How does the Covid-19 economic crisis affect health financing and what are the implications for future health budgets?

Cross-Country Analysis

How does the Covid-19 economic crisis affect health financing and what are the implications for future health budgets?

The Covid-19 pandemic evolved rapidly from a health crisis into an economic crisis in most countries around the world.

This raises important questions about the implications for health financing, now and in future years. This brief snapshot provides a review of available, internationally comparable data in an effort to shed light on how the Covid-19 crisis has affected European economies and what the likely effects will be for different health financing systems. The primary focus is on data from Q2 2020 since this covers the first wave in most European countries.

This policy snapshot builds on the Observatory’s Covid-19 webinar on ‘Covid-19 and the sustainability of health financing: anticipated effects and policy options’ (9 February 2021), which is available on Youtube.

To begin, it is important to recognize that the majority of health financing in European countries comes from public sources. According to the World Health Organization (WHO) Global Health Expenditure Database, the median country in the WHO European region spent approximately 70% of current spending from public sources in 2018. However that public spending is generated in different ways in each country. As shown in Figure 1, countries rely on a mix of taxes and social contributions to finance health spending by the public sector. In countries like Slovenia, Estonia, Austria or Germany the majority of public spending on health comes from social contributions – compulsory payments which usually provide entitlement to some social benefit, such as health care coverage; social contributions are strongly tied to the labour market since they are mostly paid by employers and employees. The rest of public spending on health is typically referred to under the broad umbrella term “general tax revenues.” However drawing on government revenue statistics from the Organisation for Economic Co-operation and Development (OECD), one can see that general tax revenues that finance health in fact are comprised of a variety of different types of taxes. In countries like Denmark or Sweden, taxes on income, profits and capital gains are the predominant form of public revenue for health, whereas in Hungary or Portugal, taxes on goods and services prevail. Property taxes make up just a small share of health revenues in the majority of European countries.

Why does it matter where public money for health comes from? If we want to understand how the Covid-19 economic crisis will affect the ability to finance health, it is helpful to understand how each country finances its health system and to then investigate how each public revenue stream is likely to be affected by the crisis and by relevant policy decisions. The following sections explore how these different revenue streams have been affected in 2020 by the Covid-19 crisis.

Figure 1. Domestic government spending on health as a share of current health spending, disaggregated by source of revenues, 2018

Social contributions and incomes have largely been protected in European countries during the crisis but this is unlikely to continue indefinitely

A key indicator of the ability to generate health revenues from social contributions is the unemployment rate. As unemployment rates increase, revenues from social contributions generally decline. In the EU-27, the unemployment rate expressed as a percentage of the extended labour force was 6.4 percent in Q2 2020, unchanged from Q2 2019, even as countries across Europe implemented lockdowns to prevent the spread of Covid-19 and economies were brought to a virtual stand-still.

The reason for relatively minor changes in unemployment rates in many countries during the first wave of the pandemic is that people who are temporarily out of work who expect to return to their place of employment are not technically considered unemployed according to the International Labour Organization definition. In many European countries, people unable to work during lockdowns were furloughed and provided with temporary wage assistance from governments and not counted technically as unemployed; in many cases this also translated into social contributions being made on those people’s behalf to health budgets through general government transfers.

As a result, the usual procyclicality of social contributions as a financing mechanism has largely been mitigated during the Covid-19 crisis in many countries through temporary policy measures to support people unable to work.

Nevertheless, labour markets are potentially in a more precarious condition than the unemployment rate data suggest. Using another indicator—labour market slack— which also counts some people who are not working but who would be working if they were able to do so, can provide a better sense of actual labour market conditions. Figure 2 shows how much labour market slack has increased from Q2 2019 to Q2 2020 compared to increases in the unemployment rate over the same time period. For example, while the unemployment rate in Austria – a health system that is primarily financed through social contributions – increased by just 1.0 percentage point from Q2 2019 to Q2 2020, labour market slack increased by 3.6 percentage points (a difference of 2.6 percentage points, as show in Figure 2).

Figure 2. Are labour markets worse off than official unemployment rates suggest?

Incomes have also been protected in many countries through similar mechanisms. For example in Sweden, where income taxes are the largest source of public finance for health, gross household disposable income fell by 6.5% between Q2 2019 and Q2 2020, but relatively speaking, bounced back so that between Q3 2019 and Q3 2020, gross household disposable income grew by 1.9%. In fact, data from many European countries through Q3 2020 suggest that it was often only Q2 where year on year incomes declined.

Falling consumption expenditure has driven the economic decline in most European countries

Declines in GDP in European countries have largely been driven by huge declines in consumption expenditure due to lockdowns and general anxiety about engaging in normal daily activities. For example, between Q2 2019 and Q2 2020, household final consumption expenditure fell by more than 20% in the United Kingdom, Spain, Ireland, Latvia and Malta. Unlike gross household disposable income, which showed positive growth between Q3 2019 and Q3 2020 in many countries, consumption continued to decline in all countries with data available from Eurostat except for Cyprus, Poland, Bulgaria and Slovakia. Even in Sweden, which did not technically lockdown, while gross household disposable income between Q2 2019 and Q2 2020 fell by just 6.5% in Sweden (see above), household final consumption over the same period fell by 8.2%; consumption also contracted between Q3 2019 and Q3 2020.

Figure 3. Decomposition of the change in general government revenues (shown in parentheses next to country name) from Q2 2019 to Q2 2020

Figure 3 shows the extent to which changes in different forms of public revenue drove declines in general government revenues between Q2 2019 and Q2 2020; countries at the top of the chart experienced the largest declines in general government revenues. In most countries, the decline in public revenues was driven by declines in taxes on goods and services (in these data called taxes on production and imports, though still referring to consumption taxes). For example, nearly half of the decline in revenues in Cyprus and Greece was driven by declines in this revenue base. Alternatively in Austria, only 8% of the decline in general government revenues was due to declines in social contributions, despite the precarious state of the labour market as described above.

For countries that have experienced significant declines in government revenues, many have had to borrow to finance their current public expenditure, including health expenditures. Fortunately borrowing costs are extremely low, even in countries that were perceived as higher risk just a few years ago, such as Greece, Portugal, Italy and Spain, where 10-year bond yields are not materially different from Germany. Interest re-payments as a share of tax revenues have also been steadily falling in recent years, meaning that the cost of servicing public debt is becoming comparatively easier.

What does the future portend for the economy?

While no one knows how or when the economy will recover from Covid-19, the International Monetary Fund (IMF) has projections through 2025 that were produced in October 2020 (Figure 4). Looking at a subset of countries, it appears that the economy is expected to bounce back fairly rapidly in 2021, with growth over the rest of the forecast period above pre-Covid growth rates. At the same time, it will take years for the level of economic activity to return to 2019 levels; GDP levels are expected to surpass 2019 levels in most countries at some point after 2023. Unemployment rates are expected to peak in 2021 following the end of labour market support programmes; unemployment rates are expected to slowly decline over the forecast period but they are not expected to return to pre-Covid levels before 2025. This lagged effect of economic recovery on unemployment rates is not unusual after economic crises as employers may be hesitant to hire new workers before the economy has demonstrated sustained improvements. It should be noted that the projections may be overly optimistic since they were produced before the autumn/winter wave of Covid.

Figure 4. IMF Projections of real per person GDP growth (top panel) and unemployment rates (bottom panel)

What will it all mean for health financing in the coming years?

While data on health spending is not yet available, it seems that countries were willing to spend more or less as needed to address the Covid-19 crisis in 2020. From health system and public health investments to labour support programmes, countries have taken on substantial public debt where necessary to address the pandemic and to try and counteract the economic impact of Covid-19.

However beyond 2020 it is hard to know how health financing will be affected. While health systems normally financed through social contributions seem to have done reasonably well in 2020, this is largely due to government transfers supporting those temporarily out of work—not due to the resilience of labour market financing itself. This level of support is unlikely to continue in the future unless countries recognize the inherent limitations of labour market financing and take steps to diversify health revenues and move away from social contributions. For those that continue to rely on social contributions to finance health, the perilous state of labour markets may result in difficulties raising revenues for the next few years. Expanding the revenue base to account for all forms of income, not just wages, may be one way to partially address these funding challenges.

At the same time, even as household spending gains strength, taxes on goods and services are unlikely to become the predominant source of health financing in countries, especially as policymakers may be apprehensive to raise consumption taxes at precisely the moment that they want to encourage households to spend money.

For countries to maintain sufficient health revenues, diversification will be key, as will searches for new sources of public finance that are comparatively impervious to business cycles. Whether greater reliance on property taxes or wealth taxes is feasible politically remains to be seen. If the costs of borrowing remain low it is possible that countries will be able to continue taking on public debt for some time, though one might expect at some point that countries will be apprehensive if their public debt to GDP ratios increase to levels deemed excessively high. At the same time, although many factors affect bond yields, if the economy heats up too much and inflation increases rapidly, it could result in interest rate increases which may subsequently drive up borrowing costs. One way or another, the ability to borrow at low cost should not be expected to continue indefinitely.

Overall, we should not assume that just because the world has experienced a major health crisis that health systems will receive additional priority in public budgets in the coming years. Many countries will need to reconsider the approaches they have historically taken if they want to ensure the sustainability of their health financing systems going forward.

Jonathan Cylus