Budget deficits – how did they happen and what can be done. John Menadue

Dec 17, 2013

The government is announcing today an update of this year’s budget. This is the government’s first major economic statement since the election. It will focus particularly on the budget deficit. It will attempt to blame the previous government as much as possible. I addressed this issue of the budget deficit and how it has come about. 

What is important is the performance of the economy. The budget is a means to that end. The budget deficit is important, but it is important not to over-react. The Europeans did this with very serious consequences for slower economic growth and large increases in unemployment particularly in southern Europe. 

Consumer and business confidence is fragile. The government’s performance and exaggeration of our economic and financial problems will not help.,

The following was posted on 29 November 2013.  Repost below.

I have written extensively in this blog about the phoney outrage of Tony Abbott and Joe Hockey about the budget deficit and the debt. How ironic it is now that the government wants to lift the debt ceiling when only a few months ago it said that it would better manage the economy and quickly lower the level of debt.

Our deficit is not a cause for panic. We have a well-performing economy. And our deficits and debt are in far better shape than most countries in the world. But we do have a longer term budget deficit problem that we need to address.  Economists call this our structural deficit problem, the long-term deficit that we have in government accounts regardless of the fluctuations in revenue and expenditure over the ups and downs of the business cycle.

It is estimated that with existing federal and state policies at the present time, we face a structural budget deficit of about $60 billion in today’s currency.

How did this happen?

The primary and major cause was the way the Howard Government wasted the tax returns from the mining boom. The parliamentary budget office put this problem in the following terms.

‘Over two thirds of the five percentage points of GDP decline in structural receipts over the period 2002/3 to 2011/12, was due to the cumulative effects of the successive personal income tax cuts granted between 2003/4 and 2008/9. A further quarter was the result of a decline in excise and customs duties as a proportion of GDP. Significant factors driving this trend included the abolition of petroleum fuels excise indexation in the 2001/2 Budget and the decline in the consumption of cigarettes and tobacco over the period.’

The IMF came to much the same conclusion. It identified two periods of Australian ‘fiscal profligacy’ in recent years, both during the Howard turn in office – in 2003 at the start of the mining boom and during his final years in office between 2005 and 2007. (SMH Jan 11, 2013)

In short, our structural budget deficit is due in substantial part to the Howard Government’s laxity with government spending and tax reductions during the mining boom. We blew the benefits of the mining boom when we should have been doing more to improve the budget surplus.

The second cause of the structural deficit is that the Rudd Government spent heavily to counter the global financial crisis. It was more successful than almost any other government in the world in avoiding a major recession and unemployment, but when the recovery took hold, the Rudd and Gillard Governments did not focus on the structural deficit problem particularly as identified by the Henry tax review. Some improvements were made to reduce middle-class welfare like the subsidy to private health insurance and the over-generous concessions that Peter Costello had given to superannuants. But the improvements were nowhere near enough.

The Abbott Government has established a Commission of Audit to address this structural deficit and other problems. But I am doubtful if it will address the big ticket items and the hard political decisions that will be required.

Despite the public perception that we are highly taxed, the fact is that Australia has one of the lowest ratios of tax to GDP amongst the 34 OECD countries. In 2010, Australian taxes were about 26% of our GDP. This compared with the OECD average of 34%.

A major contributor to our lower taxes is the large number of ‘tax expenditures’. These are tax breaks, rebates and other loop-holes which reduce tax revenue. Australia has a much higher level of these ‘tax expenditures’ than countries such as Canada, US, Korea, Netherlands and Germany.

Some examples of these ‘tax expenditures’ that reduce tax revenue are as follows:

  • Ian McAuley and I have estimated that the subsidies to the private health insurance industry via policy holders cost about $7 billion per annum.
  • According to Treasury, tax revenue is reduced by about $30 billion per annum as a result of the superannuation tax concessions.
  • According to the Grattan Institute, governments provide benefits of about $36 billion per annum to home-owners through exemptions from land and capital gains taxes, and age pension entitlements. These very large tax expenditures work to disadvantage many young people who are unable to enter the housing market or people who prefer or are forced to rent accommodation.
  • The Grattan Institute also estimates that property investors get a benefit of about $7 billion per annum through negative gearing and the capital gains discount.

The Grattan Institute also suggests that Australian government budgets could be improved by about $37 billion per annum through broadening the GST to include food and private spending on health and education, as well as lifting the pension and superannuation at retirement age to 70.

To the above possible reform measures, could be added a reformed mining tax that really raises money. If the Minerals Resources Rent Tax was raised to 40% as proposed by the Henry Review, it would raise an additional $5 billion per annum.

All the above are big ticket items that cost the budget large sums of money. These benefits and tax expenditures also heavily favour high income earners. Vested interests and rent-seekers will fight doggedly to maintain their privileged positions.

These are hard political issues, but if we are to address our structural budget deficit problem, they will need to be examined carefully and introduced progressively, or at least partially-like limiting negative gearing to new homes.

Worthwhile reform is likely to antagonise strong vested interests. That is why I am afraid that the Abbott Government is likely to direct our attention onto quite secondary issues such as ‘government waste’ which are really chicken-feed alongside the big ticket items mentioned above.

The Hawke/Keating governments showed that bold reform is possible. John Howard showed it with the GST

We can achieve necessary reform if we all stopped talking exclusively about politics and engaged in sensible policy debates.

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