Budget Repair: Tax increases or expenditure cuts?

Nov 8, 2022
Adhesive tape strips sticked to a budget sign, financial crisis, cost control.

The Treasurer wants a national conversation about how best to repair the Budget. But that conversation will only help if it is based on a realistic analysis of the difficulties involved in achieving lower spending and therefore why tax increases must be on the agenda.

Since being elected the Treasurer has railed against the inherited trillion dollars of debt. While more recently he is insisting that killing the inflation dragon is his number one priority. Both ways it is essential that the Government continues its task of Budget repair.

But what is the best way to return the Budget to balance or even a small surplus in a reasonable time? How much should spending be cut or alternatively taxation be raised to at least remove the projected budget deficits over the next four years of around 2 per cent of GDP?

The Treasurer has said that he wants to promote a national conversation around these issues, as the best way to find the optimum combination of spending and taxation. I question, however, whether this conversation can advance far without a more informed public, and that consequently more analysis of the alternative expenditure savings and taxation options is needed.

Unfortunately, too often the starting point for this discussion is that lower taxes are the most important objective, and consequently the focus should be on restraining government spending.

Of course, savings should be realised where there is government waste, but what is frequently ignored is the importance of many government services in improving well-being. Are people better off with a good education and a good health system, or should we prioritise higher private incomes so we can spend more on trips overseas or at McDonalds? In other words, the real purpose of taxation – to pay for these publicly provided services – is too often over-looked.

In a previous article (Pearls & Irritations, 22 October), I argued that during almost a decade under the Coalition, government service provision was underfunded. Essentially the Coalition’s prime objective was to return the Budget to surplus, while also cutting taxes, and the only way this was possible was to underfund services.

In its first Budget, the Albanese Government has sought to remedy some of the most egregious instances of under-funding and inadequate service provision. Also, to its credit, the Albanese Government has managed to finance its improvements in services by finding off-setting savings from some of the spending programs that it inherited. But these savings only amounted to half a percent of GDP, and that in itself indicates the difficulty of finding further savings, while at least two percent of GDP is required for full budget repair.

Accordingly, this article examines the future funding of government services, as revealed in the recent October budget, in order to facilitate a better assessment of the outlook for government spending and the extent to which more or less is needed.

As a starting point, Table 1 below summarises the spending projected in the Budget on the major programs where it is considered that savings would be very difficult to achieve – either because they are covered by legal requirements that would be almost impossible to alter (revenue assistance to the States & Territories, public debt interest, and superannuation payments) or because they represent high government priorities as demonstrated in the recent election and the Budget.

Table 1 Programs where savings are very difficult

Table 1 Programs where savings are very difficult

What this table shows is that first, these programs where savings are deemed to be very difficult, account for as much as two thirds of the projected total Australian Government expenditure in the current financial year. Second, spending on the remaining programs, which only account for a third of total spending, is already projected to fall at an average annual rate of 7.8 per cent. That in itself suggests that further savings in most of these programs might be difficult too.

That is not to say that no further savings would be possible from some of these programs but that the savings would be small relative to the size of the amount needed to fully repair the budget.

For example, probably the outstanding area where more savings could be achieved is road and rail transport spending which is projected to increase at an annual average rate of 16.1 per cent between 2021-22 and 2025-26. As John Menadue has documented (Pearls & Irritations, Articles on the 3rd and 4th of November) no business case exists for most of this infrastructure expenditure, and probably because it is recognised to be uneconomic.

On the other hand, Australian Government spending on road and rail infrastructure projects still only accounts for 1.9 per cent of total Australian Government expenditure in the current fiscal year, so even massive savings on this infrastructure will not be sufficient to restore the budget balance on its own.

Another program which is being investigated for savings is the NDIS, which is growing much faster than expected at an annual average rate of 14.8 per cent – faster than any other program other than debt interest which cannot be altered. The Government has established a review of the scheme to, inter alia, examine the fiscal sustainability of the scheme.

As Roger Beale (Pearls & Irritations, Article on the 3rd November) has shown, however, because of offsetting savings, the additional costs of the NDIS are only about half the gross costs. Also the budget costings do not allow for the possibility that the High Court will rule that people with disabilities aged 65+, who are presently excluded, must be allowed to access the scheme as well. So, it would be naïve to imagine that savings from a revamped NDIS, if any, will make a major contribution to repairing the budget.

No doubt, all of us can think of other potential savings. Personally I would nominate the Health Insurance Rebate, and the over-generous assistance to private schools, many of which are exceeding their resource standard, while government schools are expected to continue lagging behind this standard for the rest of the decade.

But even a government that was prepared to take on these extremely tough political challenges, would most likely find that it still had not balanced its budget.

Furthermore, as highlighted below, there are a number of areas where a good case could and probably will be made for spending more:

  • Housing and community amenities where spending is projected to fall at an average annual rate of 0.8 per cent between 2021-22 and 2025-26.
  • Rental assistance which is not indexed to keep pace with the rise in rents.
  • Recreation, culture and religion where nominal spending is projected to only increase at an annual average rate of 0.8 per cent between 2021-22 and 2025-26, with expenses under the broadcasting sub-function estimated to decrease by 4.5 per cent in real terms from 2022–23 to 2025–26. And that fall comes after years of previous cuts.
  • Higher education where expenditure is forecast to increase in the Budget in real terms by 1.2 per cent between 2022-23 to 2025-26, implying a further fall per student if, as expected, the number of students increases by more than that in the next three years.
  • Vocational Education looks to be similarly under-funded, with expenditure expected to increase by as little as 1.3 per cent in real terms over the whole of the next three years. And this comes after years of decline with the number of VET students peaking in 1999 and falling by 20 per cent by 2021.
  • Medical benefits, where although real spending is forecast to increase by 4.5 per cent in real terms over the period 2022–23 to 2025–26, it is questionable whether this will be enough to ensure that there are sufficient GPs to guarantee the provision of primary care in the years ahead.

In sum, it is very difficult to envisage how the Budget can be fully repaired by relying only on expenditure cuts. Instead, the Treasurer, if he is fair dinkum about budget repair, needs to get on the front foot and start a debate now about the need for more tax revenue and then how.

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