What is the hospital funding agreement politicians are talking about today?

National Cabinet meets today to discuss three big issues in Commonwealth-state financial relations: GST allocation, National Disability Insurance Scheme (NDIS) funding, and a Commonwealth government proposal to kick-start negotiations on a new National Health Reform Agreement, to take effect in July 2025.

So what is the reform agreement? What are the chances it could result in better access to hospital care when Australians need it? And what does the GST have to do with it?

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What is the reform agreement?

State and territory governments are responsible for running public hospitals, but about 40% of public hospital funding comes from the Commonwealth government.

The National Health Reform Agreement is front and centre of any discussion about health funding. Negotiated every five years or so, it was originally designed to:

• increase the Commonwealth’s share of public hospital funding
• introduce more transparency about how states spend this extra Commonwealth funding
• drive efficiency in public hospital care.

Its performance on all three objectives has been mixed.

Efficiency initially improved, but there has been back sliding and, even in the pre-COVID years, the average cost of a public hospital admission increased faster than inflation.

Transparency has been a double-edged sword, causing a heightened focus on the agreement and its formula, but de-emphasising the broader GST context.

The previous Commonwealth Liberal government reduced the planned increase in the Commonwealth share of public hospital funding in its first budget, and its share has now declined to 41%.

Tight state budgets and increasing costs per patient mean hospitals’ capacity has not expanded in line with population growth, resulting in poorer access and longer waiting times.

Working out the Commonwealth’s fair share

Under the National Health Reform Agreement, total Commonwealth funding to the states collectively will increase in line with total public hospital “activity” growth across all states.

“Activity” includes hospital admissions and outpatient activity (seeing a specialist in an outpatient clinic, for example) and is measured in “activity units” with a “national efficient price”. The price for each unit is currently set at $6,032.

The current formula is that the Commonwealth funds 45% of the costs of increases in hospital admissions, emergency department visits or outpatient attendances but only paid at the “national efficient price”. Total Commonwealth funding growth is capped at 6.5% each year.

But it’s often misunderstood

Many commentators and government officials assume the same model applies for funding to each state. It doesn’t. Funding to each state is determined by a separate process (which we’ll get to in a moment).

This false assumption about the way the National Health Reform Agreement works for each state leads to complaints the agreement constrains good policy initiatives, rewards “volume not value” and encourages unnecessary hospitalisations.

Worse, it allows states to blame the agreement for their own mismanagement of their hospitals.

And it encourages fruitless discussions between Commonwealth and state officials about “reform projects” that typically go nowhere but can be used by politicians to hoodwink the public that big issues in the health sector are being addressed.

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How funding to the states is really allocated

Funding from the Commonwealth to the states must be considered at two levels: the National Health Reform Agreement and the GST.

If you look at the national health funding body’s website, you can see tables purporting to show how Commonwealth funding is allocated to health services across Australia, down to the last dollar. This reflects the transparency objective of the National Health Reform Agreement.

These numbers are real. The dollars reported actually end up in state bank accounts.

However, the big picture is somewhat different, and this is where the GST comes in.

Money collected through the GST is allocated among the states based on need. The aim is to ensure each state has the capacity “to provide services and the associated infrastructure at the same standard”.

An independent body, the Commonwealth Grants Commission, assesses need, including the need for public hospital spending by states. It also assesses how states can raise money through taxes to meet their needs.

A state’s GST allocation is based on the gap between its spending needs and its assessed revenue raising capacity.

Importantly, most Commonwealth grants, including the National Health Reform Agreement, are taken into account by the Grants Commission in a similar way to how it assesses the state’s ability to raise payroll tax or stamp duty.

The result is that a state’s funding under the National Health Reform Agreement is effectively reallocated back to the state, with a lag, not in line with the agreement’s formula, but rather in line with the GST formula (this is essentially based on the state’s population, weighted for factors such as age, the proportion living in remote locations, and the proportion of First Nations Australians).

The National Health Reform Agreement formula, although impressively precise, is somewhat of a fiction, providing a funding flow which is effectively overridden a few years later.

The reality therefore is that the principal impact of the National Health Reform Agreement is to determine the total national contribution the Commonwealth makes to public hospitals.

However, because states often assume the National Health Reform Agreement formula is real, it has a life of its own which can shape the health and hospital system for good or ill.

What to watch for out of National Cabinet

The entrails of today’s National Cabinet decision need to be examined carefully. The words may obscure what is really happening, but there are two factors to look for.

Most importantly, will the 6.5% cap be increased? If so, by how much? This determines the total amount of money the Commonwealth might be required to pay states.

And what will states commit to in exchange for any increase in the Commonwealth’s potential spending? A commitment to work together (and share spending) on NDIS reform may be on the cards here.

Funding commitments for specific “reform projects” send signals about what governments collectively think are important issues in the public hospital system such as joint commitments to improve efficiency or to expand access to digital services, such as telehealth.

For patients, an increase in the Commonwealth share and in the cap, provided it is coupled with tighter accountability for access (such as commitments to reducing waiting times for planned procedures), could lead to a much improved public hospital system.

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