Overview

Comprehensive information on trends in and key drivers of government spending is important for an understanding of the level of sustainability of government spending and the future direction of fiscal policy.

This is the second PBO report on Australian Government spending.

The first report examined historical trends in government spending over the decade 2002-03 to 2012-13.¹

The real growth in Australian Government spending over the past decade (annual average 3.6 per cent) was significantly greater than real economic growth (annual average 3.0 per cent).

The strong growth in Australia’s national income (and nominal GDP, a key driver of revenue growth) from the historic surge in Australia’s terms of trade broadly offset this spending growth, with the ratio of Australian Government spending to nominal GDP being about the same in 2012-13 as it was in 2002-03.

This report discusses the outlook for and drivers of Australian Government spending over the medium term – the period 2012-13 to 2024-25.

The projected continuing decline in the terms of trade from its historical highs, and the depressing impact this will have on nominal GDP, mean that if government spending as a share of the economy is not to rise over the medium term, it will require real growth in spending to be significantly slower than growth in real GDP.

The Australian Government’s medium term projections are for a substantial slowing in the real growth in Australian Government spending compared with the past decade, with real spending growth (annual average growth 2.6 per cent) significantly lower than real economic growth (annual average 3.2 per cent) over the medium term.

Even with this reduction in the pace of spending growth, the projected ratio of Australian Government spending to nominal GDP over the medium term is, on average, about the same as in the past decade.

This report analyses what is driving the reduction in growth in Australian Government spending over the medium term by a detailed assessment of twenty-one programs that account for around three-quarters of projected government spending and nearly all (95 per cent) of the growth in total spending over the medium term.

Sheer arithmetic dictates that it is very difficult to reduce overall growth in Australian Government spending without reducing the pace of spending in these programs.

Based on current policy settings, the PBO’s medium term projections show that growth in spending on ten programs that grew rapidly over the past decade will be constrained to less than real GDP growth over the next decade. These programs are Family Tax Benefit, higher education, Medicare, public hospitals, Age Pension, Private Health Insurance Rebate, Disability Support Pension, government superannuation, public debt interest and Official Development Assistance.

However, there are a number of challenges to achieving these lower growth spending outcomes.

The sustained period of strong growth in Australian Government spending over the past decade can reasonably be expected to have lifted the Australian community’s expectations of continuing higher levels of government services and benefits over the medium term. Realising the projected slowing in the pace of growth of Australian Government spending implies successfully adjusting these expectations.

The PBO’s projections are based on current government policy and assume no new policy decisions in the future to expand or enhance Australian Government payments. However, this runs counter to experience over the past decade where there were significant discretionary increases in spending on a range of programs, including Age Pension, Family Tax Benefit, Disability Support Pension, carer income support, child care, Medicare and higher education.

Additionally, the projected slower spending growth over the medium term is dependent on 2014-15 Budget savings measures, most of which are yet to be legislated. Nearly all of the programs that are projected to grow at a slower pace over the medium term assume the implementation of savings measures that are yet to be legislated. Savings measures in these programs are projected to reduce spending over the medium term, with an impact of $19 billion or 0.7 per cent of GDP in 2024-25.²

The slower growth in Australian Government spending over the medium term also reflects significantly reduced growth in Commonwealth funding for schools and hospitals from 2017-18. In practice, this may result in a shift in the funding responsibility for these programs from the Commonwealth to the States rather than an overall reduction in the growth of government spending in these areas. In particular, the expected growth in demand for hospital services over the medium term is likely to place increasing pressure on State budgets.

Programs projected to grow faster over the medium term than over the past decade include defence, GST transfers to States, the National Disability Insurance Scheme and the expanded Paid Parental Leave scheme. However, reducing spending in some of these programs would not result in a net saving to the budget, due to related, broadly offsetting revenue items and/or other spending offsets. In particular, the largest contribution to Australian Government spending over the medium term is GST transfers to the States, which in effect mirrors GST collections.

While the National Disability Insurance Scheme and expanded Paid Parental Leave scheme are significant contributors to spending growth over the medium term, together accounting for 19 per cent of the growth in total spending, the net impact of this spending on the budget is reduced by levies, contributions from State and Territory Governments, and reductions in other Australian Government programs.

The above challenges to achieving lower spending growth mean that actual spending outcomes could exceed the projections contained in this report which, given current revenue projections, could place fiscal sustainability at risk.

To the extent that the projected reduction in Australian Government spending growth is not achieved over the medium term, an even greater share of the burden of fiscal consolidation would need to fall on the revenue side of the budget. That said, the Australian Government’s medium term budget projections already assume a significant increase in revenue with tax receipts projected torise from 21.4 per cent of GDP in 2012-13 to 23.9 per cent of GDP in 2019-20, and remaining at that level over the medium term.

Moreover, there are risks to the economic outlook over the medium term due to uncertainties in the international outlook and as the Australian economy transitions out of the resources investment boom to broader based growth in the non-resources sectors. These risks reinforce the need for fiscal consolidation in order to establish a fiscal buffer against the possibility of adverse economic shocks.