Long term public spending trends* John Hawksworth Head of Macroeconomics PricewaterhouseCoopers...

Long term public spending trends*

John HawksworthHead of MacroeconomicsPricewaterhouseCoopersMarch 2006

*connectedthinking

PricewaterhouseCoopers LLP6 March 2006

Agenda

Methodology and key assumptions

Total public spending projections

Focus on health spending

Summary and conclusions

PricewaterhouseCoopers LLP6 March 2006

How do you project long-term public spending as % of GDP?

Start with GAD population projections in five year age bands

Assume trend labour productivity growth = 2% per annum

Assume plausible path for employment rates by age band/gender

Derive implied trend GDP growth profile (c.2.25% pa to 2014/15; then c.2% per annum on average over next 40 years)

Input estimates of spending as % of GDP per capita in base year for health, long-term care and education by age band

Make plausible assumptions on trend real growth in unit costs for each of these three spending categories (c.2.5%/2%/2%)

Use separate model to project state pension costs

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Summary of long term PwC age-related public spending projections

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5

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20

25

30

Public service pensionsEducationState pensionsLT careNHS

% of GDP

Source: PwC main scenario projections (except Treasury for public service pensions)

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Comparison of long term PwC and HM Treasury public spending projections

3839

4041

424344

4546

4748

2004/5 2014/15 2024/25 2034/35 2044/45 2054/55

PwC main scenarioTreasury

% of GDP

Source: PwC main scenario projections using Treasury projections for public servicepensions and other spending, Treasury long-term public finance report 2005

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PwC and HMT projections very similar except for health spending (though even there trends are broadly comparable)

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NHS (PwC)

NHS (HMT)

State pensions (HMT)

State pensions (PwC)

Public service pensions(HMT)

% of GDP

Source: PwC main scenario, HMT long-term public finance reportNote: education spending projections are very similar

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Recent projections for UK public spending on pensions, health and long-term care

% of GDP increase over period shown

Health and long term care only

Pensions, health and long-term care

Treasury (Dec 2005): 2004/5 to 2054/55

+3.3 +5.5

PwC (March 2006): 2004/5 to 2054/55

+4.7 +6.8

OECD (Feb 2006): 2005 to 2050

+2.8-5.6* N/A

EU EPC (Feb 2006): 2004 to 2050

+2.6 +4.6

*Two OECD scenarios: ‘cost containment’ and ‘cost pressures’

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What drives NHS spending in long run?

Any additional ‘catch-up’ over next 5 years (Wanless: 4.4-5.6% real growth; we assume bottom end of this range)

Pure age effects - more older people -> higher costs (survivors)

Number of deaths -> change in death-related costs

Offset from healthy ageing -> perhaps c.50% of pure age costs

Non-demographic factors:

- Income elasticity of demand > 1 (superior good)

- Technological advances and relative price effects

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NHS spending as a share of national income: 1949/50 to 2004/5

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5

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7

8

Source: PwC calculations based on data from ONS, Department of Health and IFS

Gross spending (% of GDP)

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Decomposing UK public health spending growth: 1981-2002(% average real growth per capita per annum)

Total UK public health spending growth per capita: 3.4%

of which:

Age effect: 0.2%

Income effect: 2.3%*

Other effects (residual): 0.9%

Source: OECD (2006, Table 2.1)

*Assuming income elasticity of health spending = 1

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Age distribution of NHS spending (estimates for 2004/5)

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25

30

35

Age 0-4* Age 5-14 Age15-44 Age 45-64 Age 65-74 Age 75-84 Age 85+

% of GDP per capita

Source: PwC assumptions based on UK government estimates for 2000 in EPC report scaled up to 2004/5 values to match gross NHS spending plans

*Includes cost of births

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Alternative estimates of age structure effects on future NHS spending – may be significantly greater than historic effects

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0.4

0.6

0.8

1

1.2

1.4

1.6

1.8

2025 2050

PwC main scenariowith health adjustmentOECD pure ageing +death cost effectsEPC with healthadjustment

Change relative to base year* (% of GDP)

Source: PwC, OECD (2006), EPC(2006); OECD figures exclude adjustment for ‘healthy ageing’

*Base year is 2004/5 for PwC, 2005 for OECD and 2004 for EPC; EPC estimate for 2025 is based on extrapolating between 2010 and 2030 estimates.

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Estimated elasticity of UK health care spending per capita to GDP per capita

1992-2002 1982-2002 1972-2002

Total health spending

1.39 1.49 1.73

Public health spending only

1.33 1.40 1.63

Source: OECD Health Data 2005

Our base case assumption: income elasticity = 1.2HM Treasury assumption: income elasticity = 1

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Alternative estimates of income effects on NHS spending

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0.5

1

1.5

2

2.5

3

2014/15 2024/25 2034/35 2044/45 2054/55

Low elasticityMain scenarioHigh elasticity

Change relative to 2004/5 level (% of GDP)

Source: PwC estimates with income elasticities in a range of 1.1-1.3

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What drives NHS spending growth in our main scenario?

Total projected increase by 2054/55: +4.1% of GDP

of which:

Catch up effect by 2012/13: +1.1% of GDP

Ageing effect after health adjustment: +1.3% of GDP

Income elasticity/other effects: +1.7% of GDP

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Alternative PwC composite scenarios for total NHS spending

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14

2004/5 2014/15 2024/25 2034/35 2044/45 2054/55

High scenarioMain scenarioLow scenario

% of GDP

Source: PwC projections starting from HM Treasury estimate for 2004/5

PricewaterhouseCoopers LLP6 March 2006

Alternative PwC scenarios for total NHS spending vs Treasury projections

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2004/5 2014/15 2024/25 2034/35 2044/45 2054/55

High scenarioMain scenarioLow scenarioTreasury

% of GDP

Source: PwC projections starting from HM Treasury estimate for 2004/5

PricewaterhouseCoopers LLP6 March 2006

Summary and key issues

PwC and Treasury projections similar apart from NHS spending

- explained by our inclusion of non-demographic cost pressures

But: both sets of projections see rise in total public spending to around 45-47% of GDP by 2054/55 (c.42% at present)

Higher longevity might increase this; higher employment rates or healthier lifestyles might reduce the pressure on future taxpayers

Raises issues as to:

- Potential pressure on NHS model if unit costs rise in line with historic trends: how can these cost pressures be mitigated?

- Are there other major areas of public spending that can be reduced as a share of GDP?

- Balance between private and public spending?