4  Fiscal implications

The prospect of an ageing population has raised concerns about the future sustainability of government fiscal programmes. There is, however, a high degree of uncertainty surrounding the future path of demand for public resources. Some areas of expenditure will almost invariably expand as a result of population ageing, but at the same time other areas of expenditure may shrink.[15] Furthermore government revenues may also be affected by population ageing.

4.1  Health

The single largest fiscal issue relating to ageing populations is health care. Health comprises a large portion of the government’s expenditure, 19 percent in 2001 (The Treasury 2001a), and the elderly consume disproportionate amounts of the country’s healthcare resources (see Table 2). Other things equal, a rising old-age dependency ratio means that society’s demand for healthcare will rise. This alone may mean a large increase in government expenditure. This could be exacerbated if the cost of health care were to increase with the increase in demand.

Increased demand for health resources will come through two channels. Firstly, given there will be more people over the age of sixty-five, there will be more individuals in the age groups which consume a disproportionate share of health resources. Secondly, if trends in longevity continue this is apt to affect the average amount of resources demanded by individuals over the age of sixty-five. Quite how this average will be affected is not clear; three distinct scenarios present themselves.

The first we refer to as “prolonged demand”. This scenario assumes that demand for health care is a constant linear function of age. Thus average demand will rise for those over the age of sixty as a result of sustained levels of demand over increasingly longer periods of time.

The second scenario is that individuals will require the same levels of care that they do now, but that there will be a shift in the ages when higher levels of demand present themselves. This seems reasonable based on the grounds that individuals consume the most health resources close to their death – that is, demand will be “postponed”, not prolonged.

The third is that technological developments in health care will create more efficient and more effective treatments. This may result in a relative reduction in demand for healthcare resources as unit costs fall.

Assessing which of these demand scenarios is most likely is a key question for analysts and policy makers.

The first scenario portends the greatest increase in health care expenditure, although it is probably the least likely of all three scenarios. The idea that high levels of demand will be prolonged fails to take into account the dynamics behind demand for health care. It assumes that the present day proportion of health care resources demanded by those over sixty four will necessarily expand as people live longer and in doing so neglects the fact that if people are living longer they will generally be healthier, and so will demand less health care at certain “intermediate” ages, such as between 65 and 74.

Although our first scenario appears the most unlikely, it is the scenario that underpins most all long-term projections of health care expenditure in New Zealand. For example, in the Treasury’s Long-term Fiscal Model (LTFM) expenditure on health is adjusted for demographic change by allocating cost weights to age groups that broadly reflect each group’s consumption of total health expenditure.

These cost weights are assumed to remain constant in real terms over time, implying that the Government commits a constant average level of resources to purchases of health per person in a population group

Woods 2000, p.41

Consequently the Treasury’s long-term forecasts are apt to overestimate future fiscal demands with respect to health care[16].

The second scenario (postponed demand) is supported by much of the ageing literature. It is based on the argument that, contrary to the first scenario, demand will decline at ages where it is now relatively high, due to people being healthier and living longer. This is underscored by the claim that age does not necessarily cause ill health. The reasoning behind this is that many degenerative diseases that demand a great deal of resources are generally due to environmental factors or unnecessarily sedentary behaviour in old-age (Campbell 1993). Essentially, the implication is that we can prevent high health costs associated with ageing by promoting healthy living and active lifestyles.

This raises the question of future demand for long-term care as people live longer. Over the past thirty years the proportion of people in long-term care has remained fairly stable (Ashton 2000), however this may change as the proportion people in the population over the age of 85 increases. At the present time the proportion of people in long-term residential care increases sharply for those over 85 (Ministry of Health 2001) and this increase can be attributed to the greater rates of disability that occur at older ages. At the same time, although longevity is increasing in most developed countries, the health of people over the age of 85 is characterised by illness and disability (European Commission Economic Policy Committee 2001). If rates of disability amongst the “very old” do not abate it is probable that demand for long-term care will rise at greater rates in the future than at present.

Source: Ministry of Health, Personal Health Funding Formula 1996/97 cited in Bagrie 1997 p. 9.

The third demand scenario is difficult to assess because it is susceptible to the largely immeasurable effects of price and income elasticities in the demand for health care. If demand for health care is highly inelastic then efficiency gains that result in lower prices will have the effect of lowering overall demand for resources. Conversely if demand for health care is highly elastic then this raises the possibility of reductions in unit cost being offset by increases in quantities demanded, resulting in an increase in aggregate dollar amount of resources demanded.

There are inherent problems in measuring the elasticity of demand for health care. In deciding to visit a doctor or GP, individuals may initially consider the costs of a visit against perceived benefits. However, decisions to have further treatments usually arise out of physician’s recommendations. As a result it is difficult to determine if individuals respond to changes in price or income or if they simply decide to consume health services on advice from health professionals. However, it is important that we seek to better appreciate elasticity in the demand for health care because of potential future fiscal implications.

Irrespective of which scenario for demand proves most valid, changes to the cost of healthcare may be just as profound as changes in demand. Thus we need to consider supply side factors and to develop a robust framework within which to analyse the various factors that drive the cost of health care, both at the micro and the macro levels.

Potentially the most important supply side issue for the future cost of healthcare is the cost of new technologies and treatments. New technologies and treatments are generally more expensive than those that they replace (Lee and Miller 2001) but they offer the potential benefits of efficiency gains such as reductions in the number of nights that a patient is required to be in a hospital. However, whether the increased unit cost is larger or smaller than the efficiency gain is not always clear, and is treatment specific (Cutler and McClellan 2001;McClellan 1996;Newhouse 1994). Subsequently the role of policy in determining the speed at which new treatments and technologies are adopted will become increasingly important. That is, given expected increases in the demand for health care, a rise in unit costs may result in particularly large increases in overall expenditure.

If we assume that technological progress increases the rate at which health care costs rise, then, in the case of the first two demand scenarios, rising costs would mean an even greater rise in health care expenditure over the next fifty years. In our third scenario (which implies greater efficiency and therefore lower demand) an increase in the cost of health care may offset any fiscal benefits of a reduction in demand.