Annex B: Modelling assumptions

The Commission has produced projections of budget aggregates (underlying cash balance, net debt, total receipts and total payments) and some of the large and strong growing programmes. These projections are largely based on material contained in the 2013-14 Mid‑Year Economic and Fiscal Outlook.

Methodology of budget aggregate projections

The Budget aggregate projections are based on projections from the 2013‑14 MYEFO. Where the Commission has made its own assumptions (for instance about future tax revenue), these are noted in the report.

The Commission has used Treasury’s fiscal aggregate projection model (FAPmod) to produce the aggregate projections.

FAPmod combines projections of receipts, payments and balance sheet components to produce an internally consistent cash and accrual framework, with interconnected operating and cash flow statements and balance sheet.

This differs to the approach used for budget aggregates across the forward estimates period, where estimates are based on detailed programme level information.

Further information about Treasury’s FAPmod can be found in Australian Government 2009.

Receipt projections

Medium-term tax receipts are projected by head of revenue using parameters for wages, profits and consumption linked to nominal GDP growth - similar to the revenue projections for the last two years of the forward estimates period.

Consistent with current presentation in the Budget papers, the underlying cash balance does not include earnings from the Future Fund. For simplicity and consistency the charts displaying projections of total receipts do not include Future Fund earnings.

Payment projections

Payments are projected using a suite of models, including models that project spending on health, income support payments, education and training, aged care, major superannuation defined benefit schemes and defence. Whilst the details of the various spending models differ, they are mainly driven by expected changes in demand (in most cases driven by demographic change) and prices.

A number of programme estimates are included in the aggregate projections where programmes are expected to have a substantial financial impact beyond the forward estimates period, for example the National Disability Insurance Scheme.

The underlying cash balance does not include operating costs of the Future Fund. For simplicity and consistency the charts displaying projections of total payments do not include the operating expenses of the Future Fund.

Economic and demographic projections

The fiscal aggregate and programme projections are based on economic and demographic parameters.

These parameters are based on medium-term assumptions of growth consistent with historical experience adjusted, where appropriate, for long-term factors such as demographic change.

Further detail on the significant parameters is below.

Real Gross Domestic Product

Real GDP is assumed to grow by 2½ per cent in 2013-14 and 2014-15, and 3 per cent per year in 2015-16 and 2016-17.

Beyond the forward estimates, real GDP is assumed to grow at its trend rate of around 3 per cent per year. Trend growth in real GDP is projected to slow early next decade as the participation rate declines with Australia’s ageing population.

Inflation

Consumer Price Inflation is projected to be around 2½ per cent per year from 2015-16 consistent with the Reserve Bank’s medium-term target band.

Nominal Gross Domestic Product

Nominal GDP is assumed to grow at 3½ per cent per year in 2013-14 and 2014-15, increasing to 4¾ per cent per year in 2015-16 and 2016-17.

Nominal GDP growth is determined by the combination of real GDP growth and economy wide prices and is around 5½ per cent per year beyond the forward estimates period.

Unemployment rate

An unemployment rate of 6 per cent in 2013-14 and 6¼ per cent in 2014-15 has been assumed. The unemployment rate is projected to remain around 6 per cent beyond 2014-15.

Participation

A participation rate of around 65 per cent in 2013-14 is projected. This rate falls over time, primarily due to the impact of the ageing of the population.

Productivity

Labour productivity is assumed to grow at a rate of 1.6 per cent per year, reflecting historical annual rates.

Wages growth

Growth in wages is assumed to be around 2.75 per cent per year in 2013-14 and 2014-15. From 2015-16 growth in wages is projected to be 4 per cent per year. This reflects growth in the CPI and labour productivity.

Terms of trade

It has been assumed that the terms of trade decline until 2019-20, when they reach a long-run level similar to the level in 2006-07. They then remain at this level.

‘Business as Usual’ scenario

In the ‘Business as Usual’ scenario, estimates and projections of payments and receipts draw on material presented in the 2013-14 MYEFO.

However, tax collections are limited to 24 per cent of GDP.

Payments increase in line with published 2013-14 MYEFO numbers, with some differences occurring through higher public debt interest payments, due to weaker budget projections than at the 2013-14 MYEFO.

‘Reform’ scenario

The ‘Reform’ scenario makes the assumption that tax receipts do not exceed 24 per cent of GDP, (the same assumption as the ‘Business as Usual’ scenario) and that growth in payments is constrained such that the Budget improves to a 1 per cent of GDP surplus in 2023-24.

The constraint on payments begins in 2014-15 and continues until 2023-24.

Methodology of programme projections

The Commission has published projections of expenditure for the large and fast growing programmes.

These projections are based on an accrual framework.

The programme projections are based on the 2013-14 MYEFO. This does not include the commitment to increase Defence expenditure to 2 per cent of GDP within a decade.

Beyond 2016-17, programme-specific models have been used to project expenditure. These models are based on those used for the forward estimates, with modifications to incorporate drivers of programme growth over the longer term. Whilst the projections make use of the most appropriate assumptions, a high level of uncertainty is inherent in this form of modelling.

Hospitals

Hospital expense projections reflect the Commonwealth contribution to public hospital funding under the Commonwealth/State National Health Reform Agreement. Projections exclude public hospital spending on veterans.

Pharmaceutical Benefits Scheme

Pharmaceutical Benefits Scheme (PBS) projections reflect PBS expenditure under the National Health Act 1953. The Repatriation Pharmaceutical Benefits Scheme, which is a separate scheme funded through the Department of Veterans’ Affairs, has not been included.

Medicare Benefits Schedule

Medicare Benefits Schedule projections reflect Medicare Benefits Schedule expenditure under the Health Insurance Act 1973.

National Disability Insurance Scheme

National Disability Insurance Scheme projections reflect the Commonwealth’s contribution to the scheme, net of National Disability Specific Purpose Payment and existing Commonwealth programs that provide disability care and support services.

Income support for carers

Income support for carers projections reflect the five major areas of support: Carer Payment (the main income support payment); Carer Allowance (Adult); Carer Allowance (Child); Carer Supplement; and Child Disability Assistance. Only the special appropriations have been modelled.

Child care fee assistance

Child Care Fee Assistance projections reflect the Child Care Benefit and the Child Care Rebate.

Paid Parental Leave

Expenditure in 2013-14 and 2014-15 relates to the scheme as at the 2013-14 MYEFO. The remaining years relate to the Government’s proposed new scheme.

Disability Support Pension

Disability Support Pension (DSP) projections reflect the special appropriations for DSP.

Age Pension

Age pension projections reflect the special appropriations for Age Pension (including the pension supplement). The Wife Pension and Widow B Pension have not been included.

Aged care and population ageing

Aged care and population ageing projections reflect special appropriations for the Home Support, Home Care, Residential and Flexible Care programs. The Department of Veterans’ Affairs component of the Residential Care programme is also included.

Family Tax Benefit

Family Tax Benefit projections reflect the special appropriations for Family Tax Benefit Part A and Part B.

Schools funding

Schools funding projections reflect funding for both non-government and government schools and include funding the Students First - a fairer funding agreement for schools package. For the purpose of producing these projections it has been assumed that the former Government’s Better Schools Plan is implemented in full and funding provided to non-participant States and Territories continues beyond 2017.

Higher education

Higher education projections reflect expenditure projections for the Higher Education Support programme. The main element of this programme is the Commonwealth Grant Scheme. Other elements include supplementation for unfunded superannuation liabilities payments, support for students with a disability and funding to universities with students from low socio-economic status backgrounds.

Official Development Assistance

Official Development Assistance projections reflect all Official Development Assistance‑eligible expenditure and include both global (multilateral) and country (bilateral) programs and some departmental funding.

Defence

Defence projections are on the basis of expense estimates for the Defence function (including the Department of Defence, Defence Materiel Organisation and other smaller agencies in the function). Superannuation costs and expenses related to the Department of Veterans’ Affairs and Defence Housing Australia are not included. The projections also include Defence function net capital investment and as such the Defence projections are not pure expense numbers.

The defence projections differ slightly from the other expense projections, as they reflect the function and not the programme.

Job Seeker Income Support

Job Seeker Income Support projections include projections for Newstart Allowance and Youth Allowance (other). This projection is heavily dependent upon the assumed unemployment rate of around 6 per cent.

References

Australian Government 2009, Economic Roundup issue 3, Australian Government, Canberra