10 years to break the budget, 10 years to fix it

The deficit levy, the one that seems to have become an accepted certainty in three days of leaking while remaining coyly unconfirmed, should become a permanent tax increase.

As I wrote last year (No crisis, but taxes still need to rise, December 18; Income tax has to go up, December 16), Australia’s tax revenue is too low for the level of government spending that’s locked in, largely as a result of the ageing of the population as well as the extra spending agreed for education and disability.

Indirect taxes (GST and excise) are growing more slowly than GDP and, given its structure, increasing the GST rate is almost impossible. The rate of excise could be re-indexed but that would take too long and wouldn’t be enough.

The permanent income tax cuts and increased middle-class welfare given by John Howard during the temporary mining boom were reckless and now need to be reversed by his Coalition successor. The Labor Party didn’t have the courage, the competence or the economic conditions to do it, so the Coalition must clean up its own mistakes and restore the revenue.

And Tony Abbott made things worse with yet another bunch of absurd election promises: more middle-class welfare (paid parental leave) and more tax cuts (carbon tax and mining tax), plus the unpromised and unnecessary $8.8bn payment to the Reserve Bank.

Economic conditions are still not ideal, mainly because the mining boom was indeed temporary. But if revenue is not restored now, the structural deficit will get away from them.

Last night, ANZ’s economists estimated that the proposed tax would be a drag on consumption spending growth of between 0.5 and 0.6 per cent, and reduce GDP growth by about the same amount -- from 3 per cent to 2.5 per cent.

That’s likely to prompt slower, smaller interest rate increases next year, which might help to preserve employment in the face of the drop in consumption, but at the expense of increased house prices.

Based on Treasury’s long-range revenue forecasts, Treasurer Joe Hockey apparently believed a one per cent (of GDP) surplus could be achieved in 10 years with spending cuts only and no tax increases.

The Commission of Audit has disabused him of that. Tony Shepherd and the team have redone Treasury’s forecasts and decided that they are out by 1 per cent of GDP, or about $15bn in 10 years. Ten-year forecasts are meaningless, by the way, so we are almost certainly arguing about a future that doesn’t exist.

Anyway, the Commission’s terms of reference didn’t ask it to find a dollar amount of spending cuts, but simply enough to achieve a surplus of 1 per cent of GDP in ten years. That was the task. Shepherd’s team has done what was asked of it, but the task was $15bn greater than Joe Hockey thought and the spending cuts that much more unpalatable.

A reduction in spending growth from 3.7 to 1.75 per cent a year would be needed, the commission has reported. While the small-government brigade might like to see that, it’s not feasible or even a good idea in the context of the increased funding for education and disability that is locked in, on top of the increased pension and healthcare expenditure needed to fund the baby boomer dotage.

More specifically, the spending cuts needed would make the 2019 election very difficult to win because elderly voters and middle-income families would be starting to see material reductions in their standard of living. That might seem a long way off, but if Abbott wants to be more than a two-term prime minister, he needs to take action now.

The Coalition is a near certainty to win the 2016 election, almost whatever happens given the extent of last year’s victory. This would be why they are talking about a four-year deficit levy -- removing it two years before the second, more difficult election, by which time it might be forgotten.

The alternative -- pension and family welfare reductions that kick in just in time for the 2019 election -- would be far worse.

So yes, Australia’s fiscal problem is all about elections, past and future, and promises made in heat of anxiety and then broken or regretted.

More specifically, the budget now suffers from a decade of unstinting fiscal incompetence, starting with Howard and Costello’s income tax cuts and middle-class welfare increases, Rudd, Gillard and Swan’s spending and general ineptitude, and finally, last year’s ridiculous promises by Tony Abbott for more tax cuts and more spending.

The next 10 years will be spent cleaning up the mess of the past 10 years.