Australia’s weak fiscal position threatens safe haven status

Standard Life Investments, the global investment manager, believes that despite experiencing one of the mildest downturns of any country during the global financial crisis and benefiting from a commodity boom, Australia’s structural fiscal performance has deteriorated significantly over the past decade. If not addressed, this could eventually threaten Australia’s safe haven status.

Speaking yesterday in Sydney, Jeremy Lawson, Chief Economist, Standard Life Investments said: “Australia should act now to reverse its structural fiscal slippage, with a rise in taxes and a drop in spending both necessary for better fiscal control.”

Australian governments have rested on their fiscal laurels during the commodity price boom and rather than squirrel large surpluses away for a rainy day, governments have satisfied voters’ appetite for lower taxes and more generous spending.

“Australia’s tax share of GDP has declined by 1.3 percentage points (ppts) since 2003, despite the increase in government finances generated by the commodity boom and rapid income growth before the global financial crisis. Only five other OECD countries have seen larger falls. Meanwhile, Australia’s government spending share of GDP has increased by 2 percentage points over the past decade, slightly above the OECD average, and could continue to rise.

“Australia’s aging population alone could add more than 5 percentage points to the budget deficit over the next 40 years, mostly due to rising health care spending. Australia’s public finances will deteriorate over time without action to raise taxes and restrain spending.

“Our view is that long-term fiscal consolidation of the magnitude required will have to involve rising taxes as well as greater spending discipline. The states and the Commonwealth must work more cooperatively for the fiscal situation to improve. The states cannot raise enough revenue to meet all of their spending obligations and rely heavily on tied grants from the federal government, as well as GST revenue, to make up the difference.

“Although centralising more spending responsibilities within the federal government structure would better align revenue raising powers with spending responsibilities, a superior course of action would be to devolve more revenue raising powers to the states. That would better provide them with the means and incentives to appropriately manage their fiscal arrangements.

“Moreover, the management of the federal budget has been poor for more than a decade. The Parliamentary Budget Office should be given more formal responsibility for monitoring the federal budget and ensuring that policy is consistent with longer-term fiscal sustainability.

“We recognise that there are no easy solutions to this problem. If, however, governments and oppositions wait too long to confront the country’s long-term fiscal challenges, Australia could eventually lose its safe haven status. That would raise government and private sector borrowing costs, as well as reduce demand for riskier Australian assets, making everyone worse off.”