No surplus without income tax increases

The fiscal contraction from this year’s budget is about two-thirds the size of the Howard government’s first budget in 1996, yet the initial reaction of voters has been very different indeed.

Two polls published this morning have the Coalition in a “world of pain”, as The Australian’s headline puts it. According to its Newspoll, Bill Shorten now has a 10-point lead over Tony Abbott, with 69 per cent saying they would be worse off -- the largest percentage since 1993 -- and only 5 per cent saying they would be better off. It’s the worst result for the Coalition on record.

The Fairfax/Nielsen poll agrees: it has Shorten on an 11-point lead and puts the two-party preferred vote at 56 per cent for the ALP and 44 per cent for the Coalition, a swing of nearly 10 percentage points since the election.

The fairness rating of this budget is minus 30 per cent, according to the Fairfax/Nielsen poll. By contrast, the 1996-97 budget had a fairness rating of plus 22 per cent, even though it was objectively tougher.

According to analysis by Tim Toohey of Goldman Sachs, the policy decisions taken in the 2014 budget, plus last December’s MYEFO, equate to -2 per cent of GDP over four years, whereas the 1996-97 budget was -3 per cent over four years.

So what accounts for the different reactions?

The 1996 budget introduced family tax benefits, as promised, at a cost of $3.5 billion. The 2014 budget cut them.

The 1996 budget raised $2.2bn from a cut in R&D concessions and $1.6bn from the superannuation tax surcharge among a long list of revenue increases. Overall, revenue measures and spending cuts were about evenly balanced ($10bn each over the forward estimates).

In 2014 the spending cuts dominate and they mostly target the less well off.

There are almost 90 individual cuts to health and welfare programs totaling $25.8bn over the forward estimates, including the very unpopular Medicare co-payment.

On the revenue side, there are just two things: the permanent reintroduction of fuel excise indexation, which disproportionately hits poorer people, raises $4bn; while the budget repair levy on high-income earners is temporary.

But the biggest difference is that this year’s is effectively a 10-year budget. Tony Abbott and Joe Hockey committed their government to achieving a surplus within 10 years while keeping taxation to less than 25 per cent of GDP, and the budget had to deliver on that.

The result of that is the $80bn in cuts in payments to the states, with “more realistic funding arrangements for public hospitals” that don’t start till July 1 2017 and schools that don’t start till January 1 2018. With that, Tony Abbott has managed to unite the states against him right now.

It’s hard to imagine anything more absurd than a 10-year budget.

Treasury has enough trouble forecasting the four-year forward estimates, let alone 10 years. Anything can happen in a decade, and probably will. The forecast of a surplus of 1.3 per cent of GDP in 2024-25 is as meaningless as it is politically damaging.

The political pain in 2014-15 required to meet that target without increasing taxes, given the continuing blowout in health and education spending, is very meaningful indeed.

The Commission of Audit removed the effect on tax revenue of bracket creep from its 10-year revenue forecasts, which Treasury had been relying on for its long-range forecast smaller and smaller deficits. It seems the budget has done the same thing, although that’s hard to work out.

In any case, if this morning’s polls show anything, it’s that it will be politically impossible to achieve a budget surplus in 10 years with no permanent income tax increases.

At its core, the 2014 budget is a crazy, brave attempt to achieve that task by slashing health and welfare spending and forcing the states to agree to an increase in the GST.

That plan might have to be reconsidered.