Repeating the Budget mistakes of the past

From

Jeremy Lawson

The former Treasurer, Peter Costello, has been one of the fiercest critics of the federal budget laid down by Scott Morrison on Tuesday. In his eyes the government should have been aiming for an even earlier return to surplus, with any tax cuts targeted at those earning between $100,000 and $200,000 per year.

The irony of course is that Morrison’s budget strategy was straight out of the playbook of the final years of the Howard government. Then, the commodity boom was delivering surprisingly strong revenue growth. But rather than build larger surpluses for a rainy day, the extra revenue growth was assumed to be permanent and recycled into permanent tax cuts and spending increases.

The upshot is that the cyclically-adjusted budget balance deteriorated during the height of the commodity boom between 2003 and 2007 while the Organisation for Economic Co-operation and Development (OECD) average was improving. Australia’s fiscal position was still strong compared with other OECD countries, thanks to earlier consolidation, but it could have been even stronger and provided more ammunition to support growth when the commodity super-cycle ended in 2011.

Fast forward to 2018. For the first time in many years revenue growth exceeded Treasury forecasts over the past 12 months thanks to unexpectedly strong employment growth and a recovery in commodity prices. But rather than assume those surprises were mostly temporary, the government is projecting further unrealistically strong GDP and revenue growth over the forward estimates. It is this sleight of hand that has allowed them to cut taxes, albeit mostly backdated, raise spending and project a return to surplus one year earlier than previously anticipated.

The reality is more unsettling. The current global expansion is now nine years old and a variety of economic and policy fundamentals point to rising recession risks before the end of the government’s forward estimates. Moreover, whenever the next global downturn does come Australia will face that harsher external environment with much larger domestic imbalances than in 2008 as well as less monetary and fiscal room to react.

And even if the bad times do not return over the next few years, the government’s assumptions for potential nominal GDP and revenue growth appear too high and spending projections too low, especially against the backdrop of an aging population.

In truth the budget was a missed opportunity. What the country needs is more aggressive fiscal and structural reform. There is a desperate need for Australia’s tax base to be broadened and the country’s inefficient web of tax expenditures to be streamlined to accommodate higher age-related spending over the coming decades.

The relationship between the states and commonwealth also needs to work better. Current arrangements render states unable to meet all of their spending obligations, leaving them heavily reliant on tied grants from the federal government, GST revenue, to make up the difference. In addition, the taxes they do rely on, like stamp duty, are highly inefficient. There are no easy solutions to this problem but there is scope to devolve more revenue raising powers to the states.

Federal budget management is no longer best practice by international standards. We think the government should be implementing formal, independently monitored fiscal rules. These would help ensure that short-term budgetary decisions are consistent with long-term fiscal sustainability while also allowing governments to run temporary deficits during periods of below trend growth without bringing their longer-term fiscal commitments into question.

There is also a strong case for a different tax and spending mix. Australia is very reliant on direct taxes on individual and corporate income, while the tax-transfer system is insufficiently progressive. Indeed, if the government follows through on its budget commitments the system will become even less progressive over time. And though the budget did make some provision for more infrastructure spending, the amounts are insufficient to meet the country’s needs.

Pursuing such a forward looking strategy would not be easy in the current political climate. But the long-term payoffs for the country would be large, especially for the millennials that are already struggling with low pay and unaffordable housing, and who will be left to pick up the pieces if these problems are left unaddressed.

By Jeremy Lawson, Chief Economist

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