3
May
2016

In denial over our big-spending habits

by John Daley


Published by Australian Financial Review, Tuesday 3 May

Excessive drinkers often promise to cut back soon. But after many years of indulgence, some start to deny they have a problem at all. Commonwealth financial rhetoric seems to be heading this way. Denial is creeping in that there is any real need to repair the budget.

The current financial year will be Australia’s eighth successive year of budget deficits. This year’s deficit will be about 2.3 per cent of GDP – not far from the average over the last 8 years of 2.7 per cent of GDP. Current forecasts expect at least another three years of substantial deficits. It’s hard to pass off 11 years of consistent behaviour as just an unhappy casualty of the global financial crisis.

The problem persists because each year governments point to a fragile economy to justify little action. They have made much of the headwinds of a sluggish global economy. But they have said little about the tailwinds of the biggest mining boom in Australia’s history that more or less cancelled out the budgetary effects of slower economic growth.

We can’t expect the economy to get a lot better any time soon. As IMF reports over the last year show, slower economic growth in Australia and around the world may be here for a long time.

Right now, the Australian economy isn’t looking too bad. GDP is growing just below 3 per cent in real terms. Unemployment appears to be falling, significantly earlier and from a lower peak than previously forecast. Business confidence is high. Unusually low inflation is a worry, but unless the economy is in full-blown party mode, there is always a grey cloud on the economic horizon. It’s hard to believe that things are going to improve much.

The root cause of these budget deficits is not a sluggish economy internationally or in Australia. Rather the real problems are falling tax revenue and rapidly increasing underlying spending over the last decade. As income tax rates were cut and superannuation concessions increased, spending on health, welfare for age pensions and carers and aged care grew much faster than the economy.

Granted, more money for health bore fruit. Life expectancy and years of life without a disability increased, preventable deaths reduced. Voters noticed: even self-reported health improved markedly over a decade. But the big question is who is going to pay for increased spending on health now that the short-term boost to corporate tax has evaporated with the end of the mining boom?

The economy might provide some free kicks. The iron ore price – which drives corporate tax growth – has risen to US$50 a tonne from US$40 last November. Yet nominal wages growth – which drives income tax growth – has been very slow as wages barely keep pace with subdued inflation rates.

Ultimately the Commonwealth government will need to either increase taxes or reduce spending – neither of which is ever popular. The workings of our political system don’t provide much cause for hope. The bottom line in 2018-19 looks like it will be about $7 billion worse than the latest forecasts, since Parliament has refused to pass a number of budget measures, particularly cuts to parenting payments. The government has already promised extra spending for hospitals, defence and schools of at least $2.5 billion in 2018-19.

Budget deficits impose a significant cost on future generations. Younger households will have to pay an additional $10,000 in tax at some stage in their lifetimes to pay for each year with a Commonwealth deficit at this year’s level of about $37 billion. That outcome might be justified if these deficits had funded big increases in education and infrastructure. Instead they have primarily funded increased health, pensions and aged care, benefiting older generations who are unlikely to pay much tax in future.

If the Treasurer, Scott Morrison, really wants to bring down a different kind of budget, it should contain substantial tax increases and spending cuts that make a material difference to the bottom line, and the taxes that future generations will pay. Realistically, such a budget will have to wait until after the election. Public opinion is solidly behind the need for budget repair. But our political system isn’t keen to get back on the wagon. And meanwhile we’re damaging the health of future generations.