MICHAEL KEATING. The 2017 Budget – A welcome change in direction. Part 1 of 2

May 11, 2017

This Budget represents a welcome change in direction. Forget the politics, it deserves to be supported. This latest Coalition Budget finally reflects a realistic appraisal of Australia’s fiscal needs. 

In a refreshing change in rhetoric, the Treasurer declares that this Budget is based on ‘the principles of fairness, security and opportunity’.

Readers of Pearls and Irritations will recall that two years ago, in an attempt to focus political debate on important policy issues, a series of articles (later published as a book) were posted here under the same rubric of Fairness, Opportunity and Security. Not surprisingly therefore we endorse these principles, and to the extent that the Government lives up to them, this Budget represents a welcome change in direction.

But what has motivated this change in direction and what does it mean?

First, and most importantly, the Government has recognised the reality that Australians actually demand the services and levels of assistance that are currently being provided. In addition, while no-one willingly wants to pay more tax, the evidence shows that faced with the choice, Australians would prefer to pay for these services rather than miss out. Nevertheless, and contrary to the view of some of the commentariat and the government’s backbench, this Budget is not an endorsement of ‘big government’. In fact, public expenditure in Australia will continue to be lower than in almost all other advanced economies. Thus this budget reflects a return to an older mainstream style of liberalism, as espoused by Menzies and Howard, that doesn’t rail against the ‘age of entitlement’.  Instead, it recognises the principle that people are entitled to and should be supported to access essential services if we are really going to achieve fairness, opportunity and security across our society.

Second, consistent with this recognition of entitlement, the Government has finally also accepted that we have a revenue problem as well as an expenditure problem, and that we cannot realistically look forward to a lower tax take overall. Indeed that should have been obvious from the outset – neither the Hawke-Keating nor the Howard-Costello tax-reform packages resulted in lower taxation revenue, they only altered the mix of taxes.  So now that this Budget has finally caught up with reality, it has actually proposed some increases in taxes. Of course, the Treasurer is claiming that these tax increases have been forced by a hostile Senate, but that is just political camouflage for dealing with his backbench. The previous Senate opposition essentially reflected the widespread rejection by the public at large of previous attempts at smaller government.  Equally the Senate didn’t ask the Government to spend the billions of dollars on its new policies since the 2014 Budget.

So we welcome the thrust of this budget and that the Government has got real and abandoned it past futile rhetoric. But can the Budget deliver on its promises, and what is the quality of its expenditure and revenue decisions? In Part 1 of this article we will explore the first question, and in the second Part 2 we will consider the quality of the main expenditure and revenue decisions.

The Outlook for Economic Growth

As the Treasurer insists, realisation of the projected return to budget surplus in 2020-21 is, inter alia, dependent on the accuracy of the predicted economic growth. I see no reason to query most of the assumptions and forecasts/projections by the Treasury, but the risks are heavily on the downside.

In particular, the recent sluggishness in the economy is largely due to the slow rate of wage increases, with today’s newspaper headlines reporting that retail sales have stalled. The Budget forecasts of wage rates and consumer prices imply that real wage rates will increase by less than one per cent in 2017-18 and 2018-19, and by only one per cent in the following two years. This increase in real wage rates would be less than the predicted rate of productivity growth, and I suggest that this increasing share of capital is largely responsible for the economic stagnation that the OECD countries have been experiencing.

Given this weak wage growth realisation of the forecast pickup in household consumption growth to 2¾ per cent in 2017-18 and 3 per cent in 2018-19 is dependent on a further decline in the household savings rate to the very low rate of 3¼ per cent forecast for 2018-19.  Even if realised this forecast lack of savings represents considerable risks. Australia already has the highest level of household debt in the world.  Interest rates are currently exceptionally low, but a 2 percentage point increase in interest rates would lift mortgage repayments to a level where they would cost more of a household’s income than at any time in the last two decades. That sort of forced saving would certainly lower consumption.

The Treasurer’s expectations of better times ahead, may prove to be right, but they are based on very flimsy foundations.

Fiscal Outlook and Strategy

The projected return to Budget surplus in 2020-21 is the same as projected last year; the first-time since 2008 that the return to surplus has not been postponed, and to that extent it may be more believable.

I also consider that the projected pace of fiscal repair is about right, although the rate of reduction in unemployment is disturbingly slow.  Furthermore, as already noted the risks for the economy are heavily on the downside, and an adjustment to the projected rate of fiscal repair may well prove necessary.

The other feature of this projected return to a budget surplus is that it relies almost entirely on increasing revenue. In 2020-21 government payments are projected to amount to 25.0 per cent of GDP, effectively the same as the present level of 25.1 per cent in 2016-17. By contrast revenue is projected to increase from its current level of 23.2 per cent of GDP to 25.4 per cent in 2020-21 – another 2 percentage points higher. The Government’s revenue measures are estimated to raise almost $20 bn. over the next four years of which $8 bn. is in 2020-21. This effectively means that the measures only account for 6.6 per cent of the additional revenue raised in 2020-21 compared to this current year, 2016-17. In other words, most of the additional revenue will come from economic growth – underlining the importance of economic growth – but fiscal drag as inflation moves people into higher tax brackets will also be important.

The question for the future is whether the Government can continue to ignore and do nothing about this bracket creep, which is undermining the progressivity of the income tax system. Instead I suggest that some time the then government will be forced to undertake real tax reform and revise the tax scales, even if the same amount of revenue is to be raised.

There is however, an additional reason for more comprehensive review of the tax system. While the Government is heralding its projected return to Budget surplus, its own Intergenerational Report has signalled that this surplus will not be maintained if present policies are continued. In the mean-time advantage should be taken of the time delay to plan longer term expenditure savings, but for the reasons already discussed Australia will also need to have an in-depth conversation about how to raise the additional revenue to pay for the services that we so clearly demand.  That conversation will be quite different from conversations prior to this Budget, which all started from the premise that tax reform should focus on how best to lower taxes.

Michael Keating was Secretary of the Department of Finance from 1986 to 1991.

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