The medium-term budget outlook and its policy implications. Part 2

Dec 18, 2020

Yesterday Part 1 considered the medium-term outlook for the budget deficit and government debt. Today Part 2 discusses the Parliamentary Budget Office projections of revenue and expenditures, how realistic they are, and why policies will need to change if we are to return to sustained economic growth and fiscal strength.

The projections for taxing and spending

The PBO’s projections for receipts assume no changes in tax rates or thresholds beyond what has been already announced. While revenue will slowly recover from the current Covid-affected levels, total receipts as a share of GDP are projected to still be less in 2030-31 (24.5 per cent of GDP) than in 2018-19 (24.9 per cent) before the recession.

Total payments are projected to be 34.8 per cent of GDP in 2020-21, up from 24.5 per cent in 2018-19 and 27.7 per cent in 2019-20. From next year, payments as a share of GDP are projected to decline sharply, reflecting the end of the temporary assistance, reaching 26.1 per cent by 2030-31.

However, this increase of 1.6 percentage points, compared to the 2018-19 pre-Covid ratio of government payments to GDP, mainly reflects the slower growth of GDP, and not an increase in the long-run growth of budget payments.

However, it is doubtful whether enough money is being raised to sustain some government services. This then raises doubts about the adequacy of the future revenue projected, but also whether the structure of that revenue raising will be sustainable.

Pressures on government payments

Most importantly, the average annual real growth in payments per person after the recovery is expected to be just 1 per cent between 2024-25 to 2030-31. This is close to just half the average real growth rate in government payments of 1.8 per cent over the past 30 years. With such skimping, it is doubtful whether the Government can possibly meet its commitment of delivering essential services to the community.

A number of key areas require increased payments beyond the current forward projections. They include:

  • Aged care: The Royal Commission has amply documented the systemic failures and the under-funding. The Grattan Institute has calculated that to replace the present rationing with a rights-based system would require an additional $7 billion a year – a 35 per cent increase on current levels – from the federal government.
  • Tertiary education: Unlike most industries, universities did not receive JobKeeper and have suffered a major and continuing loss of revenue from overseas students. The universities are laying off large numbers of staff. Equally, funding for vocational education and training has fallen in real terms over the life of the Coalition government, and especially in the past few years. But both forms of tertiary education, and their research and training, are vital to underpin Australia’s productivity and employment growth.
  • Childcare: Labor has proposed subsidising 90 per cent of the cost. The Grattan Institute has proposed a broadly similar policy, which would increase the subsidy to as much as 95 per cent, but would gradually taper out for families with an income above $68,000. While this policy would cost an extra $5 billion a year, the resulting boost to workforce participation would increase GDP by an estimated $11 billion.
  • Income support: There is widespread agreement that rental assistance and JobSeeker rates need to increase substantially to ensure the social safety net is fit for purpose. The government effectively acknowledged that assistance was too low by temporarily doubling at the height of the pandemic the rate of assistance to people who were unemployed. However the rate of unemployment assistance should not depend upon the level of unemployment, but on what is needed to live modestly but decently.
  • Defence and foreign affairs including overseas aid: As is universally recognised Australia’s international security has deteriorated. The PBO projects that under existing policies defence expenditure will increase at an average annual real rate of 4 per cent between 2018-19 and 2030-31, increasing its share of GDP from 1.9 to 2.4 per cent. While significant, many doubt that will be sufficient, given the threats and the risk that the cost of major Defence acquisitions (ships, planes and so on) could blow out. Equally important, Australia needs to increase its ‘soft power’ by engaging more with its neighbours. Past budget savings made from cuts to diplomatic missions and the foreign aid budget must be restored and even increased.
  • Government administration: Since it took office in 2013 the Coalition has continually sought efficiency dividends. The PBO projects that on present policies, the real spending on government administration will only increase at an average annual rate of 0.6 per cent between 2018-19 and 2030-31. This is substantially less than the projected increase in the population, raising the question of whether the services can be maintained on a per capita basis.

A rough estimate of the additional funding needed to meet the government’s responsibilities for these essential services amount to another 1.5 per cent of GDP. Not all of this increase is needed straight away but it should be in place within a few years. That would mean a quite high rate of growth in real government payments in those years, but the rate of increase would then drop significantly below its long-term average rate of increase of 1.8 per cent.

Pressures on taxation

How much extra revenue would be required from tax to fund these commitments is difficult to say. It would depend upon the balance between private savings and investment once the economy has returned to full employment.

However, it is fair to say it is likely that some extra revenue would be required. As such, it is a very good reason for the government to abandon its Stage 3 tax cuts, due to be introduced in 2024-25.

Moreover, Stage 3 is highly inequitable. When all three stages of the tax reform package are combined, the PBO projects that because of bracket creep, by 2030-31 the lower four quintiles of taxpayers by income will have a higher average tax rate than they had in 2017-18. Those in the second and third quintiles (low to middle-income earners) will face the largest increases of about 4 percentage points in their average tax rate. By contrast, the average tax rate for people in the top quintile of income will be slightly lower.

It appears that the changes will be required to the structure of income tax, a timely point to also consider future revenue needs and how best to meet them. Australia relies very heavily on personal income tax, and the PBO projects this reliance to increase further under present policies, to the point where it will account for more than half of Commonwealth revenue in 2030-31. But it is difficult to find an alternative to this reliance on income tax, given that the principal alternative – the GST – is committed to the States.

Conclusion

It is clear that extra revenue will be needed to pay for the services that are essential to support both the economy and a socially inclusive society with reasonable equality of opportunity.

While some will try to argue that higher taxes will come at a cost to economic growth, there is no evidence for this self-serving contention. Australia is one of the lowest taxing countries among all the developed economies. Furthermore, the higher taxing countries in northern Europe have a higher rate of economic growth per capita than such lower taxing countries as America.

Even with this proposed increase in total government payments, the only Western democracies with a lower share of total government outlays as a percentage of GDP than Australia would be Ireland and Switzerland.

What really matters is how the tax revenue is spent. As indicated, spending on education and training, childcare, and income support will improve the economy’s growth potential. Most importantly, the anaemic economic performance over the past five years principally reflects a shortfall in demand. Fixing this will require a more equitable distribution of income, which this additional spending will help bring about.

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