Fiscally fixing health and Medicare means state income taxes

The old business adage warns there is no such thing as a free lunch. And the same applies when it comes to health policy: the notion we can make Australia’s ‘free’ health system sustainable by funding public hospitals on an ‘efficient’ activity-basis is a myth.

Under  the Gillard government’s 2011 ‘National Partnership’ funding formula, the states agreed to a national system of activity-based funding that remunerates public hospitals for each occasion of service they deliver at the so-called ‘national efficient price’ (based on average costs across public hospitals nationally).

The very notion of a national efficient price is a contradiction in terms. Its impact on the unit-cost of care is biased by less efficient hospitals and distorted by the impact of the restrictive workforce practices that are legion in all public hospitals.

Nevertheless, the focus on efficiency is understandable. In all jurisdictions, health consumes around a third of state budgets, and public hospitals account for around two-thirds of their total health spending. Since the start of Medicare in 1984, the unfulfillable promise of ‘free’, universal public hospital care has imposed increasingly onerous burdens on over-stretched state finances.

Activity-based funding, which was first introduced in Victoria in 1993, was developed as a panacea for the inherent, unsolvable problem posed by a ‘free’ hospital system — the growing disparity between public hospital capacity and the demand for ‘free’ services.

To the extent that activity-based funding encourages hospitals to increase productivity and attain at least average levels of efficiency, it can help reduce treatment waiting times and lower the overall cost of hospital services to governments.

However, it cannot eliminate the rationing of access to services by waiting lists, emergency queues, hospital bed cuts, and budget caps. These remain integral features of all state health systems and are essential to contain the potentially unlimited cost of ‘free’ hospital care.

Moreover, activity-based funding spurs hospitals to treat more patients. Higher service volumes could potentially further increase the total cost of hospital services ¾ even if funded at supposedly efficient prices ¾ and thereby increase the need to contain costs by rationing access to services.

It is too early to make a call about the impact of the national activity-based funding system on the cost of public hospital care.

The Australian Institute of Health and Welfare has declined to publish figures for spending growth due to lack of year-to-year consistency in the data for recurrent real public hospital expenditure growth over the past five years.

But even if reliable expenditure growth figures were available, any apparent impact of the new activity-based funding system on the overall cost of hospital services is confounded by ‘known unknowns’: the impact on hospital expenditure of concurrent rationing necessitated by activity-based funding increasing throughput of patients.

The bottom line is that activity-based funding is no answer for the unaffordable cost of ‘free’ public hospital care in an ageing Australia.

The Abbott government recognised this when it scrapped the unaffordable Gillard funding deal in the 2014 budget, avoiding thes $26 billion increase of federal hospital funding from 2013-14’s $14 billion  to $40 billion in 2024-25.

This has since been reversed by the Turnbull government, which has temporarily restored the Abbott ‘cuts’ to hospital funding — but only until 2020.

With this deadline looming, it is time to confront the undeniable: the fundamental unsustainability of a ‘free’ hospital system.

Instead of the states’ usual cap-in-hand approach to the federal government, seeking a non-existent money tree to fund health services, they need to address their problems in health from first principles.

The reality is that states do not have sufficient sources of revenue from the current division of tax powers under the federation to ever hope to meet their health and other responsibilities into the future.

A realistic path towards a state income tax therefore needs to be on the table in the forthcoming COAG negotiations over health.

A state income tax would kill two birds with one stone.

Winning their fiscal freedom would also release states from their obligations under Medicare. They would no longer be forced to provide public hospital services for ‘free’ as a condition for receiving federal health funding.

This would allow states to introduce a policy that will ultimately control the demand for, and cost of, public hospital services: patient cost-sharing in the form of a compulsory co-payment for public hospital treatment.

David Gadiel is a Senior Fellow and Jeremy Sammut is Director of the Health Innovations Program at The Centre for Independent Studies. Their report is Medi-Mess: Rational Federalism and Patient-Cost Sharing for Public Hospital Sustainability in Australia.