Narrow focus on budget surplus misses the point
Most of those who take a political approach to the budget assume that if it's in deficit, the way you get it back to surplus is to cut government spending or, if you're a really bad person, increase taxes.
When the severe recession of the early 1990s turned Paul Keating's budget surpluses into big deficits, he told people not to worry: as the economy recovered, the budget would "whirr back to surplus".
He was right, it did. Only trouble was it took a while to happen, and by then the chap in charge of the budget was Peter Costello - who, as any politician would, took all the credit.
When Wayne Swan and Julia Gillard began predicting the budget would be back to surplus this financial year, 2012-13, they were assuming it would happen pretty much automatically. The budget would again whirr back to surplus after all the weakness of the global financial crisis.
It hasn't happened. As we learnt this week, the budget balance for this year is now expected to be a deficit of $19.4 billion rather than a surplus of $1.5 billion.
Why? Not because the government has continued to spend like a drunken sailor, as some would have you believe, but because the budget didn't whirr back as it was expected to. Rather than growing strongly, tax collections grew by a lot less than expected.
Contrary to what most economists were expecting, when the high coal and iron ore prices feeding the resources boom began to fall back, the dollar didn't fall back with them.
So the miners' profits have fallen, but the high dollar has continued to squeeze the profits of our other trade-exposed industries as well. They haven't been able to earn as much from their exports, nor charge as much for the stuff they sell in our domestic market because imported goods and services have stayed cheap.
So far, this hasn't adversely affected economic activity. The quantity of goods and services we produce (real gross domestic product) has continued to grow at a reasonable rate, but the rise in prices has been weak, meaning nominal GDP hasn't grown as fast as real GDP.
This means we haven't had to worry about inflation, but the profits of our miners, manufacturers and tourist operators (and, for different reasons, our wholesalers and retailers) have been squeezed.
For the budget, it means collections from company tax have grown more weakly than expected, as has the tax on capital gains. (Collections from the new mining tax have been a fraction of what was expected, but for a quite different reason: because the tax was new, Treasury overestimated how much it would raise in its early years.)
So the budget hasn't whirred back to surplus as expected because, for quite unusual reasons, the recovery from the GFC hasn't proceeded normally. The spending and taxing decisions of the government have had little to do with this.
Here's the point: if problems in the economy have prevented the budget from returning to surplus, we should worry about those problems, not the delayed return to surplus.
As the budget papers say: "Fiscal [budgetary] objectives are not ends in themselves. They matter because of their implications for employment, incomes and wellbeing. In essence, good fiscal policy entails allowing the fiscal position [the budget balance] to vary in response to economic conditions in the near term, while ensuring fiscal settings are sustainable over the medium-to-long term."
What causes the budget balance to vary in response to economic conditions are the "automatic stabilisers" built into the budget. They're what does the whirring, pushing the budget into deficit when the economy goes down and pushing it back into surplus when the economy comes back up.
The main built-in stabilisers are the progressive income-tax scale and the availability of the dole but, as we've just been reminded, the other taxes also play a part.
So much for the economy's effect on the budget balance. In budget week we need to look also at the budget's effect on the economy; to assess the "stance of policy" adopted in the budget. The Reserve Bank's way of doing this is simply to look at the expected change in the underlying cash budget balance, from a deficit of $19.4 billion this financial year to a deficit of $18 billion next year, 2013-14.
But Wayne Swan has fiddled this comparison by taking payments to local councils worth $1.1 billion and paying them in the old year when they weren't due until the new year. If you adjust the figures to remove this fiddle, you get a deficit of $18.3 billion in the old year and one of $19.1 billion in the new. This says the budget overall will have a tiny expansionary effect on total demand in the economy.
The Reserve will take this into account - along with many other factors - when it decides whether a further easing in the "stance" of monetary policy (another cut in interest rates) is needed.
However, the strict Keynesian way of assessing the stance of fiscal policy is to ignore the effect of the automatic stabilisers and focus on the net effect of all the discretionary policy changes announced in the budget.
Doing it this way shows that, after correcting for the fiddle, those changes will add $1.2 billion to the deficit for the old year and $1.4 billion to the one for the new year. This says the policy stance is stimulatory, but only to the tiniest extent (remember, nominal GDP will be $1.6 trillion).
It is true, as you've heard, that the effect of all the spending and tax changes announced this week would (if they are implemented by the government that wins the election) improve the budget balance by a net $28.4 billion over five years.
But this discretionary tightening isn't planned to start until the year after next, 2014-15, by which time we can expect the economy (and the budget) to be a lot stronger.
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