Settle in for Hockey's budget horror show

The fundamental problem with the Abbott Government's first budget is it just wasn't tough enough. And the 'do-nothing' approach will only make the situation worse.

Joe Hockey’s much-anticipated mid-year economic and fiscal outlook reveals that the budget is about $10 billion a year deeper in the red than he thought just seven months ago. He is right to not try and correct this deterioration through a mini-budget of spending and tax measures (although MYEFO does contain some measures, most notably further cuts to foreign aid). However, there is much to be concerned about in the fiscal outlook and the outlook also exposes the weaknesses of the Abbott Government’s first budget.

The deterioration in the budget is due to a combination of revenue writedowns and the cancellation, softening or postponement of budget measures due to Senate opposition. The appropriate response to the revenue writedowns depends on whether they are structural or cyclical. Structural writedowns call for a policy response, not in haste but in the next budget; cyclical ones can be ridden out.

In practice it is difficult enough to distinguish between the structural and cyclical position of the broader economy with any precision, let alone whether changes in volatile commodity prices will prove to be short-lived or not. The slump in oil and iron ore prices below levels assumed in the May budget is so recent and surprising that we still don't know whether it is structural or cyclical, but Treasury already seems to be assuming that prices will stay down. If this is confirmed at the next budget, it will constitute a strong case for additional savings measures to offset the shortfall.

As for Hockey’s Senate problems, any savings measure the government fails to achieve or is forced to water down (and there have already been a few) will clearly add to the budget’s structural weakness. The latest estimates make the standard technical assumption that whatever the government had announced as policy up to yesterday will be implemented, but there are still over some of the stalled measures carried over from the May budget. Any failures on this front will cause further budget deterioration beyond that shown in MYEFO.

In the meantime, the ‘do nothing’ approach extends the date for balancing the budget by two years (to 2019-20) and raises the estimated peak level of net debt in 2017-18 (previously 14 per cent of GDP, now 17 per cent, similar to the mid-1990s peak). This is not the end of the world, but if everyone keeps saying that rather than doing something to stop the drift, then what is merely a fiscal problem will develop into a crisis at some time in the future.

The MYEFO strains credulity in arguing that the government’s fiscal goals are being met. References to 2019-20, 2020-21, 2023-24 and even 2024-25 are sprinkled liberally throughout the document to make the case that budget surpluses, relief from income tax bracket creep and debt reduction are all on the way. The number crunchers cannot be blamed for providing 10-year projections, having been urged to do so by commentators, but such projections are simply too unreliable and too subject to uncertainty to serve as an exhibit in the government’s case that its fiscal strategy is working. In any case, Australia needs a balanced budget soon, not in five years’ time.

The fundamental problem is not that the fiscal position has deteriorated since the May budget, but that the budget was not sufficiently rigorous in the first place. Its pathway to a structural budget balance (let alone a surplus) was simply too stretched out to mean very much and it relied too heavily on the pernicious process of personal income tax bracket creep.

In the lead-up to the Abbott Government’s first budget, I suggested that it needed to demonstrate a structural tightening building to 2 per cent of GDP (about $30 billion a year) after three years. It failed to do so. For all the criticism of the Abbott government’s first budget, it was actually too timid. Events since then have simply compounded the error, adding to the structural effort that needs to be made in the future.

I further suggested that the focus of budget tightening should be on curbing spending, not raising additional revenue. But the budget update shows that spending as a share of GDP is set to increase slightly in 2014-15 and then fall ever so slowly to 25.2 per cent in 2017-18, which is still above the long-term average. It does not fall below the long-term average until the never-never of 2024-25.

The next episode of the government’s budget horror show comes early in the new year, in the shape of the very long-term fiscal outlook statement known as the Intergenerational Report. This will quantify the upward pressures on government spending from ageing and other factors looking 40 years ahead, and will provide new material for Hockey to re-launch the case for spending restraint in the lead-up to the 2015-16 budget.

Robert Carling is a Senior Fellow at the Centre for Independent Studies

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