Commentary 12th May 2014

Budget crisis! What budget crisis?

The budget deficit has been heading in the wrong direction since 2007, when the Howard government, supported by Labor, lowered the effective tax rate by approximately 3 per cent of GDP. 

However, the structural problems first started to show up when a budget deficit emerged shortly after the onset of the Global Financial Crisis as the government's revenue decreased significantly. The deficit since then has pushed the debt-GDP ratio up and the current government is now calling for budget emergency measures, such as a temporary tax levy.

However, there is no budget crisis. The government debt-GDP ratio is currently almost 35 per cent, which is the same level reached during the 1991/1992 recession and well below the level that prevailed from Federation up to 1950. This is far from being a crisis. Furthermore, a temporary tax levy is not going to alleviate the debt trajectory; the only way to change that is to reduce the structural budget deficit, which requires a permanent reduction in government deficit-GDP ratio by 3 percentage points or an increase in the tax revenue-GDP ratio of 3 percentage points, noting that the current deficit is approximately 3 percent of GDP. A temporary tax levy is also a very random way of taxing income earners who happen to be in high-income brackets at the period at which the levy is in force. If the Abbot government wants to go the tax way, it would be much better to introduce a wealth tax and increase the GST.

That there is no budget crisis does not mean that nothing should be done to reduce the budget deficit – why should future generations pay for this generation's excess spending? Furthermore, improving the budget deficit will automatically improve the current account balance and put Australia in a much better position to respond to potential future crises. The deficit is structural in nature and should be reduced to, preferably, less than 1 per cent of GDP – a deficit that is sustainable and that would keep the debt-GDP ratio unaltered. It can be gradually changed to a surplus when the economy gains momentum. The government should be applauded for giving deficit reduction high priority.

That there is no budget crisis does not mean that nothing should be done to reduce the budget deficit – why should future generations pay for this generation's excess spending?

Professor Jakob Madsen

Professor, Department of Economics

Of course we have to wait and see what measures tomorrow night's budget will contain, but judging by the media speculation and by the Report of the Commission of Audit suggestions, the government's repair initiatives appear a bit random and patchy. For example, the Parental Leave Scheme (PLS), repealing the carbon tax, abolishing the mining tax, implementing the Gonski reforms and the national disability insurance scheme are all going to be very costly, and will add to the budget hole that is almost $50 billion this financial year. It is odd to introduce the PLS and eliminate the mining and carbon taxes at a time of "budget crisis" – not to mention the fact that none of these measures makes any sense from an economic perspective, and that Australia needs to show much more commitment to carbon reduction than it has thus far shown.

The government should also reconsider its corporate welfare subsidies to the mining sector in the form of fuel tax concessions, which cost Australian tax payers more than $2 billion a year. Reintroducing price indexation of fuel taxes, if implemented, is certainly a very welcome step to reduce carbon emissions and, at the same time, aid the structural budget deficit.

So where should the government save on their budget? Hockey has rightly pointed out that we need to increase the pension age as the life expectancy at the age of 65 has gone from 12 years in 1909 when the pension age of 65 was introduced to 21 years today. Since the age pension costs the government $40 billion annually, an increased pension age is an effective way of lowering the deficit because of direct savings and because the increased labour force participation will increase the tax revenue. However, as the planned increase won't take effect until 2035, it will have no effect on the current budget position. It is, therefore, vital that the pension age is increased to 70 now and not in 2052 as suggested by the Commission of Audit! Superannuation taxes also need to be increased gradually from the minuscule effective rate that is currently in place. The government would also save several billions of dollars a year if it included owner-occupied housing in the age pension asset test.

Payments to families such as Family Tax Benefit and paid parental leave that currently cost $26 billion also need to be pruned, probably substantially. Some of the savings on payments for families could be used to subsidise daycare as in the Scandinavian system so that females have stronger incentives to re-join the labour market after childbirth and, implicitly, pay for some of the costs through taxes. The prime age labour force participation rates in Australia are 10-20 percentage points below those of Scandinavia, so there is plenty of room for improvement on this front.

Professor Jakob Madsen is the Xiaokai Yang Professor of Business and Economics in the Department of Economics, Faculty of Business and Economics at Monash University.

By Jakob Madsen

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    Professor Jakob Madsen

    Professor, Department of Economics Monash Business School

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