Should young Australians be more concerned about their futures?

Young Australians do not seem to be particularly concerned about their futures. The data discussed in a recent post suggests that measures of optimism and pessimism depend a great deal on the specific question that is asked and the context in which it is asked. Nevertheless, it is reasonably clear that young Australians are less pessimistic than young people in many other high-income countries.

Perhaps young Australians should be more concerned about their futures. In considering this question I will rely largely on two reports: 

• Renewing Australia’sPromise: Will young Australians be better off than their parents? (authorship anonymous) published by the Foundation for Young Australians (FYA) in November 2014; and
• The Wealth of Generations, by John Daley and Danielle Wood, published by the Grattan Institute in December 2014.

The FYA report attempts to compare the lives of young people today and their future prospects with the lives and prospects of their parents when they were at a similar age. Young people are defined in various ways e.g. between 15-24 years of age, 20-24 and 25-34. The comparisons are largely between relevant data for the present and thirty years ago (1985). The aspects covered by the comparisons are: work and incomes, education, housing, government services, health and environment.

The focus of the Grattan report is somewhat narrower than that of the FYA report. It looks in some depth at change in household wealth, incomes, and government taxes and transfers of people in different age groups.

The environment: 

The FYA report argues that Australia is likely to become a hotter place and to be more at risk of fire and drought as today’s young grow older. Some precautionary measures are desirable even if the FYA report is too pessimistic. From an international relations perspective it is important for Australia’s efforts to control GHG emissions to be defensible in international forums. (Interestingly, the FYA report does not include a discussion of international relations; perhaps the region in which we live is now so peaceful that the potential for international conflict no longer comes readily to mind as an important factor affecting the wellbeing of future generations of Australians.)

If the climate change pessimists are correct, nothing Australian governments can do will make much difference, except for policies supporting adaptation. Technological advances will probably help future generations to cope with any increased risk of fire and drought if appropriate investments are made in research.

Health: 

The FYA report suggests that young people will live longer and healthier lives than their parents as a result of advances in medical technology and adoption of healthier lifestyles. Between 1985 and 2015 life expectancy of 25 year olds increased by 6.2 years for males (from 74.5 to 84.7) and by 4.5 years for females (from 80.3 to 84.8).

Education: 

Over the last 30 years there has been a massive increase in the amount of time people spend being educated but the quality of education does not seem to have kept pace with that in other OECD countries.  Data presented by FYA shows Year 12 completion rates have risen from 44% to 77% (20-24 age group) and the percentage of people with university degrees has risen from 26% to 35% (25-34 age group). PISA scores indicate that basic skills in maths and reading have slipped substantially relative to the OECD average.

Housing: 

The Grattan report notes that home ownership is declining, especially among the young. The percentage of 25-34 year olds owning their own home slipped from more than 60% in 1981 to 48% in 2011. FYA notes that the ratio of house price to income rose from 3.2 in 1985 to 6.5 in 2015, while the ratio of housing loan interest to income rose from 3.9 to 7.1. However, the Reserve Bank’s estimates suggest that repayments on new housing loans as a percentage of household disposable income were much the same in recent years as in the mid 1980s.  The relevant percentages are higher than in the early 1980s, but lower than in the late 1980s.

It is also relevant to consider how the price of housing and rents compare with movements in the CPI over the past 30 years. Over the period from December 1984 to December 2014 the CPI All Groups index rose on average by 3.6% per annum, the housing component of the index rose by 4.1% per annum. Over this period, the annual rate of increase in the rental sub-group was 4.9% in Sydney, 4.0% in Melbourne and 3.3% in Hobart. This data is not consistent with a general decline in affordability of rental accommodation over the last 30 years.  The fact that it is costing more to live in Sydney suggests that many people find Sydney to be an attractive place to live.

Government Services and Taxation: 

The FYA report makes the widely-known point that over the next 40 years an increase in the proportion of old people in the population is likely to result in an increase in government spending on programs which benefit older people, while young people are likely to be required to contribute more in taxation and to receive less services in return. Young people are already contributing more than their parents’ generation; this is evident in the increase in average student (HECS) debt on graduation from zero in 1985 to about $24,000 in 2011.

The Grattan report provides a more detailed examination of intergenerational transfers. It notes that since 2003-04 there has been a substantial increase in net transfers per household of $9,400 to the 65+ group - mainly in the form of health spending and cash benefits - which has been funded by increases in government debt.

The Government’s latest intergenerational report has projected that under current legislation net debt per person will rise from $10,400 in 2014-15 to $65,000 mid-century, measured in today’s dollars. It is probably not reasonable to expect old people, children and others on relatively low incomes to make much contribution to servicing that debt, so a middle income earner could be looking at having to service an additional debt approaching $100,000 on top of their home mortgage.

We can expect the open season for crazy tax ideas to continue in Australia until we manage to get government spending under control.

This cartoon by Nicholson was published in “The Australian” newspaper in 2010.

Work, incomes and wealth: 

Data presented in the FYA report indicate that the unemployment rate of 13% for 15-24 year olds is similar to that in 1985. However, there are many young people engaged in casual and part-time employment who would prefer to work more. Over the past three decades the percentage of young people who are not able to get as much work as they would like has more than trebled (rising from 4.7% to 16.6%). 

As to the future, a decline in the proportion of young people in the population will not necessarily bring about a return to the situation where young people will be able to find secure employment more readily. Technological change can be expected to continue to result in displacement of a growing number of occupations and labour market regulation may continue to favour people who have secure employment relative to job-seekers. Technological change will also provide new opportunities, but the FYA report makes the important point that ability to take advantage of such opportunities will depend on skill development to ensure that “technology augments young workers rather than displacing them”. That might be easier said than done in the context of current opposition to labour market deregulation and education reform.

The FYA report notes that there has been a modest increase of 6.8% in median weekly earnings of 15-24 year olds over the last 30 years. That represents a rate of increase five times slower than experienced by people aged 45-54.

The Grattan report shows that older Australians have also captured most of the growth in Australia’s wealth over the past decade. Households in the 65-74 age bracket are on average $200,000 wealthier than households of that age eight years ago, while the wealth of households in the 25-34 age bracket have gone backwards. The main driver of the growth in wealth of older Australians has been an increase in house prices. Young people have missed out on this as a result of their lower home ownership rates.

As an old person it would be easy for me to be complacent about growing intergenerational disparities of wealth. After all, it is reasonable to expect that older people will ultimately pass on much of their accumulated wealth, isn’t it? Data in the Grattan report suggests, however, that inheritances are typically received later in life and primarily benefit people who are already wealthy. Gifts to younger generations are typically small and also primarily of benefit to well-off households.

Concluding comments

In the past I have often tried to dismiss the fears that young people have expressed to me about their future lives with some comforting words about the benefits of ongoing economic growth. I still think the problems discussed above will be manageable if Australia can maintain rates of economic growth comparable to those experienced during the last 30 years. 

   

However, it will be difficult to maintain economic growth comparable to the past, given projected changes in the age structure of the population. We may not have much economic growth at all if an increasing tax burden is placed on investors and medium to high income earners. Investors can easily find attractive opportunities elsewhere in the world and medium to high income earners are likely to be increasingly attracted by the pleasures of early retirement, particularly if they can look forward to a government-funded pension after their savings are sufficiently depleted.

In my view young Australians have good reasons to be concerned about their futures.

Does the McClure report provide a basis for sensible welfare reform?

My first impression of the report of the Reference Group on Welfare Reform was not favourable. I couldn’t make sense of it.

The four pillars metaphor got in the way of the story the report was attempting to tell. When I went looking for the structure that the pillars were meant to support I got lost. So I then went looking for four major problems that reforms were intended to address and could only find two.

At that point I realized that the pillars were just a device to tell readers that the material in this report has been organised under four subject headings.  The reason why the material was organized in this way still escapes me, but that probably doesn’t matter. The report was probably not intended to be read by people like me.

One of the major problems that the members of the reference group (Patrick McClure, Sally Sinclair and Wesley Aird) have sought to deal with is the complexity of the existing system of welfare payments. The report is concerned that complexity creates problems for individuals in understanding the system and accessing support, and makes it more difficult to administer the system efficiently. There is also an underlying problem of inequity, with people in similar circumstances being treated differently. The reference group has proposed a simplified payment architecture, with five primary types of payment. It looks like a sensible reform, but I am not well placed to comment.

The other major problem that the reference group has sought to address is long-term dependence on income support by people who have potential to become self-reliant. The report proposes that the problem be tackled with an investment approach along the lines of that adopted in New Zealand. The key features of the proposed approach seem to be:

• Conducting actuarial calculations annually to estimate the lifetime liability (i.e. contingent liability to government) of the overall income support system and support for specific groups.
• Identifying those groups at greatest risk of long term income support dependence and those groups with the strongest chance of breaking this reliance with tailored support.
• Making a broad range of services available to assist at-risk clients to break their reliance on income support. The Federal Government is envisaged to be the driving force behind service delivery.
• Ensuring that interventions are evidence-based, and “testing and learning” to ensure continuous improvement of support services.

The proposed investment approach seems promising, but it is not obvious that the report has taken into account criticisms of the New Zealand scheme, such as those raised by Simon Chapple in an article published in 2013. Chapple pointed out that the investment approach adopted in New Zealand can produce policy outcomes that are inconsistent with a standard cost benefit framework. For example, the investment approach counts movement of people off welfare for any reason – including movement into the black or grey economy, emigrating and going to prison - as a benefit.  It provides the administering agency with an incentive to focus on reducing government spending rather than achieving more desirable outcomes such as helping welfare beneficiaries gain employment.

In my view Chapple’s objections to the New Zealand scheme should probably not weigh heavily against the adoption of a similar scheme in Australia, but the issue deserves more careful consideration than I can give it here. It would have been desirable for the reference group to have discussed the issues involved in its report. It will be interesting to see how Patrick McClure or other members of the group now deal with the similar criticisms that have been raised against their proposals by Michael Fletcher. They can hardly argue that their report speaks for itself.

If this report had been prepared by the Productivity Commission I am sure it would have provided a more thorough investigation of the fundamental issues that should be considered before the government adopts an investment approach to welfare along New Zealand lines.

Have Australians become highly pessimistic about prospects for future generations?

On “Personal Reflections” last week Jim Belshaw mentioned a conversation with one of his daughters who said she and most of her generation had given up on the idea of home ownership because it was no longer an achievable dream. I would not be surprised if many young Australians hold such views these days.

Jim mentioned his conversation in the lead-in to his discussion of the results of some polling by Essential Research, which asked respondents whether they think that over the next 40 years various groups of people will be better off or worse off than they are today. The results are surprisingly negative. Apparently, only 14% think that retirees will be better off. The corresponding numbers for other groups are: 15% for the middle aged; 14% for families with school aged children; 18% for young adults and 24% for children.

I suspect that respondents may have been primed to be somewhat pessimistic in their responses by preceding questions which Essential asked in the survey. Those questions were about awareness of the Intergenerational Report, consequences of the changing population age structure and climate change.

The results of a poll conducted by Essential after last year’s budget are similarly pessimistic. The poll suggests that 21% of Australians think that the standard of living for the next generation will be better than today, 27% think it will be much the same and 48% think it will be worse (4% don’t know).

An Ipsos Mori survey, reported in The Guardian in April last year, asked a range of questions and seems to have obtained somewhat more optimistic responses. When all respondents were asked do “you feel that your generation will have had a better or worse life than your parents' generation”, 40% said better. Responses to that question by people under 30 were less optimistic: 30% said better. When all respondents were asked “do you feel that today's youth will have had a better or worse life than their parents' generation”, 30% said better. Again, responses by people under 30 were more pessimistic: only 22% considered that today’s youth would have a better life than their parents.

The Ipsos Mori (I.M.) survey suggests that Australians are more optimistic than people in most high income countries, although they are much less optimistic than people in China and some other countries experiencing rapid economic growth. A similar picture emerges from surveys by Pew Global which asked: “When children today in (survey country) grow up, do you think they will be better off or worse off financially than their parents?”. The Pew data is available for a larger number of countries and for both 2013 and 2014. Unfortunately data for Australia (and some other countries) was only collected for 2013.

The results of the I.M. and Pew surveys can be compared from data shown in the graph below. In constructing the indexes shown in the graph I assigned a value of 1 to “better”, -1 to “worse” and 0 to “same” and “don’t know” (and averaged the I.M. data when two years data was available).

In order to put some perspective on this data it would be desirable to compare it with earlier surveys. I have found some information on an international survey undertaken by the Angus Reid Group and reported in The Economist in August 1998.  The 16,000 adults included in the survey were asked about future prospects for themselves and their children, and the results were used to rank the 29 countries covered according to the optimism of their citizens.  Australia was ranked about the middle (14th).  Respondents in the United States and Britain were more optimistic (ranked 4th and 9th respectively) while those in France and Japan were less optimistic (ranked 28th and 29^th respectively). 

That information is from a review I wrote of a book entitled Measuring Progress, edited by Richard Eckersley. Unfortunately, I have not been able to find the survey report or data table, but the article in The Economist indicates that only a quarter of Japanese expected their children to be better off than they were. That figure lies between the recent I.M. and Pew estimates.

An indication of the way optimism about the next generation changes over time with changes in economic conditions is provided in a review of U.S.data by Journalist’s Resource. Pessimism about the standard of living of future generations fell during the 1990s and has since risen again to levels comparable to those in the early 1990s.

There is not a great deal of comfort in knowing that Australians are not as pessimistic about the prospects for future generations as are people in most other high income countries. The situation could easily get worse with a deterioration in economic prospects in Australia.

It is quite possible that people are mistaken in their pessimism about prospects for future generations, but perceptions can have an important influence on well-being and can also influence attitudes and behaviour. We should know more about why people are pessimistic and whether their perceptions are well founded. Recent reports by the Grattan Institute and the Foundation for Young Australians are relevant to this question and should probably be discussed on this blog in the near future.

Postscript 1:

I have just found my copy of the report of the 1998 Angus Reid Poll referred to above. It was filed away in a place where it was not difficult to find. I am amazed that on this occasion my filing system worked better than Google.

The survey was conducted in May/June 1998. The relevant question was: “all things considered, do you think your children will be better off or worse off than you?”. Apparently 57% of Australians thought that prospects for the next generation would improve, 22% thought they would get worse and 21% thought they would stay the same or were unsure. The corresponding numbers for the U.S. were 78%, 14% and 9%. At the optimistic end of the scale, corresponding numbers for China were 85%, 4% and 11%. Towards the pessimistic end, the corresponding numbers for France were 33%, 52% and 15%; and for Japan, 24%, 59% and 17%.

Postscript 2:
I have just come across some LSAY (Longitudinal Survey of Australian Youth) data which suggests that young people in Australia are optimistic, despite their dissatisfaction with "the state of the economy' and "the way the country is run". In 2013 when their average age was 25.7, 90.1% of the Y03 cohort were happy with their career prospects, 96.3% were happy with their future, 59.9% were happy with the state of the economy and 53.6% were happy with the way the country is run. This group had remained consistently optimistic over the period from 2004 to 2013.

Postscript 3:

My attention has also been drawn to the annual survey of Australian youth conducted by Mission Australia. This captures views of young people on a range of issues, including their aspirations and views on how likely their aspirations are to be achieved. In 2014, there were 13,600 survey respondents aged 15-19 years. Respondents volunteer to take part in the survey in response to an invitation and an electronic link provided via schools.

Aspirations which respondents viewed as highly important (extremely important or very important) included: career success (87.4%); financially independence (86.1%) and home ownership (72.6%). Corresponding percentages viewing aspirations as highly likely to be achievable (extremely likely or very likely) were as follows: career success (55.9%); financial independence (65.5%) and home ownership (71.0%). I am not sure what counts as career success, but those numbers suggest to me that young Australians tend to be pessimistic about their chances of achieving financial independence and optimistic about their chances of home ownership.

Respondents were also asked how positive they felt about the future. In 2014, 63.8% of respondents felt positive or very positive about the future. The corresponding percentages for 2013 and 2012 were 67.5% and 70.6%. 

Why should Australians be concerned about the deficit and debt projections in the latest Intergenerational Report?

Before publishing the latest intergenerational report, Joe Hockey, the Australian Treasurer, said that people are “going to fall off their chairs” when they see some of the graphs in it.

I didn’t fall off my chair. The picture of government debt levels painted by the report is not as bad as I was expecting. The report suggests that under current legislation – the budget measures that have obtained Senate approval – net debt would increase to around 50% of GDP by 2055, slightly higher than the current level in Germany and substantially below the current level in the United States and United Kingdom.

The reason why net debt is not projected to deteriorate as rapidly as I had anticipated is bracket creep – the movement of individuals into higher income tax brackets as a result of inflation.  Bracket creep is projected to result in a substantial increase in the ratio of tax revenue to GDP over the next five years.

Bracket creep is a sneaky way to raise additional revenue. In the past, governments have adjusted tax rates downwards from time to time to compensate for bracket creep, but there is no provision for that to occur automatically under current legislation.

Consideration of bracket creep helps to focus attention on the main problem with government deficits and growing debt levels – namely, the need for debts to be serviced and repaid from government revenue of one kind or another. Some readers might like to remind me at this stage that future Australian governments could follow the example of the Greeks, among others, and neglect to service debts. The downside of that strategy is that if you ever want to borrow again the cost of funds is likely to be much higher, to reflect the risk of default.

The intergenerational report notes that bracket creep can reduce incentives to work, particularly by people on low incomes. This implies that the marginal excess burden (MEB) associated with bracket creep might be fairly high.

So, what is MEB? In broad terms, taxes impose an excess burden or deadweight cost to the extent that aggregate income is reduced by imposing the tax, for example as a result of reduced incentives to work or invest.  (That definition of excess burden is not perfect but it has the virtue of being reasonably easy to understand.) The MEB is the excess burden associated with a small tax increase as a percentage of the additional revenue collected. Thus, for example, a 40 percent excess burden means that for each $1.00 of additional revenue raised, there is an associated deadweight cost of 40 cents. With an MEB of that magnitude, each additional dollar of revenue raised - for infrastructure spending for example - would need to yield a return (discounted to present value terms) of at least $1.40 in order to be worthwhile.

A few years ago the Henry Tax Review commissioned a major study by KPMG (Econtech) of the marginal excess burden (MEB) associated with different forms of taxation in Australia. While the estimates of MEB ranged up to 90 percent, more typical estimates were 40% for taxes on capital income, 24% for labour income, 8% for GST and 2% for municipal rates.

Tax revenue from bracket creep could be expected to involve an MEB somewhat higher than the MEB on labour income. On that basis, the projected increase in tax revenue from bracket creep, equal to about 2% of GDP, could be expected to involve an excess burden of around 0.5% to 0.8% of GDP. That is quite a lot of wealth to be throwing away on top of the deadweight cost of about 6.5% of GDP associated with current levels of taxation.

The obvious way to reduce excess burden is to substitute taxes with relatively low MEBs, such as GST, for income taxes. That would raise concerns that lower income earners might be worse off, but I doubt whether those concerns would be justified if an increase in GST was used to compensate for bracket creep.

The fundamental problem that cannot be overcome by replacing one tax by another to fund high levels of government spending is that MEBs rise exponentially as the tax rate rises. Thus, as shown in the Figure below, if relevant elasticities result in a moderate MEB of 10 percent with a tax rate of 10 percent, the MEB rises to 37.5 percent with a tax rate of 30 percent and to 83.3 percent when the tax rate is 50 percent. I constructed the graph for a report entitled “How Much Government?”, prepared for the New Zealand Roundtable in 2001. The reasoning behind the graph is an application of the standard tools of economic analysis and is spelled out in the report (page 53).

So, what are the implications for excess burden of taxation of the net debt projections in the intergenerational report? The report estimates that the projected net debt of around 50 percent in 2055 under current legislation would involve an increase in net interest payments from 0.7% of GDP to 3.5% of GDP. Under current legislation, assuming an MEB of 40%, there will be an additional deadweight cost of around 1.2% of GDP just to pay interest on government debt. If the government raises taxes sufficiently at that point to eliminate the 6% deficit (underlying cash balance) that would double the additional deadweight cost estimate. Adding on the deadweight cost of bracket creep, gives a total additional deadweight cost of increased taxation equal to about 3% of GDP.

Another way to look at the issues involved is to consider the excess burden of taxation required to pay for the projected increase of government spending equal to 6.5% of GDP - which is the difference between the projected average ratio under the current legislation (31.2%) and the average ratio for the 40 year period 1974-75 to 2013-14 (24.7%). That is the perspective adopted by Henry Ergas in The Australian, March 9, 2015 (article behind paywall). His conclusion is that the required tax increase would cause “a permanent loss of nearly 3 percent of GDP”.

The main reason why the deficit and debt projections should of concern to Australians is that they imply that our grandchildren will have to pay a high cost for government spending that is primarily for the benefit of the current generation. I doubt whether many people would be keen to have the government spend so much money on them if they were aware that for every $1.00 of benefit they receive, their grandchildren would be likely to have to pay about $1.40 plus interest.