Health Funding

by Stephen Duckett

Presented, Wednesday 4 November

The 2014 budget did serious damage to Commonwealth-state relations and the confidence with which states could plan and manage health services. It did this by abrogating an Agreement about public hospital funding which had been signed by governments of all political persuasions and unilaterally imposed a new funding model on the states.

The funding model promulgated in the 2014 Budget was presented in the budget papers as ‘saving’ more than a billion dollars over the forward estimates, with savings described as being in the tens of billions over the ensuing decade. The words ‘saved’ and ‘savings’ are an example of creative accounting. They are savings to the Commonwealth budget only, but are not real savings to the public purse at all. Instead, they are simply a massive and unsustainable transfer of costs from the Commonwealth budget to state budgets.

The previous funding Agreement had dealt with some of the dysfunctional aspects of federalism in health care by creating an alignment of incentives. It made the Commonwealth share directly in the costs of activity growth in health care, which gave it an incentive to develop policies in its sphere that might mitigate that growth. For example, the Commonwealth traditionally funds primary care while the states fund hospital care. Making the Commonwealth share responsibility for hospital funding gave it a stronger incentive to improve primary care and reduce the number of avoidable and expensive hospital visits, generating actual savings to the public purse. The 2014 budget removed that alignment of incentives.

The 2014 Budget provided that future indexation to the states would be in line with a ‘combination of the Consumer Price Index and population growth’. If this is taken at face value then the 2014 proposal is the most parsimonious indexation arrangement that has ever applied to public hospital funding grants.
Both elements of the Commonwealth announcement – use of the Consumer Price Index and population growth – are flawed. On the price side, in the past public hospital funding indexation has included various combinations of the Consumer Price Index and indexation with Average Weekly Earnings (the latter acknowledging the fact that wages and salaries account for over 70 per cent of hospital costs). Such an index typically moved faster than the Consumer Price Index, since wages tend to grow faster than prices. On the population side, previous indexation arrangements have been weighted by the current age distribution, acknowledging that the average older person uses hospitals more than the average younger person, so that as the population ages, hospital use will grow faster than the population does.

In addition, previous indexation arrangements (negotiated by both Liberal and Labor governments) have included a ‘betterment factor’. This took account of the fact that health costs increase faster than general inflation and that hospital utilisation increases faster than simple population growth, even after taking into account the ageing of the population. In the past higher-than-CPI cost increases may have reflected a mix of inefficiency and exposure to movements in both international and domestic input prices. This effect has been mitigated in recent years, through greater pressure for efficiency and the more widespread use of activity-based funding. Activity growth above population growth is a result of changing practice patterns at all ages, likely due to the rise of chronic disease, and especially in older age groups as new anaesthetic agents and improvements in health make surgery and other interventions less risky for the elderly. Other changes in technology and treatments are also likely to be contributing to higher costs.

I have not quantified the impact of the Commonwealth cuts in these remarks. Previous evidence to the Senate has suggested that it could be of the order of $60 to $80 billion dollars over a ten-year period. I think these estimates are on the high side, partly because the forward estimates amounts were based on periods of higher rates of growth in both costs and volumes. Some of the so-called savings would thus be adjusting the forward estimates and projections to a more realistic set of expectations. Unfortunately I have seen nothing in the public domain that separates out the effect of the policy change (the move from indexing based on activity and costs to basing indexation on age and inflation) from the use of more recent estimates of costs and use. For this reason the public does not know what the real impact on state budgets will be over the next decade. Public policy formation and public debate is always better if it is based on clear numbers, and it is regrettable that the savings estimates still being floated around are such a muddle.

Previous work done by Grattan Institute has demonstrated that there are considerable inefficiencies in public hospitals both generally and in use of the hospital workforce. We estimated at the time that there could be savings in the system of about $1.5 billion a year, or around $15 billion over a decade, without negatively impacting hospital services. So there is a huge gap between our estimates of the savings that could be safely achieved, and the savings that states may be forced to achieve. This is the case even if we assume that the real impact of the Commonwealth changes over a decade is half the $60 – $80 billion estimate that has so far been floated.

Absent a revenue-side solution, if ‘savings’ of this magnitude have to be absorbed by the states, then there would inevitably be a severe degradation of services to the public.