How to fix our budget emergency

by John Daley

Published by The Australian, Monday 25 November 2013

When then opposition leader Tony Abbott said earlier this year that Australia faces a “budget emergency”, he was right, even if it is a curious kind of emergency. There is no flashing blue light, no cardiac arrest on the operating table.

Yet in terms of their finances, Australian governments are unfit and overweight. Most worryingly, they have gone into denial and are eating more cheese. Tough decisions are required to get them healthy again.

Australian governments face a decade of deficits – up to 4 per cent of GDP, or $60 billion a year in today’s terms, by 2023. The squeeze on budgets comes from rising health costs, likely pressure on welfare spending as the economy turns down, an inevitable fall in the terms of trade, and the propensity of governments of both stripes to spend big on signature initiatives such as paid parental leave, new schools funding and the disability insurance scheme.

Tough choices cannot be put off much longer. Deficits impose heavy costs not only on the next generation but increasingly on this one, in the form of interest bills on the rising debt. Governments cannot expect that higher economic growth will result in budgets growing out of trouble.

Instead, they must cut expenditure and raise taxes – the hard work of budgetary reform. Our leaders must be forthright in explaining to Australians what happened to government budgets over the past decade, and why we need to get healthy again.

Grattan Institute’s new report, Balancing budgets: tough choices we need, surveys the options for governments to get their budgets in order. Their choices are limited.

We examine all realistic reforms that would contribute $2bn a year. We look for a package of reforms that is big enough to make a difference, does not produce unacceptable economic and social effects, and spreads the burden of reform. Sharing the pain is not only fair, it makes change easier to sell to the public.

One potential package would broaden the GST to include fresh food and private spending on health and education. It would raise the age of access to superannuation and the age pension, remove the exemption for owner-occupied housing from the assets test for the age pension, and limit tax concessions on superannuation deposits.

Introduced as a whole, this package of reforms would add about $38bn a year to the federal budget. It would spread the burden across rich and poor, workers and retirees. While these reforms are unlikely to occur all at once, it will be hard to close the looming budget gap without tackling any of them.

Broadening the GST would affect all income groups, but hit low-income earners hardest, although compensation could reduce the impact. Including the primary residence in the age pension asset test would primarily affect middle-income earners – people doing well enough to own their own home, but not so well that they do not qualify for the age pension.

Limiting superannuation tax concessions would mainly hit high-income earners, who reap most of the benefits of concessions for contributing more than $10,000 a year. Raising the age of access to superannuation and the age pension affects everyone under the age of 63.

Despite the impact of a broader-based GST, the package would probably slightly reduce inequality overall. The major sensitivity is that it appears to affect older Australians more. This may be more perception than fact; even so, the work of balancing budgets should address a significant inequality that has emerged in recent decades in our pension and superannuation systems: the skew of benefits towards the aged rather than to those most in need.

Another large group of choices involves changes to the taxation of housing, including negative gearing, and capital gains. Yet practical implementation problems may reduce how much these options improve budget balances.

Serious budget repair almost always involves tax reform. Aside from changes to the GST, increasing fuel excise in line with inflation would raise significant revenue, although it hits low-income earners particularly hard. Higher rates of existing taxes could raise large revenues. Raising the GST and municipal rates would slow economic growth less than other taxes.

Our report looks at other areas where governments could cut costs, but the payoff is often not as big as some might think. The often touted cuts to the public service and “middle-class welfare” will do relatively little to improve budget balances, for example.

Realistic reductions in spending on transport infrastructure, industry support, school class sizes, higher education subsidies, pharmaceuticals, health services, and defence could collectively improve budget positions by $21bn a year. But the economic and social impacts would be acceptable only if the cuts were targeted and executed unusually well.

Sustainable budgets depend on governments making tough choices. They can duck them for a while and probably stay in power, but they will be damaging Australia’s long-term prosperity. The “budget emergency” Abbott deplored is now his to repair. His willingness and ability to do so will help to define his prime ministership.