Canberra’s $40 billion question: where will the money come from?

by John Daley

Published by The Australian Financial Review, Thursday 16 January 2014

Wednesday’s appearance before a Senate committee by the chairman of the Commission of Audit, Tony Shepherd, was a promising sign.

History shows that inquiries like the commission can be an important part of fixing budgets, but only if they’re accompanied by thorough public debate. So far, discussions about Australia’s budget issues have fallen woefully short.

Two important questions lie behind any proposal to fix government budgets: how much money will it raise, and what will the side-effects be? We spend a lot of time thinking about the second, but not enough talking about the first.

The Commonwealth’s forecast fiscal budget deficit for this year is over $40 billion. Grattan Institute estimates that in a decade the collective budget deficit for Commonwealth and state governments could be as large as $60 billion in today’s dollars. With those figures in mind, the GP co-payment proposal, projected to raise $0.2 billion a year, is not going to do much to fix the problem no matter how long we spend debating its merits.

Think much, much bigger

Governments need to think much, much bigger. By their very nature, big changes to the budget will have other big effects on our society and economy. So we need to find proposals that will make a big enough difference to the budget to be worthwhile, but don’t have unacceptable side-effects or make life harder for those already worst off.

Grattan Institute’s 2013 Balancing Budgets report looked hard to find such proposals. We didn’t find many.

Broadening the GST to fresh food, health and education would raise $13 billion, after providing compensation to low-income households. The GST is one of the most economically efficient taxes, so the effects on growth would be minimal.

Expanding the GST would be regressive – the burden would fall more heavily on those on low incomes – but this can be managed via compensation through the income tax and welfare systems. And at the moment, a lot of the benefits of GST exemptions go to wealthy households, which spend a lot on private health and education. Don’t like that idea? We could instead increase the age at which people can access the Age Pension and superannuation.

That would eventually raise $12 billion a year, and the overall social, economic and distributional effects would more or less even out. Assuming that the eligibility ages are lifted gradually, those already retired would be unaffected.

All other Australians will share the burden in the future as they age. Higher workforce participation rates would contribute to economic growth, increasing our collective wealth. Some of those who had planned to retire soon would need to work for longer, and appropriate provisions would have to be made for those physically unable to do so.

There’s nothing else as big as those two options that doesn’t have much more serious consequences. For example, we could leave marginal income tax thresholds constant for another 10 years, or perhaps increase the corporate tax rate to 34 per cent.

Each of these would raise more than $10 billion, but would also drag on the economy by discouraging working and investment.

Cutting spending

Another path is to try to save $40 billion per year by cutting spending. But Australia has pretty small government, and there’s not much fat to cut that won’t reduce the quality of services.

For example, to get $10 billion without materially reducing social and economic outcomes, we’d have to do all of the following: increase school class sizes by an average of four children per class ($3 billion); halve student subsidies for university courses ($3 billion); abolish the private health insurance rebate ($3 billion); and cut the recurrent defence budget by 12 per cent.

That’s a lot of work – and if the cuts in these areas weren’t implemented very carefully, big problems could emerge.

There are some spending changes that would actually have positive social and economic effects. Including owner-occupied housing in the Age Pension assets test and reforming the way government buys pharmaceuticals through the PBS are “money for nothing” for the federal government in policy terms, although the government would have to tackle some big vested interests.

These are the kind of things that a robust budget discussion needs to cover, and which the Commission of Audit can help to promote. With a better understanding of the size of the options, we can start talking about the hard choices we need to make.

A billion dollars sounds pretty big. But it’s only around 2 per cent of the current federal budget deficit. So next time someone says they have a billion-dollar proposal to fix the budget, ask them where they’re going to find the other $39 billion we need.