Abbott's now in real fiscal trouble

Comments from the Business Council and Australian Industry Group, published yesterday, look like a major headache for Tony Abbott.

Both groups, neither of which is a fan of big government, nonetheless called on the the Gillard government to rethink its expenditure cutting spree.

Fairfax papers report the BCA's Jennifer Westcott as saying "our members are telling us that the economy could well be softer than Treasury has projected, and in these circumstances it would be reasonable to revisit the need to return to surplus in 2012-13" and AiG's Innes Willox as saying cuts were "already very substantial and we must now be getting close to the point where it could be self-defeating and fiscal policy could excessively slow the economy and, ironically, impede the recovery of tax revenues".

That's right, keep spending at the current level, or risk seriously damaging the already-softening economy.

For Treasurer Wayne Swan and finance minister Penny Wong, that's a pretty easy request to meet – neither wants to cut spending any harder than they already did in last week's MYEFO statement.

The government copped plenty of flak for its cuts to the baby bonus and tertiary education funding, and plenty of opprobrium for demanding businesses pay their tax bills monthly instead of quarterly.

These were part of a package of 'savings' that reduced expenditure by $16 billion to give the government a chance of delivering a tiny surplus of around $1.5 billion.

In recent days Wayne Swan has shied away from reaffirming that he'll actually hit that target, but this looks like a feint. Along with the Treasury boffins, Swan has only just finished going through the expenditure/receipts balance line by line, and suddenly can't guarantee he'll hit his own carefully calculated target?

Under-promising and over-delivering looks more likely. By refusing to guarantee a surplus, Swan appears to be drawing out an attack from the opposition benches so that he can rub coalition noses in it when the tiny surplus is, in fact, achieved.

This rhetorical pattern is becoming a daily feature of question time. Having allowed itself to be pummelled to the point of collapse for the past year on the carbon tax, the government is stepping up to the dispatch box with example after example of how Treasury modelling was overly pessimistic about price rises that would flow from the tax.

So Tony Abbott is taking something of a hiding in the media for a string of predictions he made about prices rises that have not only failed to materialise, but in many cases have gone the other way. Greg Combet has listed a string of household costs that have fallen – milk, seafood, breakfast cereal, and Barnaby Joyce's hyperbolic '$100 lamb roast' prediction. They're all slightly cheaper now than before the carbon tax came in.

But back to spending cuts. The BCA and AiG comments put a tiny bit of pressure on the government, and a massive amount of pressure on the coalition, which plans to do away with the carbon tax, mining tax (not that it appears to be worth a cent), maintain lower-income tax cuts and increases in the family tax benefit and pension (which the carbon tax pays for), and instead balance the budget through more extreme expenditure slashing.

Indeed, a rigorous portfolio-wide policy review process led by shadow finance spokesman Andrew Robb has carefully put together a list of spending cuts that, we're told, we'll get to see closer to the election.

However, with the BCA and AiG offside that might need to be re-thought. All that hard work may need to be undone.

The BCA and AiG comments are part of a global recognition that spending cuts can reduce economic output by far larger proportions that was previously accepted as economic orthodoxy (The IMF's world-changing U-turn, October 15).

The danger of overly austere budgets is clearly set out in a chart published yesterday by Britain's Telegraph newspaper, based on research by the National Institute for Economic and Social Research (Niesr) – see it here.

Niesr's research shows that when a national economy has cut rates effectively to zero, and exhausted the possibility of expanding money supply through quantitative easing, there is nothing left to cushion the blow of public spending cuts. It says that Greece's budget slashing has killed off economic activity, and therefore tax revenue, to such an extent that it has increased the nation's debt to GDP ratio by 32.4 percentage points.

Now, Australia is a very long way from that kind of scenario. But other far less indebted European nations are finding their own 'fiscal multipliers' are larger that 1 – that is, a dollar of spending cuts causes more than a dollar of economic contraction.

The RBA still has a rate cuts left up its sleeve before we get into negative real interest rates, and nobody thinks we'll have to quantitatively ease in the foreseeable future.

However, the global rethink on the 'fiscal multiplier' should be enough to make Australians very afraid of the Abbott spending cut plans.

In short, team-Abbott is going to have to do some rapid rethinking of its plans before an election is called. Most sources I have spoken to around parliament, on both sides of politics, put the election on one of two weekends next September – nearly all agreeing that a snap House-of-Reps-only election in March would only be considered in a moment of extreme desperation.

So there is time for the coalition to work out how to massage the revenue side of the federal budget to bring it into balance.

Simply slashing public spending no longer looks like an option.