Pearls and Irritations

In this final Part 3 of my comments on the 2018 Budget I discuss what this Budget reveals about the Government’s values and priorities, and its performance compared to those targets.

As the Government constantly reminds us, its proudest boast is the almost 1 million jobs that have been created since it was elected in 2013. However, the rate of economic growth has slowed somewhat since the Abbott/Turnbull Government took office. Thus, this rapid job growth has come at cost to the rate of productivity increase, which has averaged only an annual rate of increase of 1 per cent, compared to 1½ per cent during the Rudd/Gillard years. Indeed, in the last two years (2016-17 and 2017-18) labour productivity has hardly increased at all. So the Government’s “job success” story largely reflects a failure to increase productivity: not much of a success at all!

A second aim for the Government has been to shrink the size of government. But in 2018-19 budget outlays are expected to increase by 3.1 per cent, following increases of 2.0 and 2.7 per cent in each of the two preceding years. As a result, outlays have been increasing as a share of GDP – hardly smaller government. However, in the following three years, starting in 2019-20, government outlays are forecast to increase at an average annual rate of only 1.1 per cent. This represents a significant downward revision to the forecast increases in the previous Budget for the same years, although the policy decisions since then have actually added to budget outlays. In other words, the Government’s apparent success in restraining outlays, mainly reflects the impact of unexplained ‘parameter revisions’. But more important, is the likely future growth rate of outlays over the longer-term. This is what will determine the sustainability of the return to budget surplus, given the government’s commitment that after 2021-22 tax receipts will not be allowed to rise faster than GDP.

In Part 1 of this series of Budget Comments (Pearls & Irritations, 11 May), I spelt out my reasons for doubting that budget outlays could be constrained to less than the rate of growth of GDP over the medium-term, while meeting Scott Morrison’s commitment to ‘guarantee the essential services that Australians rely on’. Indeed, it is more likely that to meet that commitment, outlays will need to increase a bit faster than GDP, say at an average rate of 3 per cent, which would be consistent with past experience.

The reality is that so far the Government’s cuts in government spending have focussed heavily on reducing assistance to people who are not politically powerful and/or are not seen as government supporters. For example, age pensioners will receive additional assistance in this Budget, but the people who are most in need – unemployed people, sole parents, and social security recipients who rent – will receive no additional assistance. Similarly, new expenditure on culture has recently been heavily focussed on the War Memorial, the Monash Memorial in France at a cost of $100m., and – the latest – a multi-million dollar memorial for Captain Cook. While, on the other hand, other cultural institutions, such as the ABC and the National Library and Gallery, have suffered from continuing cuts, leading to service reductions.

All past experience tells us that to restrain the growth of budget outlays over an extended period, let alone reduce these outlays, requires major policy changes to the big spending areas of welfare, education, health and defence. But the government has not been prepared to take the policy decisions necessary to achieve big savings in each of these areas. To its credit, the Government has introduced changes affecting schools funding, but that requires a redistribution of funding and will not deliver savings. Similarly, it is not hard, as readers of this blog will know to propose changes to health funding that would deliver a more cost-effective system, but again any savings would most likely be redeployed within that system.

Where the Government has loosened its purse-strings is expenditure on national security. There are good reasons for this, but somewhat surprisingly, Defence expenditure is only estimated to increase by ¾ per cent in 2018-19, and even over the longer period from 2017-18 to 2021-22, Defence spending is projected to increase at an annual average rate of 3¼ per cent. This is less than the Government’s projection of nominal GDP growth, and further reinforces the doubts that Jon Stanford and I have expressed about the efficacy of the Government’s defence strategy and its implementation (Pearls and Irritations, 8 & 9 May). In addition, foreign aid continues to be cut, and it is now at its lowest ever level as a share of GDP. This form of soft power is also important to our national security; possibly more important than hard power in determining our security in the South Pacific at this juncture, and the wisdom of cutting foreign aid really is questionable.

Another key part of this Government’s quest for smaller government has been cutting the public service, and staffing levels have fallen by 5½ per cent over the five years to 2018-19. This cut may however have represented false economy. Over the same period, the total running costs of government departments have increased at an average annual rate of 7¾ per cent, which probably translates into an average annual increase of more than 8 per cent in real terms[i].  At the very least this very rapid growth in government running costs casts doubt on the value of contracting out so much of the work to consultants; it is not really contributing to smaller government expenditure which is what matters.

The area where the Government has most increased expenditure has been on new infrastructure investment. This has been useful in sustaining the economy when it was coming off the boom in mining investment, and more recently, now that dwelling construction appears to have peaked. But there is a concern about the value of this investment over time. As readers of Pearls and Irritations know most of this infrastructure spending has not been evaluated in advance of the spending decision – probably because it wouldn’t get a pass in any decent evaluation[ii]. In addition, the infrastructure spending has the advantage that if it is declared to be ‘commercial’ – even when most of it will not raise anywhere near the revenue to cover the cost – then it is treated as if it were financed off-budget and it doesn’t add to the budget deficit.

Finally, what does the Budget reveal about the Government’s competency and its claims to always be better economic managers than Labor:

1. As noted above, the economy is not performing all that well, with sluggish economic growth continuing. The Government’s projection of a faster rate of growth in the future is only based on very questionable assumptions.
2. There are particular doubts about the reality and credibility of the Budget projections, and therefore whether the Government will in fact achieve its objective to ‘Ensure that the Government lives within its means’ (Budget speech).
3. The lack of transparency in the Budget projections, and the irresponsible approach to infrastructure investments, are not consistent with good management.
4. The Government’s values seem to reflect a mixture of conservatism and populism, and not the liberalism of previous Liberal governments. Expenditure savings seem to be heavily focussed on the ‘undeserving poor’, but the scope for further redistribution along these lines must be coming to an end. There are also areas of neglect – such as higher education, and particularly VET, and low-cost housing – where additional expenditures are needed.
5. In sum, the Budget message that we can have tax cuts and return the Budget to a sustainable surplus is not real. If personal income tax cuts are to be made, then they should be more targeted and be paid for by raising other revenue – most obviously by dropping the company tax cut and removing concessions that are mainly accessed by the top 5 per cent of taxpayers, and which are basically unnecessary or even unfair.

Michael Keating is a former Head of the Departments of Finance and Prime Minister & Cabinet. He was centrally involved in the preparation of many Budgets over many years.

[i] The ABS price deflator for Australian Government non-defence consumption expenditure fell slightly over this period.

[ii] See articles posted on Pearls and Irritations by John Austen and Luke Fraser over the last year or more, and most recently the article by Marion Terrill and Danielle Wood, posted 7 May.

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