The economics of Medicare co-payments

It seems likely that the Federal Budget will introduce a $6 charge for visiting the GP when bulk billing is the way the GP is paid. In other words the patient hands over $6 when they visit.

The aim of the measure is to reduce the cost of Medicare to the government. There are two reasons the government want to do this:

1. To reduce expenditure and so reduce the budget deficit.
2. To offset rising Medicare expenditure.

The second reason is the one which needs explaining. As the population of Australia gets older on average there will be greater calls on medical services. Old people get ill more often and medical science finds more and more ways to keep people alive. That's great for the people, but expensive for Medicare.

The problem with free GP visits is that some of them are not necessary, or benefit the patient little. The aim of the co-payment is not so much to raise money as to cut out some of these visits.

The diagram shows the demand for GP visits. When there is no charge to visit the GP then there will be 0C visits. 

The problem is the cost of providing the GP service for all visits over 0D is greater than the benefit gained. (The benefit may be gained by the patient or society as a whole.) 

For simplicity I am assuming all GP visits cost the same amount. The benefits of each visit vary, some contain infectious diseases and save lives, however some might simply need the advice of a pharmacist and add little benefit.

The GP visits D to C cost the Medicare system ABCD (price x quantity) to provide, but only benefit society by the amount ACD. 

So the logic of the co-payment is this. By introducing the $6 charge E to C visits are perceived by the patient to be not worth the expense. The patients lose the benefit FEC. However the government save the cost GBEC, a substantially greater saving for the benefit lost.

The drawbacks of the co-payment system are obvious. here are just two:

1. The system is regressive. As the lowest paid will pay the same as the best paid the $6 represents a higher percentage of their income. This affects the goal of equality.

2. As health care is an imperfect information good patients are not well placed to decide if going to the doctor is a sensible thing. Some will keep the $6 and miss the chance of the early diagnosis and treatment of a serious illness.

The Sydney Morning Herald has a piece here on the proposal.

Hockey's case on economy shown to be politics, not economics

Andrew Neil, a right wing journalist from the UK, interviewed Joe Hockey last week. here are a couple of Youtube clips about the interview.

Hockey does not generally submit to interviews and comes off very badly when pressed by Neil, one of a number of top class interviewers in the UK known for getting answers out of people. Hockey's media people obviously didn't know about the trick of having the interviewers microphone set louder than the interviewee!

Neil establishes that Australia is doing better than any other G20 country and that it is difficult to justify claims of a crisis.

The first clip here

On Lateline later Neil answered questions and gives some credit to the Treasurer's case but still puts it into context. He moves away from the Budget as the interview continues.

Lateline clip here

'Final' Direct Action plans published

The government have published their final White Paper on how Direct Action will replace the Carbon Tax.

The idea of direct action is that companies will 'bid' for contracts that will allow them to introduce measures to reduce carbon emissions. The government claim that they will meet the 5% reduction target in carbon emissions by 2020 as a result.

Very few people have any confidence that this new scheme will work. Economists have a very clear view on the effectiveness of various schemes to reduce negative externalities.

BEST

Permit trading schemes

Tax

Regulation

Nothing

WORST

The Direct Action scheme counts as regulation. Perhaps the kindest thing that can be said about it is that it is better than nothing.

The problem of regulation is that it relies on somebody deciding the amount of reduction and/or the budget for the regulation. Neither will be necessarily the optimal (allocatively efficient) amount and are likely to be restricted by both budgets and political constraints.

The advantage of both tax and trading schemes is that they rely on the market and can be managed so that the economy adjusts to the socially optimal position. Both have the weakness that negative externalities must be well understood to achieve their goal. 

However trading schemes have the huge advantage of allowing the cheapest possible reduction in negative externalities. By this standard Direct Action comes a very poor third in reducing carbon emissions.

The Guardian outlines the practical problems of the proposed Direct Plan here.

Better than expected inflation figure triggers significant reaction

Inflation is reported to be at 2.9% on the headline rate and 2.7% on the underlying rate. This is less than expected and has been a cause for relief for the RBA.

The RBA have a target range of 2 to 3% inflation. The widespread expectation was that headline inflation would rise to about 3.2% for the quarter to March and that this would cause the central bank to raise interest rates from their current low to reduce inflation.

The relief is on two counts.
1. A rise in interest rates would cause lower discretionary income for households and reduce Consumption. Also it would reduce Investment by firms which are sensitive to the cost of borrowing. Both are components of Aggregate Demand.

2. The exchange rate would likely rise as interest rates rose (Australia already has very high interest rates compared to the other industrialised economies). This would make exports more expensive and imports cheaper and stifle the export led growth on which much relies.

The news led to a sharp fall in the value of the Aus$ (by around 0.75 cents against the US$). This was due to traders lowering their expectations on the possibility of a rate rise.

It is well worth looking at the ABS statistics which can be accessed in the links section (key data). 

The likelihood is that rates will stay on hold for the rest of the year. This is good as business and consumers like stability. It gives them confidence and they can plan their next moves.

It is, however, unlikely that even 3.2% inflation would be the cause of a rise in rates. The RBA knows that it takes two years for interest rate changes to work through the economy to reduce inflation. They will be looking at the longer term forces affecting inflation over those two years when deciding on interest rate changes. So rates may rise anyway!

Signpost to 2014 budget

The Treasurer, Joe hockey, spoke last night about likely measures in the 2014 budget and his vision of the future for public finances.

The Budget is a major issue for the exam and understanding the philosophy of the budget measures is important. His speech last night gave important clues to this and it is useful to get a head start on that before the mind-numbing detail of the actual budget itself.

Hockey is concerned that government spending is growing in an unsustainable way and that this will lead to a growing structural budget deficit in the future. It's simple, if spending always grows faster than revenue then this will happen.

Note that most countries are envious of Australia's public finances. Australia has a low level of public debt and a low borrowing requirement as a share of GDP compared with other developed countries. 

That isn't what Hockey is worried about despite his attempt to persuade people there is a 'Budget crisis'. That's just politics.

Hockey is worried that unless the projected rise in spending is brought down then taxes will have to rise in the future to balance the budget.

He may be right. Australia's public spending rises by about 3.75% a year. If growth is less than 3.75% and tax rates stay the same then the budget deficit will widen. 

Some question the need to act drastically now. Growth could easily exceed 3.75% and 'bracket creep' would actually raise tax revenues faster than that. Government's would however be foolish to rely on that rate of growth.

Actually what Hockey is saying is that the growth years are over for Australia. Australia is a low productivity, high cost developed country which has lived off natural resource income while the comparative situation got worse. He also knows that an ageing population is going to put more strain on welfare spending over the next few decades. He is saying 'Winter is coming'.

The Age covers his speech here

"Stop using fossil fuels" - IPCC

The IPCC have published their findings on what must be done to prevent the worst effects of climate change. They say the worst polluting fossil fuels must stop being used as soon as possible and renewable energy used instead.

What this really means is that fuels like brown coal, the dirtiest fuel, should be replaced with new capacity built in renewable energy such as wind and solar. They warn that if carbon emissions are not reduced radically by 2050 then it will be necessary to move into 'negative carbon emissions' after that.

They suggest that if action is taken now the cost will be small. They estimate about 0.1% of GDP per year. Whatever is done energy will cost more than it does today and, frankly, people will just have to suck it up.

Renewable energy is more expensive than energy from fossil fuel. However the external costs of using fossil fuel far outweigh the additional private costs of switching to renewable fuel. The problem is that the external costs fall on future generations and this allows climate criminals, such as the idiot Abbot, to use cheap debating tricks to convince people that there is no need to take urgent action on this matter for short-term political gain.

On the bright side the IPCC point out that there are more immediate external benefits of moving away from fossil fuels. These are all due to lower pollution levels and so better health. 

Australia is so far behind the rest of the world on this matter it is difficult to imagine any leadership on this issue. Carbon pricing remains the most efficient way to tackle the problem and nuclear energy the most obvious short-term replacement for fossil fuels. The rest of the world will have to wait until after the next election for any help from Australia.

The Guardian covers the story here

Australia taking a step backwards - IPCC here

The Standard of Living

Pretty much everything in VCE Economics comes back to the standard of living. What this means is a difficult thing to pin down.

What we do know is:
* GDP alone is a poor indicator.
* Real GDP per capita using PPP is a much better one, but misses critical issues.
* The Human Development Index includes important additional factors and can be used to compare and monitor changing living standards.

However there isn't a perfect measure as non-material living standards are very difficult to measure and very different across nations.

The Social Progress Index tries to monitor living standards using a wide range of indicators. Australia still does well, but comes 10th (rather than 2nd in some HDI rankings). The 2014 data is linked below and it is well worth a look to try and grasp what standard of living really means and what can affect it.

Social progress imperative website is here

When is free trade not free trade?

Australia has 'concluded a free trade deal with Japan' and will sign another one with South Korea in the next two days. This is an important step forward, but isn't properly free trade.

In the eighteenth century Adam Smith, and in the nineteenth David Ricardo, showed that everybody gains from free trade. Economists have accepted this ever since. It is therefore astounding that any country retains barriers to trade in the twentyfirst century. However some do and so do Australia and Japan after this deal.

There is abolition of tariffs on some goods. Cars from Japan to Australia, for example, will fall from a 5% tariff to zero. But not necessarily all at once. Other tariffs are merely reduced, such as the tariff on beef from Australia to Japan, which was an eyewateringly high 38.5%  will be halved. A 19.5% tax is still huge as a barrier to trade.

Tariffs are not the only barrier to trade. Quota's used to be a popular way to reduce trade and the new deal allows an additional 20,000 tonnes of Australian cheese to be exported to Japan. Another popular barrier to trade is to extol the benefits of local products. Australia is a master of this is their 'Australian owned' or 'Australian made' propaganda.

The simple fact of the matter is that all trade barriers harm the standard of living of countries. What protection (or economic nationalism as it is often called today) does is raise the prices paid by consumers and protects inefficient domestic producers from competition. Competition forces down costs and promotes allocative and technical (productive) efficiency.

Australia suffers more than most developed countries from the protectionist fallacy. People buy into the idea that local jobs are 'saved' by it. All protection can do is delay the inevitable and, usually, when the trade barriers are removed the domestic industry is so hopelessly inefficient it closes. Ask Ford, Holden and Toyota if you need proof of this.

The ABC covers the trade deal here

Time to start the debate on tax?

The government worries about the size of the budget deficit and is going to take steps in the Budget to fix that. The problem is that short term changes won't fix a long term structural problem.

There are two ways to balance a budget.
1. Cut government spending
2. Raise more revenue through taxes.

Let us suppose that over time a government aims to balance its budget. That is it spends as much as it raises so there is no net addition to the national debt.

This does not mean that in each financial year the government will balance its budget. It actually means in years of low economic activity they will borrow (to boost the level of national output) and in the years at the top of the economic cycle they will run a surplus to repay debt. The result is a balanced budget over the economic cycle.

The problem for Australia is that they are borrowing in most years, resulting in a budget deficit over the economic cycle (known as a structural budget deficit). Although as the chart below shows Australia has no real debt problem compared to other nations.

Australia does not tax its citizens much either when compared to other developed countries (26.5% of GDP compared to an OECD average of 34.1% in 2012). It also has a fantastically complicated tax system which sees most people getting tax rebates each year.

A solution is to expand the tax base by taxing more things and doing this in a simple, non-refundable way. That is by taxing spending, not income. In Australia this is done by using the Goods and Services Tax (GST).

There are two ways the GST can raise more money.
1. Put the rate up from 10%.
2. Extend the range of goods and services GST is applied to.

The advantages of GST are that it is pretty difficult to avoid, so raises a lot on money and is simple to administer.

The disadvantage is that it is a regressive tax. The poor pay a higher proportion of their income in GST than the rich. It is not as easy to compensate the poorer households for this (while it is easy for income tax) and so it adversely affects the goal of a equity in the distribution of income.

Martin Parkinson, the Treasury Secretary spoke about this possibility yesterday here