Michael Keating[i]. From Deficit to a Balanced Budget

The issue of budget repair has not been addressed adequately in the current election campaign. See below an earlier article by Michael Keating on various revenue and expenditure items that need to be considered.  John Menadue

A Report by the CEDA Balanced Budget Commission

The Committee for Economic Development of Australia, which has a long history of independent public policy engagement, this week released an important report discussing the options for restoring the Australian Government Budget to balance.

The starting point for this report is that despite 25 years of uninterrupted economic growth, Australia is now in its eighth year of continuous and substantial fiscal deficit, with no sure prospect of returning to surplus and staying there. Furthermore, the longer it takes to get back to Budget balance, the more difficult the task becomes; if only because of increasing interest payments on a rising debt burden.

Continuous budget deficits mean that Australia has less capacity to respond to future economic shocks and the political choices to insulate and boost our economy become limited. These continuous deficits also penalise future generations.

As the Report notes, both political parties are committed to return to a fiscal surplus as quickly as is reasonable, and they are both also committed, at least for the time being, to limiting the share of taxation to around 23.9 per cent of GDP. The problem, however, is that so far there has been no community or political concensus on how best to restore fiscal balance within this declared taxation limit. The purpose of this CEDA Report is therefore to consider packages of measures that could restore fiscal balance by a target date of 2018-19, while working within that tax limit.

Using the latest Treasury economic projections, the key finding of this report is that this challenge can be met, and fiscal balance in 2018-19 could fairly readily be achieved drawing from a variety of options. All the options are considered to be well within the contemporary conversation on tax and spending choices, and to be politically acceptable and achievable. The measures actually selected are also considered to be of sufficient magnitude to make a substantial difference to the deficit outcome, within the relevant time period.

Given, (i) the Treasury projections for economic growth, (ii) the 2018-19 Budget deficit projected in last December’s Mid-Year Economic and Financial Outlook (MYEFO), and (iii) a taxation limit of 23.9 per cent of GDP, then a balanced budget in 2018-19 implies that government outlays should be equivalent to no more than 25.5 per cent of GDP[ii]. This in turn means that in 2018-19 dollar terms the task for the CEDA Budget Commission was to find $2 billion in spending cuts from the MYEFO outcome for that year, and $15 billion in revenue enhancements.

In effect, this Report has come to the conclusion that while action on both sides of the Budget is required, essentially Australia has a revenue problem rather than an expenditure problem. This is of course what most other experts have argued, and one wonders how much progress can be made towards fiscal restoration if the Government will not accept this basic truth.

Five packages of options are reproduced in the report, which collectively would raise far more revenue and/or cut expenditures by much more than necessary to restore the Budget balance within three years. However, the intention is that a selection could be made from these various measures, recognising that not everyone (including members of the Budget Commission) will agree with all of the measures proposed.

The revenue measures from which a selection would be made, include:

  • reducing the superannuation tax concessions,
  • reducing the capital gains discount,
  • raising taxes on luxury cars, alcohol and tobacco,
  • halving the fuel tax scheme,
  • removing negative gearing,
  • removing the private health insurance rebate exemption,
  • reducing industry tax concessions,
  • increasing petrol tax,
  • lifting the capital gains tax on superannuation fund earnings,
  • reducing work related deductions, and
  • continuing the Budget repair levy of a 2 percent higher tax rate on annual incomes greater than $180,000, and which is due to cease in 2017-18.

As noted the measures to reduce outlays amount to much less savings, but the selection includes:

  • lower drug prices under the pharmaceutical benefits scheme,
  • reduced assistance to industry,
  • cutting the private health insurance rebate,
  • a Higher Education efficiency dividend,
  • further reducing the public service by reducing the scope of activity, and
  • improving the cost effectiveness of medical treatments.

Readers will make their own assessment about these various measures. But all of them have been canvassed publicly and collectively they amount to considerable more than sufficient to achieve the goal of fiscal balance by 2018-19. Accordingly, perhaps the key finding of this report is that the task of fiscal restoration is not all that hard, and that if the effort were made with a bit more consultation to gather support, then there is no reason why any government cannot restore the Budget within three years.

However, that still leaves the more difficult problem of the longer-term outlook for the Budget. Even if a balanced Budget is achieved in 2018-19, longer term projections in the 2015 Intergenerational Report show that on currently legislated programs, Australian government spending is likely to resume increasing faster than GDP. Thus, with a fixed tax limit, continuing budget deficits would quickly reappear.

The CEDA Balanced Budget Commission ‘agreed it was not sensible to adopt an inflexible rule on what Australian Government spending should be as a share of GDP in three or four decades time’. My own personal view is that there are good reasons why government spending is likely to increase its share of GDP over the longer term. In particular, as incomes rise the demands for services such as health and education rise disproportionately, as do demands for improvements in the quality of life, all of which lead to increasing demands upon government. In addition, in Australia’s particular case, we are trying to run a decent welfare and social system, while total expenditures remain well below almost all other advanced democratic countries[iii].

So in my view this report provides yet another reminder, that the key issue for tax reform is to establish a system that can raise the necessary revenue to fund the services that Australians will expect in the future in as efficient and equitable way as possible. Unfortunately that is not the discussion about tax reform that political parties are promoting at the moment.

Furthermore, time is not on our side. As the CEDA report points out if we do nothing, then on present policies the projected deficit in 2054-55 would be equivalent to 6 per cent of GDP. But an equally critical point to note is that in that case, nearly two thirds of that deficit would be represented by public debt interest payments. As the report points out, this ‘outcome illustrates the destruction of political choices and economic flexibility caused by continuous accumulation of deficits’.

On the other hand, if we take action now, we would only need a modest rise in taxation along with continuing tight expenditure control to maintain fiscal balance. And with nominal GDP projected to be seven times bigger in 2054-55 than in 2014-15, net interest payments would be less than one tenth of GDP – a trivial share.

In short, as the CEDA report concludes, Budget repair is much more important than small tax cuts, even if they could be afforded, which at present is very doubtful.

 

iMichael Keating was a member of the CEDA Balance Budget Commission. He was also a former Secretary of the Departments of Prime Minister and Cabinet, and Finance.

iiThe difference between revenue at 23.9 per cent of GDP and outlays at 25.5 per cent is accounted for by non-tax revenue.

[iii] Total general government outlays represented 36.4% of GDP in Australia in 2015, compared with 37.9% for the USA, 40.5% for New Zealand, 40.1% for Canada, and 49.4% for all of OECD Europe (Source: OECD Economic Outlook, 98 database).

print

This entry was posted in Economy, Politics and tagged , , , . Bookmark the permalink.

4 Responses to Michael Keating[i]. From Deficit to a Balanced Budget

  1. supermundane says:

    Economist Bill Mitchell’s rejoinder: http://bilbo.economicoutlook.net/blog/?p=33255

  2. Wayne McMillan says:

    As much as I can see that continuing budget deficits that grow greater than GDP could be a problem, I am not comfortable with the idea that the Ricardian Equivalence Theorem ala Barro that is assumed in your article i.e future generations will pay with higher taxes for the deficits of today, applies anymore. I am revising my whole approach to deficit and surpluses in the light of new theoretical developments in Economics, and I must note that many economists in the business world appear to be ignorant of these findings. I am alarmed at the recent emphasis on budget repair when the economy is flat and we still have massive underemployment and considerable unemployment. How many viable full- time jobs are being created for our youth and our graduates?

  3. barbie says:

    Thanks again for the blog post. Really Cool.

  4. Wayne McMIllan says:

    Michael,
    Central Governments in the 21st century that have a freely traded fiat currency don’t need to borrow, so why is there concern about interest repayments? The CEDA Balanced Budget Commission needs to look at the new developments in monetary theory. The Commission Report is based on false assumptions from old, flawed monetary theory.
    When will this preoccupation with Commonwealth government budget deficits, to the detriment of underemployment and adequate government investment in education, health and research and development stop?

Comments are closed.