Roll up for the MYEFO horror show

Highlighting the severity of 'Labor's mess' may help buy Hockey political capital for painful cuts, but it could destroy the very confidence he needs to turn the budget around.

There is an old Goya drawing that, once seen, is hard to forget. Entitled Esto es peor (This is worse), it depicts the mutilated body of a soldier impaled on the branches of a tree.

It's ghastly, but after today it’s likely to be one of the few works of art more grim than Treasurer Joe Hockey's first sketch of the state of the nation's finances – the Mid-Year Economic and Fiscal Outlook.

At the time of writing, the selectively leaked facts of this document make for horrifying reading. The accumulated budget deficits over the forward estimates have reportedly increased... wait for it... by about 500 per cent since Wayne Swan handed down the last budget in May, and by about 200 per cent since the pre-election fiscal update in August.

Wow. This is worse.

Hockey is unlikely to skimp on the gory details. He will want everyone to know that Labor's profligate spending caused this crisis – if that 'fact' is repeated enough in the press, voters will be left with a horrifying picture that is difficult to forget.

In reality, however, it is not a fact.

While Labor did spend and borrow heavily through the GFC, and while, at the time of writing, it appears to have exceeded its own cap on the rate of spending growth – the slightly rubbery promise of "2 per cent on average over the cycle" – this is much, much less than half of the picture.

There are two sets of forecasts against which today's MYEFO results/projections can be measured – one by Treasury, and another by the Parliamentary Budget Office. While their methodologies have some differences, their estimates as to what is happening to the federal budget over time are nearly identical.

Both find that it is a structural problem in the revenue side that has ravaged the budget, not on the spending side.

Specifically, the PBO last year reported that between fiscal 2002-03 and fiscal 2011-12, there was a 6 percentage point fall in structural balance of the budget, which comprised a blowout in structural spending of 1 percentage point, and a much bigger fall in structural revenues of 5 per centage points.

Yesterday, my colleague Alan Kohler rather blithely skated over a major point of contention between Labor and the Coalition by repeating that fact that the first Rudd government "inherited a structural surplus" (Income tax has to go, December 15).

Kohler is right, but only just. The budget went into structural deficit in the 2007-08 fiscal year, but the sharp fall in structural revenues began with income tax cuts in the last year of the Howard government.

This point of contention deserves much more attention than it has received to date, because it paints the real picture of what's happening ­– unlike Hockey's expected sketch of a mutilated economy impaled on a tree.

In both the PBO and Treasury modelling last year, it is noted that a natural recovery process is underway.

The PBO's analysis found "the budget has been in structural deficit since 2006-07 or 2007-08 and that, while declining, the structural deficit will persist at least until 2016-17".

The Treasury modelling found "Over the medium term, the improvement in the structural balance reflects the government's commitment to limit real spending growth and allow tax receipts to recover naturally ... the key point to draw from the analysis is not the specific year in which the budget returns to structural surplus, but the steady improvement over time”.

We are now in a very dangerous political game. If MYEFO is presented with all the horror predicted, this government will risk further sharp falls in consumer and business confidence in a one-eyed bid to convince voters that the Gillard-Rudd government was "the worst government ever".

Labor should be castigated for exceeding its own spending cap (if that is what MYEFO reports), but not for its plan for a steady return to surplus.

If Treasurer Hockey has managed to paint the economy – and the nation's fiscal position – in as dim a light as possible, the corrosive effect on confidence will be larger than necessary. And, in fact, that is the opposite of what Hockey needs to repair the revenue side of the budget.

The "steady improvement" over time will be a thing of the past. In that case, only savage spending cuts will do the job or, as Kohler suggests, large tax hikes which themselves would further damage private consumption and confidence.

There may be no way out of the 'great reckoning' Australia now faces – but talking the economy and the budget position down guarantees that fact.

The 'This is worse' view of Australia's economic and fiscal future will become a self-fulfilling prophecy.