Pearls and Irritations

What are the budgetary implications of the AUKUS nuclear-powered submarine deal?

Here are some numbers provided by a Defence spokesman to select journalists. It is expressed in today’s dollars so does not include future inflation.

Since it was a background briefing not an official communique it’s not clear who takes responsibility should these costings prove wildly wrong. Given past underestimates of procurement costs they perhaps should be taken with a grain of salt given that this is the most complex endeavour Australia has ever undertaken.

The Maths

Over the 32 financial years 2024 to 2055 the subs are estimated to cost between $268 and $368 billion.

In case you can’t get your head around a billion dollars it is 1,000 million dollars. If each one million dollars was granted to a poor household (and I’m not suggesting that) it would create an extra 268,000 to 368,000 millionaires. That would be on par with the populations of Hobart, Geelong or Wollongong let alone Darwin or most other regional cities. In other words, this sub deal involves a lot of money that needs to be found from somewhere.

However, it looks less frightening when spread over its expenditure horizon. Over the budget forward estimates from 2023/24 to 2026/27 it will cost $9 billion of which $6 billion will be saved from the abandoned French submarine deal. The government says the net additional cost of $3 billion will be found from scrapping other planned defence procurements.

Presumably the army, air force and navy won’t be happy about that. The Leader of the Opposition, Peter Dutton, has said that his funding support hinges on the new sub deal not detracting from other military infrastructure. He has suggested it be funded by cuts to the National Disability Insurance Scheme which is one of the government’s fastest growing programs.

After allowing for $27 billion in savings from abandoning French subs and other military equipment, the extra net cost of the AUKUS subs is projected at between $23 and $31 billion from now to 3032/33. Though it won’t impact the budget for the next four years it will add between $3.8 and $5.2 billion a year in the six years thereafter.

Beyond the next ten years the program will cost a total of $218 to $310 billion. The cost of 12 Attack Class French subs were still included in the last budget’s forward estimates. They were costed at $90 billion in Sept 2021. Deducting $24 billion saved on them over the next ten years would leave $66 billion to be saved thereafter. That suggests an extra net cost to the government of the AUKUS subs of $152 to $244 billion from 2033/34 to 2054/55. That averages $4.8 to $7.6 billion a year.

The government has not provided any long-term projections of its gross or net debt in dollar terms. What it has told us is that the net debt/GDP ratio of 23% by June 2023 will jump to almost 32% by June 2033. If the AUKUS subs are not paid for by higher taxes or cuts to public spending, they will add $3.8 to $5.2 billion to the government’s annual deficit between 2027/28 and 2032/33. That means by June 2033 the net debt will be $23 to $31 billion higher than it would otherwise be. That is an addition of 4.0% to 5.4% on the estimated net debt of $572 billion at June 2023.

The Challenge

Finding the extra $3.8 to $5.2 billion a year between 2027/28 and 2032/33 and the extra $4.8 to $7.6 billion a year thereafter to 2054/55 will be challenging for the federal government given that it is has an ongoing structural deficit (gap between expenditure and income) of around $50 billion a year.

The Treasurer and Finance Minister have essentially three choices. Firstly, run bigger deficits and debt and reinforce Labor’s reputation as the party that can’t manage money. Secondly, raise taxes and risk the same fate as Bill Shorten’s brave 2019 election agenda. Finally, cut spending across the board or tighten eligibility criteria for fast growing programs such as disability, aged and health care by introducing means tests.

Assuming no policy changes, the federal net debt (after offsetting its financial assets) is expected to grow from $572 billion in June 2023 to $767 billion by June 2026, a rise of $195 billion. Most of this stems from accumulating annual budget deficits. As we have seen AUKUS subs thanks to the scrapping of French subs and a reordering of defence priorities should add nothing to this debt. But beyond 2026/27 the AUKUS subs will add about $175 to $275 billion to the net debt by 2054/55 assuming savings of $84 billion from discarding French subs.

Tax changes that might be considered include abandoning the stage 3 tax cuts costing about $25 billion a year, broadening the range of goods and services subject to the GST, introducing a death estate duty or inheritance tax, abolishing negative gearing on investment properties, ending cash refunds for dividend franking credits that exceed a taxpayers annual tax liability, scrapping the capital gains tax concession, applying a minimum 30% tax on family trust income distributions, applying a resource rent tax on miners, and replacing the “safeguard mechanism” that caps carbon emissions from the biggest polluters with a carbon tax on all polluters.

On spending cuts, one newspaper said policy initiatives or proposals that could be squeezed out by the cost of AUKUS submarines are transport infrastructure (about $12 billion a year), boosting school funding to meet the school resource standard (about $6.5 billion a year), raising care payments to $88 a day (about $3.1 billion a year), increasing the Medicare rebate for GP consultations (about $2.1 billion), plans to expand long range missile capabilities (about $1.5 billion), paying early childhood educators 20% more (about $1.0 billion a year) and lifting rent assistance by 30% (about $0.67 billion a year). Of course, this is just one menu since the list of possibilities is endless.

The Bottom Line

The bottom line is that the more Labor spends on “guns” the less it has for “butter”. In other words, if it wants to give defence top priority it can’t also fund increased social programs let alone cut income taxes and repair the budget. To use another metaphor “it can’t have its cake and eat it too”. The government was already facing a herculean task balancing its books, the AUKUS subs have made that more difficult.

Finally, the premise that Australia needs to spend three to four times as much on long range nuclear submarines than conventional ones so it can attack naval craft off the coast of China rather than defend our own shores is questionable. As is the presumption that China is an imperial power that wants to occupy Asia like Japan once did.

China certainly wants reunification with Taiwan which almost all nations recognised as part of its jurisdiction fifty years ago, but as for expanding beyond its traditional borders China has never stated such an intention. Unlike the USA and Russia, it kept out of wars in Afghanistan, Iraq, Syria, Libya, Georgia, and Ukraine. If it wanted to conquer its neighbours, it would have overthrown democratic Mongolia which is more than twice the size of Ukraine, is mineral rich and has limited capacity to defend itself. But China has respected its sovereignty.

President Xi recently said he wanted the People’s Liberation Army to become a “great wall of steel that can effectively safeguard national sovereignty, security and development interests“. That emphasised internal defence, not external aggression as some commentators construed. Indeed, the long-standing basis of Chinese foreign policy has been the “Five Principles of Peaceful Coexistence: mutual respect for sovereignty and territorial integrity, mutual non-aggression, non-interference in each other’s internal affairs, equality and mutual benefit, and peaceful coexistence.”

But Australia is now locked into the AUKUS pact and all it entails in helping America confront China. The Government will now have to manage the fraught fiscal, logistical, and strategic implications associated with that.

Equally concerning, are these graphs of American and Australian views on China over time:

Americans’ Favourable versus Unfavourable views on China

Australians’ Opinions of China as an Economic Partner or a Security Threat

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