1. Long term public spending trends* John Hawksworth Head of Macroeconomics PricewaterhouseCoopers March 2006 *connectedthinking

2. PricewaterhouseCoopers LLP 6 March 2006 Agenda Methodology and key assumptions Total public spending projections Focus on health spending Summary and conclusions

3. PricewaterhouseCoopers LLP 6 March 2006 How do you project long-term public spending as % of GDP? Start with GAD population projections in five year age bands Assume trend labour productivity growth = 2% per annum Assume plausible path for employment rates by age band/gender Derive implied trend GDP growth profile (c.2.25% pa to 2014/15; then c.2% per annum on average over next 40 years) Input estimates of spending as % of GDP per capita in base year for health, long-term care and education by age band Make plausible assumptions on trend real growth in unit costs for each of these three spending categories (c.2.5%/2%/2%) Use separate model to project state pension costs

4. PricewaterhouseCoopers LLP 6 March 2006 Summary of long term PwC age-related public spending projections % of GDP Source: PwC main scenario projections (except Treasury for public service pensions)

5. PricewaterhouseCoopers LLP 6 March 2006 Comparison of long term PwC and HM Treasury public spending projections % of GDP Source: PwC main scenario projections using Treasury projections for public service pensions and other spending, Treasury long-term public finance report 2005

6. PricewaterhouseCoopers LLP 6 March 2006 PwC and HMT projections very similar except for health spending (though even there trends are broadly comparable) % of GDP Source: PwC main scenario, HMT long-term public finance report Note: education spending projections are very similar

7. PricewaterhouseCoopers LLP 6 March 2006 Recent projections for UK public spending on pensions, health and long-term care % of GDP increase over period shown Health and long term care only Pensions, health and long-term care Treasury (Dec 2005): 2004/5 to 2054/55 +3.3+5.5 PwC (March 2006): 2004/5 to 2054/55 +4.7+6.8 OECD (Feb 2006): 2005 to 2050 +2.8-5.6*N/A EU EPC (Feb 2006): 2004 to 2050 +2.6+4.6 *Two OECD scenarios: cost containment and cost pressures

8. PricewaterhouseCoopers LLP 6 March 2006 What drives NHS spending in long run? Any additional catch-up over next 5 years (Wanless: 4.4-5.6% real growth; we assume bottom end of this range) Pure age effects - more older people -> higher costs (survivors) Number of deaths -> change in death-related costs Offset from healthy ageing -> perhaps c.50% of pure age costs Non-demographic factors: - Income elasticity of demand > 1 (superior good) - Technological advances and relative price effects

9. PricewaterhouseCoopers LLP 6 March 2006 NHS spending as a share of national income: 1949/50 to 2004/5 Source: PwC calculations based on data from ONS, Department of Health and IFS Gross spending (% of GDP)

10. PricewaterhouseCoopers LLP 6 March 2006 Decomposing UK public health spending growth: 1981-2002 (% average real growth per capita per annum) Total UK public health spending growth per capita: 3.4% of which: Age effect: 0.2% Income effect: 2.3%* Other effects (residual): 0.9% Source: OECD (2006, Table 2.1) *Assuming income elasticity of health spending = 1

11. PricewaterhouseCoopers LLP 6 March 2006 Age distribution of NHS spending (estimates for 2004/5) % of GDP per capita Source: PwC assumptions based on UK government estimates for 2000 in EPC report scaled up to 2004/5 values to match gross NHS spending plans *Includes cost of births

12. PricewaterhouseCoopers LLP 6 March 2006 Alternative estimates of age structure effects on future NHS spending – may be significantly greater than historic effects Change relative to base year* (% of GDP) Source: PwC, OECD (2006), EPC(2006); OECD figures exclude adjustment for healthy ageing *Base year is 2004/5 for PwC, 2005 for OECD and 2004 for EPC; EPC estimate for 2025 is based on extrapolating between 2010 and 2030 estimates.

13. PricewaterhouseCoopers LLP 6 March 2006 Estimated elasticity of UK health care spending per capita to GDP per capita 1992-20021982-20021972-2002 Total health spending 1.391.491.73 Public health spending only 1.331.401.63 Source: OECD Health Data 2005 Our base case assumption: income elasticity = 1.2 HM Treasury assumption: income elasticity = 1

14. PricewaterhouseCoopers LLP 6 March 2006 Alternative estimates of income effects on NHS spending Change relative to 2004/5 level (% of GDP) Source: PwC estimates with income elasticities in a range of 1.1-1.3

15. PricewaterhouseCoopers LLP 6 March 2006 What drives NHS spending growth in our main scenario? Total projected increase by 2054/55: +4.1% of GDP of which: Catch up effect by 2012/13: +1.1% of GDP Ageing effect after health adjustment: +1.3% of GDP Income elasticity/other effects: +1.7% of GDP

16. PricewaterhouseCoopers LLP 6 March 2006 Alternative PwC composite scenarios for total NHS spending % of GDP Source: PwC projections starting from HM Treasury estimate for 2004/5

17. PricewaterhouseCoopers LLP 6 March 2006 Alternative PwC scenarios for total NHS spending vs Treasury projections % of GDP Source: PwC projections starting from HM Treasury estimate for 2004/5

18. PricewaterhouseCoopers LLP 6 March 2006 Summary and key issues PwC and Treasury projections similar apart from NHS spending - explained by our inclusion of non-demographic cost pressures But: both sets of projections see rise in total public spending to around 45-47% of GDP by 2054/55 (c.42% at present) Higher longevity might increase this; higher employment rates or healthier lifestyles might reduce the pressure on future taxpayers Raises issues as to: - Potential pressure on NHS model if unit costs rise in line with historic trends: how can these cost pressures be mitigated? - Are there other major areas of public spending that can be reduced as a share of GDP? - Balance between private and public spending?