Presented to Melbourne Economic Forum, December 2015

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Attitudes to the best approach to budget repair are influenced by beliefs about the value of small government, and the priority of economic growth.

Many believe that Australia has relatively large government, and that the key to budget repair is smaller government that will lead to faster economic growth and a stabilised budget.

While there are many reasons to prefer smaller government, particularly promoting the scope for individuals to make choices that shape their own lives, smaller government is unlikely to solve Australia’s budgetary problems. Across the OECD, there is no obvious relationship between size of government and size of government deficits.

In any case, Australia has relatively small government. Although government expenditure is currently towards the upper limit of historic expenditure, Australian government expenditure is low relative to the OECD. This is so, even if compulsory superannuation contributions are taken into account. Australian governments spend less in most categories. In particular, welfare spending is relatively low due to Australia’s highly targeted welfare system.

Australian tax rates are also relatively low. Income taxes are not particularly high if one takes into account social security contributions, which have a similar incidence to income taxes.

There are likely to be continued pressures to increase the size of government. Around the world, as economies grow, governments are typically spending an increasing proportion of GDP on healthcare. In Australia, increased spending on health over the last 20 years has coincided with materially improved health outcomes.

Instead, budget repair will depend on the hard grind of both expenditure reductions and revenue increases. This will include facing up to the difficult politics of unsustainable inter-generational spending and revenue transfers. History suggests that budget repair is more likely to succeed when governments both reduce expenditure and increase revenue; otherwise the politics of budget repair is very difficult to manage. And the sheer scale of the federal deficit means that it is very unlikely that the gap can be bridged purely through even the bravest of expenditure reductions.

Indeed the Commonwealth’s plan for many years has been to repair its budget primarily through revenue increases delivered through fiscal drag.