Professor Michael McMahon:

The council is grateful to the Chair and members of the committee for inviting us to appear before them again. As they know, we value these engagements and see them as an integral part of our work. This meeting in particular is a welcome opportunity to discuss how existing levels of service, ELS, costs are formed, how they differ from our own stand-still costs and why estimating such costs is so important for fiscal budgeting. We know the committee is interested in how the calculations work and how the costs are expected to evolve. We are happy to shed some light on this. As the Cathaoirleach said, I am joined by Mr. Killian Carroll and Dr. Eddie Casey. I will defer to them for some of the questions in the weeds. I also apologise to the committee for the slightly longer than usual opening statement, but we felt it was useful to get quite a lot down on the page first of all. I will get through it as quickly as I can.

First, I want to make a few general points about why this work is important. Understanding the costs of maintaining existing public supports and services is an essential starting point to the budget. It tells us the cost of continuing to do what we are already doing. We label this the stand-still cost, the cost of standing still. In other words, it is a matter of just maintaining what you already do. In health, for instance, this entails maintaining the same number of doctors or nurses per patient, paying them the same relative wages, administering the same drugs, all while reflecting a larger and older population. For a long time, Irish budgets have focused primarily on the new things we can do with each budget day package. This focus made more sense in a time when price inflation was relatively low and demographic pressures were less pronounced. However, Ireland has recently had to grapple with increased price pressures in the wake of the pandemic and the war in Ukraine. As well as that, demographic pressures are coming to bear more and more as Ireland’s population ages quickly. These two factors magnify stand-still costs.

Understanding stand-still costs, as I said, is essential to good budgeting. The pressures are in some senses unavoidable and so should be planned for. Accounting for them properly can give policymakers a more accurate sense of what space is left over for new measures. The council has been providing estimates of stand-still costs for over five years now. The approach involves a few steps. First, we develop projections of population changes and ageing to assess demographic pressures. These draw on a pretty standard cohort component method. Second, we use macroeconomic forecasts to assess price and wage pressures, as well as other macro changes. Third, we combine these inputs through a cell-based macro simulation to estimate expenditure changes.

There are a few caveats, as with all forecasting, in relation to stand-still costs. The approach does not consider possible efficiency gains or policy changes that could generate savings. The focus is on current spending, although capital spending also faces pressures from prices and population growth. It is purely a planning input. We are not advocating indexation as a policy, merely showing its likely costs. When we do it, we assume public sector pay rises in line with the general economy unless there is a public sector pay deal in place. This assumption implies the public sector is neither better nor worse off relative to the private sector. Finally, we work hard to identify appropriate population cohorts and price drivers to model how spending will evolve. This draws on assessments of historical trends.

The official ELS estimates are calculated in a way that is a little bit different. The term “ELS” has been used for years, well before Covid-19. It is in the summer economic statement from 2018, for instance. Typically, ELS was used to refer to the costs of maintaining services just one year ahead. This would take account of demographics, price pressures and other macroeconomic factors, like unemployment. While one-year ahead calculations can be quite detailed, ELS calculations for further ahead typically are not. The summer economic statement in 2021 introduced a simple 3% assumption for two years ahead and beyond, that is, the estimated cost of maintaining existing levels of service was estimated as being equivalent to 3% of existing spending. The 3% figure itself was based on an assessment of typical pressures arising in historical budgets. This remains a rule of thumb for costs facing the Government in the years after the budget year.

Looking to next year, 2024, the Department estimated ELS costs to be €1.8 billion, or 2.4% of the core current expenditure base. These costs do not factor in the costs associated with a potential public sector pay deal for 2024, which is typically included in ELS costs, although there remains €0.85 billion unallocated current expenditure for 2024 and this will likely be used to fund any pay deal.

Looking further ahead, the Department assumes ELS costs equivalent to 3% of current spending, which means €2.4 billion in 2025 and €2.5 billion in 2026. The Council’s stand-still estimate for 2024 was €4.5 billion and averages close to €5 billion annually for 2025 and 2026. Of this, demographics are €1.7 billion and price and wage pressures are €3.4 billion. As inflation recedes, stand-still costs average €4.6 billion from 2027 to 2030. Unlike the ELS calculations, these specifically look at demographics, the costs of maintaining welfare rates and public sector pay in line with general wage growth and the cost of other inflationary pressures. They also maintain Ukrainian supports and Covid-19 spending.

I will now talk a little bit about health in particular. In the lead-up to budget 2024, there was widespread coverage of potential health overruns. Despite this, the budget 2024 allocation for health was less than the expected 2023 overrun, plus the estimated stand-still costs for 2024.

Budget 2024 provided an increase of €0.8 billion for core current health spending in 2024. Of this, €0.7 billion was to maintain the existing level of service. This is less than the council’s stand-still estimate for 2024 of €1.1 billion, of which €0.8 billion is for demographics and €0.3 billion is for higher prices. A potential public sector pay deal would add to this, but there are some unallocated funds to cover it.

It is possible that non-core spending related to Covid-19 within the health Vote could be used to cover ELS costs. If so, this would bring the health allocations to just €0.1 billion shy of the council’s stand-still estimates as the Covid amounts for health are set to increase by €0.3 billion in 2024.

As well as the gap to stand-still costs, there is a possible overrun in 2023 that will raise the overall level of health spending. Health spending was running €0.6 billion ahead of forecasts going into the budget. Once overruns occur, it is important that a detailed assessment be carried out. This should involve assessing the factors driving recent overruns to highlight where ELS costs have been underestimated. Failing this risks repeating the overruns.

It is also important that budgets take a forward-looking approach. The ELS’s 3% assumption is based on Ireland’s historical experience. However, this is not necessarily a good guide to what we can expect in future. The population is ageing rapidly and price pressures may continue to remain higher than historical levels over the next few years. As such, these pressures may well be more significant than we experienced in the past.

A part of the problem facing healthcare spending is not new. In 2021, the council published research showing that health overruns had been a feature of Ireland’s experience for a considerable number of years, making up more than half of total annual spending overruns. Health overruns averaged €590 million annually from 2015 to 2019, with €260 million due to hospitals and €148 million due to community primary care services. About two thirds was pay related or staffing related.

The overruns will not be surprising. What might surprise is that our 2021 analysis suggested they are fairly predictable. In other words, the size of the overruns corresponded closely to the additional amounts that would have been needed to stand still. Simply allowing for stand-still costs in full would have been broadly sufficient to cover both the planned allocations and the overruns eventually seen.

Part of the problem seems to be that hospital and primary care budgets are often set very tight, maybe with the hope that efficiencies will be generated. This might have had more merit if it had a record of producing savings or preventing overruns. Instead, providing limited budget increases in big spending areas appears to have set the scene for spending overruns. This looks like a failure of planning, coupled with wishful thinking.

What economists call a “soft budget constraint” seems to have taken hold. Managers know overruns will be financed, so there is little incentive to stick to ceilings and create efficiencies. That is not to say healthcare spending cannot be made more efficient. Ireland ranks as a high spender on health internationally, even with a relatively young population today. This is particularly evident for outpatient services – daily hospital services excluding overnight or longer-term hospitalisations. However, Ireland has had more average spending on capital areas and still has a middling rank when it comes to its health infrastructure.

Staff planning could be far better. The HSE’s pay-and-numbers strategy is meant to give detailed information on the number of staff to be hired; yet this is often submitted at the end of the year in question or, at the earliest, in February of the same year.

Spending on an older population is likely to continue to grow. The number aged over 65 will more than double by 2050. Over-65s are also expected to live three years longer on average by then. This means more pressure by way of annual increases for healthcare and pensions just to stand still. The council’s long-term projections suggest annual public spending related to ageing will rise by 4.8 percentage points of GNI* between 2023 and 2050 – about €14 billion in today’s money.

To address these challenges, healthcare spending forecasts need to be more realistic and developed earlier. That means taking account of long-term demographics, price pressures and increased demands as people’s incomes rise.

More generally, if we realistically wish to generate savings in health, a more strategic approach is needed. This might involve a larger-scale review of health spending independently led and supported by IGEES economists. It would not need to be driven by an overarching objective to cut pay or staff numbers, but to find savings and to develop more effective ways of using the same staff and resources, hence making for a better work environment.

Good fiscal decision-making requires good budgeting, which, crucially, involves understanding the costs of maintaining existing public supports and services as an essential starting point. We thank the committee for hearing us out, particularly given the longer opening statement, and for the opportunity to discuss this aspect of Irish fiscal policy. We look forward to answering members’ questions.