Hostage to fortune

Additional volatility is being built into government revenue. This does not bode well when governments find spending so enticing.

Whatever politicians in Europe and the United States may have thought over past years, nations have no special privileges when it comes to consistently outspending their incomes. Their comeuppance arrives, even if more slowly than it does for individuals and businesses. The responsible course is to ensure that budgets are balanced over business cycles. As good an objective as this is; it is no easy task because who knows what lies ahead.

Expenditure is relatively easy to estimate. Most of it is locked in and will go on rising as populations and their averages ages increase. Revenues are the hard part.

Countries which have flatter taxes (those, for example, that are relatively more reliant on broad-based expenditure taxes) and with industries relatively less exposed to world demand tend to experience shallower swings in revenue flows. Australia is not one of these countries and Swan’s budget, and the mining and carbon taxes which feed into it, makes revenue even more volatile.

Most analyses of the budget appear to concentrate on the virtue or otherwise of individual spending and taxation changes; on the sleight of hand used to nudge the budget into a small surplus and whether it will be achieved in any event; and on the political impact of the budget. The strategic import of the budget being increasingly hostage to fortune is largely lost in the noise.

The prudent course during buoyant economic years is to assume that the inevitable forthcoming economic downturn will be steep. Money has to be put away by governments in similar fashion as should individuals and businesses subject to the vagaries of fortune. Costello and Howard effectively put money away by paying off government debt; which was in the black in net terms when they lost office.

During the period 1996/07 to 2007/08 they accumulated surpluses of $97 billion. Leaving aside legitimate doubts about whether they did nearly enough, perhaps if the times had not turned sour and they had not lost office they would have gone on wisely to build a sovereign wealth fund. We will never know. What we do know is that Swan, with the assistance of two prime ministers, has accumulated deficits of $174 billion from 2008/09 to 2011/12, and the outstanding stock of net debt is estimated to reach around $142 billion by the end of June.

Wild spending contributed most to this dramatic turnaround, but taxation receipts also fell from 23.7 per cent of GDP in 2007/08 to 21.8 and then to 20.2 per cent in the following two financial years. This budget and the forward estimates now include volatile revenue from the MRRT and carbon dioxide emissions and these revenues are largely being spent. Even when the Treasurer had a windfall gain in prospect of $4.8 billion over the next four years because of the Greens’ refusal to back a reduction in the company tax rate; did he pocket it? No, he spent it on quite unrelated pork barrelling giveaways to try to solicit votes.

The MRRT is particularly susceptible, as is mining revenue more generally, to economic downturns. A new vulnerability has been injected into government revenue with no counterpart intention to put a substantial part of this revenue away in good years; beginning now. On the contrary, we are on the cusp of enormous new entitlement spending programs on dental and disability schemes without any substantial offsetting spending cuts.

Carbon related revenue is subject to even more uncertainty. Revenue is based on a carbon tax and later a carbon price that is completely out of kilter with current world prices. If carbon prices were to stay at their current international level or collapse, as some believe they might, revenue projections would be badly hit following the expiration of the fixed price (tax) at the end of 2014/15. The problem is that this revenue is sensitive not only to levels of economic activity but to the machinations of a relatively immature world emissions market.

Entitlement programs are difficult to unwind as they are finding in Greece and Spain, in other European countries, and in the United States. Australia is not immune from rioting in the streets if the circumstances became stressed enough. It is a mistake to think we are.

Entitlements of all kinds need to be affordable over the long term and throughout bad economic times. When government revenue is increasingly susceptible to external economic conditions, the only sensible course is to base expenditure programs on revenue stripped of its cyclical highs, and to quarantine the unspent revenue in a sovereign wealth fund. This has two benefits. First it disciplines spending. Second it provides the wherewithal to support government programs in bad economic times.

Of course, the amplitudes of revenue swings will be reduced if Abbott gets in and repeals the MRRT and the carbon tax, but they will remain large enough to justify a much more disciplined approach to spending and saving. The GST was a warning shot. Australia was in a very fortunate starting position. Howard and Costello get any credit due to politicians. Swan gets none. However, most credit is still down to good fortune than to good policy.

Peter Smith’s book, Bad Economics, will be published very soon by Connor Court. You can pre-order (post free) here…

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