Part IV: Overall results (continued)
The spending and revenue projections in this report suggest that governments will need to make policy adjustments to maintain a sustainable fiscal position over the next four decades. The outlook over the next decade is positive, with the budget projected to remain in surplus. However, the projections for the central scenario suggest the government would need to make a fiscal adjustment of around 5.0 per cent of GDP by 2041-42 to maintain budget balance. This fiscal adjustment could take the form of reducing spending growth through policy change, imposing higher taxes on future generations of taxpayers, or combining these approaches.
Uncertainties surrounding the necessary fiscal adjustment
Considerable uncertainty surrounds the projections of the size of the likely fiscal adjustment. In particular, the economic and demographic assumptions which underpin the projections of demographically-driven spending are uncertain. For example, labour shortages arising from an ageing population may increase the labour force participation of older workers. This would delay retirement and increase this group's incomes, reducing the budgetary impact of population ageing.
In addition, the projections assume that non-demographic spending and total revenue will remain a constant share of GDP over time. However, pressure to increase non-demographic spending in various areas (for example, the environment and defence) may increase spending on these programmes as a share of GDP.
The report's central scenario suggests spending pressures will rise in around 15 years. However, early policy action would help prevent the need for more severe policy changes in the future. Therefore governments must continue to consider the long-term fiscal implications of policy decisions.
Assessment of the adjustment task in a historical context
An adjustment of around 5.0 per cent of GDP by 2041-42 represents a significant challenge. While governments have achieved fiscal adjustments of a similar size on occasion, most changes in spending appear to be largely cyclical and are not maintained over time (Chart 33). In the past, total spending has diverged 5.5 per cent of GDP from the 30-year average of 24.6 per cent of GDP. Total revenue has diverged 3.9 per cent of GDP above the 30-year average of 23.9 per cent of GDP.
Chart 33: Historical total Commonwealth general
spending and revenue
Note: There is a break in the series between 1998-99 and 1999-00. Data for the years up to and including 1998-99 are consistent with the cash ABS GFS reporting requirements. From 1999-00 onwards, data are derived from the accrual ABS GFS reporting framework. Due to methodological and data-source changes associated with the change, time series data which encompasses measures derived under both cash and accrual accounting should be used with caution.
Recognising future pressures on government finances highlights the importance of maintaining the current rigorous fiscal and budgetary framework. This framework has been central to achieving Australia's current strong financial position. In the future, a strong fiscal and budgetary framework will assist in containing the size of a fiscal adjustment.
Nevertheless, recent OECD work shows that compared with other OECD countries, Australia faces relatively moderate long-term fiscal pressure.2 Many OECD countries face higher potential age pension burdens than Australia because their public pension schemes are related to an individual's earnings or are universal, and because the schemes are not sufficiently pre-funded.
However, there is no room for complacency. To maintain the flexibility to deal with long-term spending pressures, governments must retain the current disciplined approach to fiscal policy and the medium-term fiscal strategy. Intergenerational considerations partly prompted the Government to adopt the medium-term strategy in 1996, and its efforts to return the budget to surplus and reduce debt have helped to lay a sound foundation for long-term fiscal sustainability. It will be important to maintain this approach in the future, including while demographic and other longer-term spending influences remain relatively favourable over the next decade.
The Government can improve the economy's capacity to manage future increases in social spending or other longer-term expenditures by continuing to pursue policies that boost long-term economic growth. This includes promoting productivity growth, labour force participation and by facilitating job creation to reduce unemployment. Already, the Government has adopted policies to achieve this (for example, labour market reforms, the macroeconomic policy framework and welfare reform). However, it must continue to focus on this as a key priority. Tax reform is also important in terms of providing a robust tax base that will grow in line with the economy.