The budget deficit is just a stone in the shoe

The view that high government spending is to blame for the upcoming budget deficit is wrong. In fact, real government spending cuts in 2012-13 are the largest on record.

When Former Treasurer Peter Costello revealed the budget outcome for 2001-02, he announced a budget deficit of 0.2 per cent of GDP*. This was a slippage from the budget surplus he was forecasting when he delivered the budget more than a year earlier. The change in the budget bottom line was largely the result of lower tax receipts, particularly for withholding and company tax. 

This was a prudent policy decision from Costello as he allowed the budget’s automatic stabilisers to react to softer than expected economic conditions. In that year, the Australian economy had been buffeted from the fallout from the bursting of the technology bubble in the US in the prior couple of years and there was a jolt to economic conditions, however temporary, from the terrorist attack on the US in September 2001. The deficit was also driven by a surge in real government spending which rose a quite massive 9.1 per cent in 2000-01 and a further 3.5 per cent in 2001-02 to be above 25 per cent of GDP.

Fortunately, the hit to revenue in 2001-02 was a one off and the following year, the tax to GDP ratio jumped to the second highest on record before moving to record highs in the years beyond. While government spending was not cut in 2002-03 or indeed in any of the next five years, as a share of GDP it eased to 24.1 per cent by 2005-06 before falling below 24 per cent in the next two years.

This illustration helps to show that when left to their own devises, the automatic stabilisers in the budget work. They see more revenue received on the tax side in an upswing up and less revenue on a down swing. It was a similar situation in the early 1990s recession when revenue fell and the budget went into deficit and even in the early 1980s when Australia was hit by recession.

There is nothing new in the phenomenon, but it is something that remains a prudent and sensible part of macroeconomic policy setting.

Such an approach fits perfectly with the requirements from the Charter of Budget Honesty which, among other things, sets out that fiscal policy be set with a view: “to moderating cyclical fluctuations in economic activity, as appropriate, taking account of the economic risks facing the nation and the impact of those risks on the Government’s fiscal position” (Ditch the Charter of Budget Honesty, April 29).

In two weeks from today, Treasurer Wayne Swan will deliver his sixth budget and based on the revenue shortfall from the weaker than forecast growth rate in the economy outlined by Prime Minister Gillard yesterday, there is likely to be a deficit of around $20 billion for 2012-13. This sits in contrast to a surplus projection of $1 billion when the budget was framed a year ago.

What’s more, it seems likely that the revenue shortfall for 2012-13 will parlay into 2013-14 and beyond meaning that there will probably not be a budget surplus until the end of the forward estimates in 2016-17.

There is a perception that the budget issue (and I deliberately call it an issue, not a problem) is a function of high government spending and that urgent cuts are needed to return to surplus as quickly as possible. This view is not supported by the facts.

The cut in real government spending in 2012-13 remains the largest on record. Government spending is down around 4 per cent which means that the government spending to GDP ratio will drop to 23.75 per cent which compares with the average level of around 24.8 per cent in the last 25 years.

It is also important to recognise that anyone, including Wayne Swan or his shadow, Joe Hockey, or Bob Katter, Clive Palmer or the proverbial drover’s dog could deliver a budget surplus tomorrow if they wanted to. All they would need to do is tax you and me and the business community to the tune of $20 billion and voila! Or they could rip some cash out of household incomes, company profits or superannuation or cut spending on defence, health, education or elsewhere.

It’s easy, but why would you bother?

The 1996 Charter of Budget Honesty would suggest such policies foolhardy given the state of the economy.

The Charter stipulates that the government: “pursue spending and taxing policies that are consistent with a reasonable degree of stability and predictability in the level of the tax burden”.

Hear, hear to that clause!

The Charter notes that in the: “formulation of government fiscal policy… The government’s fiscal policy is to be directed at maintaining the on‑going economic prosperity and welfare of the people of Australia and is therefore to be set in a sustainable medium‑term framework.”

Overall, Australia’s budget position is like having a stone in your shoe – a little uncomfortable but it is not like the fiscal mess prevailing in the US, UK, Italy, Japan or about 40 other countries where they are facing the equivalent of leg amputations.

When the economy does pick up, policy makers should undoubtedly go for a surplus. This almost goes without saying. Until then, accept the fact the budget will be in small deficit, not much away from 1 per cent of GDP. I suspect the rating agencies will see this and confirm the triple-A assessment of Australia. 

We should all be grateful for the fact that our taxes aren’t being hiked oppressively or our services slashed simply to meet the objective of a budget surplus that no one outside Australia gives two hoots about and that if delivered, would all but guarantee an economic slump and an unemployment rate nearer 7 per cent.

Hands up the economic zealots who want that?

*  Revisions mean that the budget deficit for 2001-02 is currently estimated to be 0.1 per cent of GDP.


Stephen Koukoulas is Managing Director of Market Economics and a former economics advisor to Prime Minister Julia Gillard.