The EU may silence a crowing Swan

With larger national debt than Paul Keating left for John Howard and little room to manoeuvre, events unfolding in Europe this weekend are a latent bomb for Wayne Swan.

Treasurer Wayne Swan had every right last week to lead the nation in a chorus of "three cheers for GDP!" The national accounts revealed growth figures that, even if revised down slightly, were simply stellar.

Yet for all his basking in economic sunshine, Swan knows that strong growth does not remove two pressing problems for the nation's finances.

Firstly, because GDP growth is so heavily dependent on mining investment, the shape of our current tax regime and the flimsy design of the MRRT mean that Treasury will still struggle to do much more than deliver 'thin' surpluses.

The Henry tax review predicted all this. Its call for a heavier resources 'super-profits' tax – the implementation of which was so monumentally fluffed by Swan and Kevin Rudd – reflected Treasury's belief that a nation balancing strong mining profits against an even stronger investment boom would leave Canberra short-changed.

There is no way to replay that sorry period of policymaking history. The Gillard-negoiated MRRT is what it is, and not only is it impossible for Labor to revise or strengthen it, but a Coalition government will surely tear it up.

That means that an Abbott government's cost-cutting frenzy will have to not only make up the ground that Swan's latest budget failed to achieve, but will have to cut another $10 billion or so over forward estimates to make up for lost MRRT revenue.

To recap, Swan opted for more generous middle-class welfare in May, instead of generating a surplus that could have begun to pay down our burgeoning national debt. Until May I argued, along with many other commentators, that federal public debt was not a problem – but budget day showed why it was (Swan's dangerous debt game, May 10; Federal budget 2012: End of a miner miracle, May 8).

The short version is this: we now have a national debt larger, even in real terms, than the one Paul Keating left for John Howard to begin paying down. Howard and Peter Costello would probably have made little progress in doing so, without the revenue from 'mining boom mark I' – a boom with a very different profit and investment characteristics.

As it was, the nation got lucky. Howard and Costello had enough cash to pay down the debt at the same time as putting a grin on voters' faces with rising welfare 'entitlements' for the suburban middle classes, topped off with a few cash-splash cheques and 'bonuses'.

Now, however, Swan – and Abbott and Hockey for that matter – know that we are not going into such halcyon days. Without a major overhaul of the tax system (a la the Henry Review) that includes unpopular measures such as a GST hike, federal governments won't be able to fund the level of public services that most voters like very much.

Problem number two is so big it's hard to see (yet we are talking about it daily). The run-away train of European fiscal policy, which reaches the next fork in the tracks with this weekend's re-run of the Greek general election, could rip the guts out of an already tight federal budget. Business might be sanguine about riding out that storm but the Treasurer should not be.

As some commentators have noted, the EU is China's largest export destination. If it veers towards calamitous break-up, the flow-through to commodity prices, as China sends its factory workers home, will ravage federal tax receipts (more through depressed corporate taxes than the already low MRRT tax take).

An early warning sign of that process comes today in a forecast from UBS that oil prices might fall as low as $US50 a barrel, from a current level just above $US100 a barrel. You don't have to be in the oil game to realise that any economic slowdown that produces that price drop must impact the major commodities that we sell – coal, iron ore and LNG.

In a speech later today, Swan will praise his own government again, by lauding its creation of covered bonds – a development that allows our own banks to attract local savings that might otherwise have flowed abroad. He's right to say that that helps make our banks less dependent on volatile international wholesale funding markets. He deserves another cheer for that.

But the same logic should be applied to fiscal policy. The federal budget is firmly hitched to volatile global commodity markets – so while businesses and consumers might think they'll do okay if the euro bomb goes off, the federal budget won't.

The GDP party was fun while it lasted. Now, though, we all need to sober up and realise that stellar growth does not equate to sound fiscal policy.

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