Michael Keating. The Government’s mid-year budget update. Part 2.

Where to from here? 

So what is the Government’s strategy to return the Budget to return to surplus as the government has promised over the medium term?

The May Budget was almost universally criticised for its unfairness. While restoring fiscal health of the nation may require sacrifices, the evidence clearly showed that in the May Budget the Government did not demand equality of sacrifice (for example, see my comments on the Budget posted on this site last May).

Unfortunately the new evidence from the MYEFO suggests that this unfairness continues. Essentially the Government has balanced the cost of its new policies announced since the Budget, mainly involving new expenditures on what it believes to be extra security, by making further cuts in existing programs. The net result of these various policy changes since May is that the further net addition to outlays over the four years to 2017-18 is expected to be only $4.1 bn. But the cuts have mainly affected politically soft targets, with foreign aid taking the biggest hit with another $3.7 bn cut, on top of the previous cut in the May Budget of $7.6 bn. By comparison it might be noted that foreign aid has been the fastest growing item in the UK Budget over the last four years, increasing by 25 per cent, while expenditure on most other UK government functions has fallen. Indeed, the Conservative Prime Minister is on record as saying that the increase in foreign aid is his proudest achievement. In Australia, however, we are spending more in a dubious attempt to enhance our military power, but slashing spending which might increase or at least maintain our soft power overseas.

Of course, merely balancing new spending with cuts in existing programs will not of itself return the Budget to surplus. Overall the Government’s approach to the task of budget repair remains the same as outlined in the May Budget, as it continues to rely for the most part on increasing revenue rather than expenditure restraint. Thus government payments are projected to actually rise as a percentage of GDP from 24.1 per cent in 2012-13[1] to 25.2 per cent in 2017-18; that is the Abbott Government is itself budgeting for a substantial increase in payments relative to the level of payments under Labor, equivalent to one percent of GDP. While on the other hand, total government receipts are projected in MYEFO to increase by two percentage points from 22.8 per cent of GDP in 2012-13 to 24.8 per cent in 2017-18. In other words, total payments are being only modestly restrained while receipts increase substantially as a result of allowing bracket creep as people move over time into higher income tax brackets. The Government has promised to cap tax revenue at 23.9 per cent of GDP, but in the meantime receipts are bearing the main burden of Budget repair, while the expenditure cuts are principally being used as the basis for a reordering of expenditure priorities more in line with this Government’s values.

The response of the business community, or at least their self-appointed spokespeople, to the MYEFO’s receding prospect of restoring the Budget surplus has been to argue that this further highlights the need for economic reform. And as already suggested in my previous companion comment, faster economic growth would greatly assist in balancing the Budget. However, that begs the question of what sorts of reform would most help improve economic growth. According to the Business Council, the reform agenda should focus on taxation, federalism and industrial relations. But faster economic growth requires improved productivity growth or increased workforce participation, and the evidence is not strong linking either of these two key variables to reform of taxation, federalism or industrial relations. While such reforms might be supported, realistically their pay-off in terms of productivity and participation can only be expected to be fairly small.

Instead the evidence is that the best way to improve participation is to increase the education and skills of people who presently lack the skills for the jobs of tomorrow. And innovation based on research and education is also likely to have the greatest impact on our future productivity growth, at least in the longer run. But unfortunately these are precisely the areas that the government has chosen to target for expenditure savings. Instead there is scope for more expenditure restraint, but this would involve improving the efficiency and effectiveness of services and their value for money, especially in relation to school education, health and infrastructure. The Abbott Government has, however, shown no evidence of looking seriously at program effectiveness and instead its quest for savings has seemed to be mainly guided by its own particular political values and prejudices.

Looking to the longer term future, of course Australia will have to live within its means, and despite our best efforts to accelerate economic growth, those means may well not increase in the years ahead as fast as we have become used to. In that case the need for ongoing expenditure restraint will become even more important, but so too will the need for tax reform. In sum, what the MYEFO again reminds us is that society faces a fundamental choice between less expenditure or a more effective tax system, or more likely some combination of the two. In a previous comment on an ‘Alternative Budget Strategy’ (posted July 22/23) I showed how additional revenue totalling some $42 bn could be raised in 2017-18 by real tax reform that reduced the various tax expenditures (ie concessions) and closed a number of tax loopholes that are presently used to avoid paying tax. In my view this would be the best place to start if we want to put our public finances on a sustainable footing for the future.

 

[1] I use 2012-13 as the starting point for this comparison, rather than 2013-14, because the payments for 2013-14 were artificially inflated by the incoming Abbott Government by bringing forward some payments into that year and by the payment of $8.8 bn to the Reserve Bank, which of itself increased total payments by 0.6 per cent of GDP.

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One Response to Michael Keating. The Government’s mid-year budget update. Part 2.

  1. Wayne McMIllan says:

    When will economists stop the nonsense about getting the budget into surplus, when we are in a period of economic downturn. Economists across the spectrum are now realising that when a country has a fiat currency, creating surpluses and fiscal austerity is nonsense and harmful, especially when the economy is in a downturn and we have little or no inflation. Enlightened mainstream economists are now in agreement on this point, although they may differ on how long a country should be in deficit and how it should be financed. We have the Modern Monetary Theorists to thank for doing the hard yards, as they have been popularising it for some time despite some silly opposition from rabid fundamentalists.
    In addition, most sensible economists [except rigid blinkered Treasury Boffins and ossified academics] will tell you that politicians spouting analogies between the economy and a household budget either know very little about Public Finance and monetary /fiscal policy or are spin doctoring for political advantage.
    Look at Australian economic budget history how many times has the Ausralian budget ever been in surplus for long periods of time?
    Warwick Smith says it more eloquently than me :
    ” Until people understand the basic realities of monetary economics we cannot have a meaningful discussion of government finances. Rather than worrying about deficits and surpluses we should be asking whether the economy would benefit from greater or lesser government expenditure or taxation. This calculation balances unemployment, spare capacity, and the need for infrastructure and services against inflation risk. It’s a complex calculation but the underlying principles are pretty straightforward.”

    [ See Warwick Smith’s recent article at ‘The Conversation’, 17 December 2014, 6.48am AEDT
    “Why the federal budget is not like a household budget “

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