Sizing up Hockey’s budget task

To rein in the budget deficit, the Coalition needs to do much more than chip away at Senate obstruction and target the real problem: excessive social spending.

The mid-year budget update has unleashed speculation about what the Abbott government might do to rein in the budget deficit -- and a torrent of both helpful and unhelpful suggestions as to what they should do.

Lacking in all this is an overall monetary target, which is best defined as the annual, ongoing amount of deficit-reducing measures to be reached in the first year after the measures have been fully implemented.

An obvious answer, but almost certainly the wrong one, is that the target should be the updated estimate of the deficit this year, in round terms $40 billion. It is wrong for two reasons: there are some deficit-reducing measures in the pipeline that won’t be fully implemented for several more years, and in the budget jargon, the estimated deficit for the current year isn’t all ‘structural’.

The appropriate policy response to a budget deficit hinges on that word ‘structural’; it depends on how the deficit has come about and whether it is likely to be temporary or entrenched. One of the benefits of having a low level of public debt is that governments can easily borrow more to finance temporary deficits, wait for the causes to dissipate and compensate with surpluses when conditions turn favourable.

The problem is that while the structural budget deficit provides the best guide for fiscal policy, it is very difficult to measure. Anyone who says they can quantify the structural deficit with any precision is talking through their hat. It is especially difficult in Australia because of the importance of commodity prices to the budget result (and for state budgets, house prices and turnover also).  For years, the Treasury steadfastly refused to publish estimates of the structural budget position because they were too unreliable. In recent years it bowed to pressure to publish them. The latest results make interesting reading.

The structural deficit this year is closer to $30bn than $40bn. And it is heading down to around $10bn in 2016-17 and zero the following year. However the range of uncertainties is such that Treasury puts a band of about plus or minus $15bn around its point estimate. That means that by 2016–17, there could be a small structural surplus of $5bn and the government wouldn’t have to do anything more apart from steering all its stalled measures through the Senate. The bad news is that in the same year there could still be a structural deficit of $25bn, even if the Senate does play ball.

Given this wide range of possibilities, the structural estimates can be no more than a rough guide to action. But they do point to the government needing to do more than just chip away at Senate obstruction. Sure, the recent slump in commodity prices could prove temporary; the Chinese economy could do much better than expected; Europe could muddle through; the Japanese economy could surge ahead; and the US could shrug off interest rate hikes next year and go from strength to strength. All these things are possible, and they would put the government out of its budget misery, but Joe Hockey shouldn’t count on them happening.

In my judgment the government should aim for structural measures totaling at least 1 per cent of GDP in 2016-17 (about $17bn) in addition to the measures included in the last budget and getting all the stalled measures through the Senate. This would provide for a small structural surplus (mid-point of the range) in 2016-17. If this effort turns out to be more than needed and the surplus is larger, they should make an earlier start to cutting income tax and handing back the proceeds of bracket creep than the current expectation (2020–21!)

Ideally the structural measures would be more ambitious than 1 per cent of GDP, making possible definite plans to reverse bracket creep in 2016-17.

The significance of 2016-17 is that it is the last budget year in the current government’s term. Three years should be sufficient for any government worth its salt to overcome what is essentially a modest structural deficit problem.

Just how they would lop $17bn a year off the deficit by 2016-17 is another matter. The Abbott government and its Labor predecessors have pretty well exhausted the old favourites:  cutting defence and foreign aid, imposing amorphous ‘efficiency dividends’ on departments and streamlining the machinery of government.

What remains is politically much harder. It means taking money away from people (i.e. voters) through reduced social benefits or increased taxes. This would certainly test the Coalition’s appetite for electoral suicide, but at least it doesn’t have to mean reducing benefits in absolute terms. Just making them grow more slowly than currently planned counts as a ‘saving’.

By 2017 there will be about 10 million Australian households. Taking $17bn away from us means an average of $1,700 a year per household. How this sum is distributed and how it is divided between spending cuts and tax hikes will be hotly debated.

But any suggestion that low and middle-income households should be fully sheltered; or social security, health and education quarantined from cuts; or most of the burden carried by higher taxes, should be rejected. The federal budget is paying out more than $170bn a year in direct (monetary) and indirect (in-kind goods and services) benefits to households, a figure that has ballooned over the years. The problem is too much social spending, not too little taxation.   

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

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