Close But No Cigar

I give the budget a begrudging tick. True, the envisaged increased spending on child care is excessive and extravagant; and the treatment of 327,000 pensioners who managed to save a modest nest egg iniquitous and inequitable. But, these egregious missteps aside, the budget does what is feasible these days to continue the process of narrowing the deficit.

There is a lot of blather that the government has squibbed the task of cutting spending. Well, economics and politics is the art of the possible, as the government found out last year.

It is simply glib to suggest that deeper cuts should have been made to expenditure. Tellingly, I haven’t heard those who suggest this actually nominating the areas to cut and by how much. In fact, the times have passed when razor gangs were able to slash expenditure programs with righteous impunity.

Mrs Thatcher had a policy of making deep cuts to expenditure in order to provide taxpayers with tangible benefits as a counterweight to the squealing of special interests. Unfortunately, that policy no longer has legs when a majority of voters have become net recipients of government largesse.

As the entitlement state builds there is enormous pressure on governments to meet loudly proclaimed needs. Peter Walsh warned years’ ago of child care being the next big entitlement push. He was right. Does anyone now think it can be rolled back? Healthcare and schools are voracious devourers of taxpayers’ dollars. And, however worthy it is, we now we have the NDIS to fund at great and increasing cost.

In these circumstances, it is rich to blame Hockey for not committing electoral suicide by trying to push back too strongly on the tide having tried, albeit ineptly, last year. If Treasury have it right, progress is being made; slow though it is. For next year, the deficit is forecast at $35 billion which is less than this year’s (2014/15) estimate of $41 billion and last year’s actual of $48 billion.

Treasury also estimates a structural deficit, which attempts to take out cyclical influences, including the ups and downs of the terms of trade. This deficit is forecast to fall from 2½% of GDP this year to 1½% next year; then down to 1%, and then to zero percent, before turning positive in 2018/19.

Mind you, spending is still too high even in the context of the constant clamour for more and more ‘government’ money. The ratio of spending to GDP will be stuck next year at this year’s relatively high level of 25.9%. The peak of spending to GDP under Howard and Costello was 25.1% and ended in 2007/08 at 23.1%; helped considerably, it should be said, by resource-based buoyant economic growth.

There is debate about whether declining revenues or increased spending is primarily responsible for deficits and debt. Spending under the twelve Howard and Costello budgets averaged 24.1% of GDP. In the eight years since (including the estimate for next year) spending averages 25.3%; so spending levels have certainly increased. But revenues have correspondingly fallen from an average of 25% to 22.8% of GDP. On the whole, therefore, falling revenue has been a major factor in the worsening fiscal outcomes. So without at all diminishing the spending problem we do, as well, have a revenue problem.

Business confidence is one key to boosting economic activity and revenue. While the small business tax concessions in the budget were well received, confidence more generally turns a good deal on whether growing government debt is being effectively tackled. Growing debt undermines confidence

Will we become like Greece? Will governments start increasing taxes? Will it get to a point where government debt is downgraded, which will have a flow on effect to private debt? What will happen when world interest rates start to rise? What will happen if the world fell into another recession and our terms of trade plunged further? And so on.

Australia’s gross federal government debt is low by international standards. It was 35% of GDP in 2014 according to the OECD. This compared with Germany 80%, Greece 190%, Japan 230%, UK 100%, US 105 %, Ireland 130%, France 115%, and the OECD average of 110%. However, Australia is more vulnerable than most to terms of trade cycles and debt is a slippery slope. Already it is costing 0.7% of GDP in net interest payments.

In the budget, federal government net debt is estimated at 15.6 % of GDP this financial year and is forecast to grow to 17.3% next year before peaking at 18% in 2016/17 and then falling back. This, I think, should underpin confidence and, if it remains on track, should forestall any downgrading of Australia’s debt.

But everything (revenue, deficits and debt) will turn not primarily on the budget itself, but on the forecasts for economic growth here and overseas. Treasury assumes that growth will be 2½% this year rising to 2¾% next year and then to 3¼% to 3½% thereafter. It sees this being driven by non-mining business investment underpinned by the lower dollar (which has fallen by 13% against the TWI since its peak in September 2011). Also assumed is that growth will pick up a little in Europe and a little more still in Japan and in the US, and that while China’s growth will fall back, it will remain above 6%.

Many commentators regard these assumptions as optimistic. I don’t know. Quite simply forecasting is a fraught business. Happily, the price of iron ore has risen significantly above the level assumed in the budget projections. So things can go right as well as wrong. We need to keep our fingers crossed that Australia continues to be lucky.