Remind me again, what's the problem with hospital funding?

State and territory leaders will meet in Sydney today to nut out solutions to health and education funding gaps. New South Wales Premier Mike Baird will again call for the GST to increase to 15%, while Victorian Premier Daniel Andrews will recommend increasing the Medicare levy to cover the shortfall.

Treasurer Joe Hockey is expected to propose the states take full responsibility for funding public hospitals if the GST does indeed rise.

But what exactly is the problem the leaders are trying to address? And how did we get into this mess?

First, let’s go back to last year’s budget, when the issue came to a head. As health economist Stephen Duckett neatly summarised on The Conversation,

The 2014-15 budget took an axe to Commonwealth payments to the states for health care. It abruptly terminated grants to states under the ironically named National Partnership Agreements, and, from 2017, sliced more than $1 billion a year from public hospital grants through reduced indexation.

Commonwealth funding cuts to hospitals

Last year’s budget cut billions of dollars of hospital funding, due to take effect from 2017-18. It also removed funding guarantees for public hospitals.Budget 2014-15

So, the Abbott government modified the agreements the Rudd-Gillard government transacted with the states and territories to assist with funding growth.

The federal contribution to the states and territories remains a key source of funding, but indexed growth funding is to be cut from 2017. This puts more pressure on the states and territories to meet the growing cost of health care.

Health costs

Australia spent about A$140 billion on health care in 2011-2012. That’s about A$6,000 per person each year. Hospital care accounted for nearly 40% (A$53 billion) and medical care in the community cost nearly A$10 billion. Medications cost almost A$19 billion.

The reason hospital costs are of outstanding importance to the states is that, unlike general practice and medications, they pay for them. Of the A$53.5 billion hospital services (both public and private) received in 2011-12, the state and territory governments paid 42.8%, while the Commonwealth contributed 36.5%. Non-government sources provided the remaining 20.7%.

And the cost of funding hospitals is rising, as you can see by this chart.

State contributions for all health care rose from 23.2% to 27.3% from 2001-2002 to 2011-2012, while Commonwealth contributions fell from 44.0% to 42.4%. It is a continuation of this trend of less Commonwealth/more state and territory contributions – and the risk that hospitals will swallow more of the state budgets – that irks the premiers.

Ratio of health expenditure to tax revenue%

The proportion of tax revenue states and territories spend on health is increasing, while the proportion the Commonwealth spends is decreasing.AIHW.

Premiers are also concerned about the trajectory of growth: Australian Institute of Health and Welfare modelling from 2008 projected that annual hospital expenditure would more than double from 2012-13 to 2032-22, from A$36 to A$81 billion.

Why are health costs rising?

When considering rising health-care costs, it’s important to note that dollars spent may simply reflect growing prosperity. With more money to spend it is hardly surprising that we devote more to health care. Indeed, health care is a “superior” good, meaning there is no natural upper limit to our investment, as there may be for “normal” goods such as food.

As the Australian Institute of Health and Welfare explains:

health expenditure tends to correlate with increased revenue more strongly than [with] increased demand for health services.

So the proportion of our expenditure on health may rise as our aspirations grow, partly driven by an awareness of what new technology can do to ease and prolong our lives. This has been the pattern for years within OECD countries.

But this doesn’t remove the difficulty the states and territories face in raising revenue to meet the demand of rising expectations from an expanding and ageing population and reduced contributions from the Commonwealth.

The problem is probably not as dire as it has been portrayed, but we may as a nation choose to cut our cloth differently. If we wish to increase the state and territory contribution to hospital costs, states and territories will need to generate the necessary revenue. This is where the debate moves into the territory of changes to the taxation system and the agenda of today’s leaders' summit.

Stephen Leeder does not work for, consult, own shares in or receive funding from any company or organization that would benefit from this article, and has disclosed no relevant affiliations beyond the academic appointment above.