieve in practice,” Sathanapally told the National Press Club before the federal budget in May 2024.
Australia, like other advanced economies, is expecting much slower economic growth across the next 40 years than we’ve had across the past 40 years.
Productivity growth expectations have been wound back by Treasury, yet to many analysts they appear optimistic.
Research by the e61 Institute shows there has been no productivity improvement in the burgeoning care sector – which includes disability services, aged care, health and childcare – during the past two decades.
Productivity Commission chairwoman Danielle Wood has said growth in the care sector means other parts of the economy will need to deliver a higher productivity dividend if we are to fund services at the level the community expects.
But Grattan chief Sathanapally says even if productivity growth exceeds expectations, it is still unlikely to close the structural budget gap
“As a relatively low-tax country we can afford to raise more revenue, but of course there are better and worse ways to do this,” she told the press club.
“Broadening the tax base and reducing tax concessions tend to be much less economically damaging than simply raising the headline rates of tax.”
Economists of all persuasions tend to agree that wealth in housing and superannuation get particularly generous treatment.
Superannuation tax breaks cost the budget almost $45bn a year, predominantly benefiting top income earners, and are projected to cost more than the Age Pension by 2036.
Sathanapally points out that the combination of capital gains tax breaks and negative gearing “encourages speculation in the housing market, in place of other more productive uses of funds”.
“We know from experience that governments baulk at these types of politically difficult choices around tax,” she told the press club.
“Because it gets pretty noisy when there are any losers to be found, as though there is some world where we don’t have to countenance any trade-offs.
“But, frankly, we are sitting on a wretched generational bargain and it has gone on for long enough.”
Although Jim Chalmers asked his department to model the impact of changes to negative gearing and capital gains tax concessions, the Treasurer has killed off policy changes in that area because he was not convinced changes would boost housing supply.
Labor’s 2019 election platform included curbing the tax breaks on property investment which, according to the Parliamentary Budget Office, cost the $12bn a year in forgone revenue.
Better targeted migration policies also will provide a fiscal and productivity dividend.
Older workers – with their experience and wisdom – are not necessarily less productive. Treasury says planning for the needs of an ageing Australian population also may require reducing the barriers to labour force participation for older people who may wish to work, women and historically under-represented groups.
“At the same time, policy settings can reduce barriers for families to have the number of children they would like to have,” the IGR says.
“Employers can make themselves more attractive to older workers by being more flexible about when and where they work, and providing training and development to ensure skill sets remain up to date.
“This will help realise the potential older workers have to offer. Existing infrastructure and services can be adapted to better meet the needs of older Australians.
“This could include adopting emerging technological developments such as automation, making public areas and public transport more accessible, and building new housing and adapting existing stocks to meet the needs of older people (including to support downsizing).”
Without lifting our growth rates, fixing our tax system, keeping older workers engaged and modernising our economy the evidence is clear: we’ll succumb to decades of deficits, rising debt and expensive social services.
