8
May
2014

Our bloated budget needs to hit the treadmill

by John Daley


Published by The Drum, Thursday 8 May

In the lead-up to next week’s Commonwealth Budget we’ve seen more than the usual amount of softening up for tough measures.

With the Commission of Audit report, and talk of a deficit levy, austerity is in the air. It is assumed that the Budget is not well.

Clearly Australian budgets are not lying on the operating table without a pulse. Australian governments have much less debt than many others in the developed world. With public debt at less than 15 per cent of GDP, the Commonwealth’s credit rating is safe.

But Australian government budgets have been overweight and unhealthy for several years, even if it hasn’t been obvious. The mining boom and the global financial crisis concealed a “structural” deficit. In other words, if there had been no mining boom, and even with no temporary stimulus spending to address the financial crisis, the Commonwealth would have had a budget deficit of 2 to 3 per cent of GDP – more than $30 billion in today’s terms – for the last five years in a row.

This underlying deficit has become more obvious as mining prices have fallen and the Global Financial Crisis recedes into the past.

In 2013-14, the Commonwealth’s budget deficit will be about $38 billion after excluding the one-off cash injection to the Reserve Bank. This is much too high when the economy is not even close to a recession.

Real GDP growth is 2.8 per cent a year, and unemployment about 6 per cent. These measures could be better, but this may be about as good as it gets for some time. If the Commonwealth government was right to spend substantially to stimulate the economy during the GFC, then in today’s better economic times there should be surpluses to pay back the past spending.

So the patient could be in better shape. But doctors disagree about the cause of disease – some blame falling revenues, others runaway spending. In fact, the patient has both conditions.

Commonwealth revenues are well below their long-run trends. Revenue is 23 per cent of GDP. The long-run average since 1982 is above 24 per cent, and was above 25 per cent between 1999 and 2007. Even then, government revenues were well below the OECD average. Contrary to what some think, Australia does not have a “big government”.

Nevertheless, rapidly increasing spending has also contributed to high deficits. Commonwealth expenditures aside from grants to the states are almost 21 per cent of GDP, reflecting a steady drift upwards from 19 per cent in 2003. High mineral prices are masking even greater rises in spending as a proportion of GDP. When mining prices fall, spending as a proportion of GDP will rise.

But if there is no emergency, why shouldn’t Australia continue to enjoy ample wine and cheese?

The Commonwealth budget needs to both lose weight and exercise more. Although changing our behaviour is never urgent, every year that goes by makes the task harder. The most compelling reason is that sustained budget deficits require tomorrow’s taxpayers to pay for today’s spending. If we are investing to make our children richer, perhaps this is fair. But that has not happened over the last 10 years.

Most of the increase in government spending above GDP growth paid for more health and age pensions. These might be worthwhile social outcomes, but they are not investments. Governments also spent more on infrastructure, but this is only worthwhile if it is the right infrastructure at the right time for the right price. As the Productivity Commission has noted, project selection has often been poor.

Balanced budgets – and therefore lower government debt – are also important because they provide flexibility in a crisis. In 2008 and 2009 Australia could afford a vigorous response to the global financial crisis precisely because it had so little government debt.

Many on the left are uneasy at calls to balance budgets. It is true that in the short-run, tightening budgets can increase unemployment. But the alternative is worse. If governments run continued deficits, and see their debt increase, eventually they will be forced to cut much harder. These cuts are likely to fall on the most vulnerable, where governments spend a lot of their money.

How should we cure the Australian budget? Some believe that hard cuts to the public service are needed. But even if the Commonwealth government reduced the public service by 15,000 people, this would save no more than $1.5 billion a year, when Australia has a budget problem of more like $30 billion a year.

Tighter targeting of the age pension – while politically difficult – would help a lot more. Including owner-occupied housing in the pension assets test would strip $7 billion a year from the Commonwealth budget.

Yet it is unlikely that reduced expenditure alone can solve the problem. Revenues will have to rise as well. The most promising avenues are tighter targeting of superannuation tax concessions (plausible changes could yield $9 billion a year), and ending negative gearing (worth $4 billion a year in the short term, reducing to $2 billion a year as losses accumulate).

In short, the Commonwealth budget needs to both lose weight and exercise more. Although changing our behaviour is never urgent, every year that goes by makes the task harder.

The alternative is asking our children to pay for current spending. The elderly are also at risk if a future crisis forces governments to cut basic services to the most vulnerable in the community.

Few will credit the Treasurer, Joe Hockey, for a tough budget on Tuesday. But if he makes real progress in improving the health of the Budget, our children will thank him.