Fudging The Budget

This article from the May 2013 edition of the IPA Review is written by Senior Fellow at the IPA, Sinclair Davidson.

One of the key 2013 election battlegrounds will be the state of the economy. If government apologists are to be believed, Australians have got it good. Inflation is low, unemployment is low, and interest rates are low. Taxation as a percentage of GDP is lower than when the Howard government left office and spending decisions are fully justified by the global financial crisis. For those who insist on belly-aching and negativity, just remember it could have been worse.

The thing to remember about the Rudd-Gillard years is that this will have been a government that is long on rhetoric, extra-long on excuses, but short on performance. This government has always elevated politics above performance. Rereading the 2008-09 Budget speech one gets the impression that the biggest threat facing Australia was inflation. Both the government and the Reserve Bank of Australia were completely unprepared for the global financial crisis. This shows in the panicked response to that crisis with two hastily cobbled stimulus packages that sprayed money into the economy, drove the budget into deficit, and has generated an increase in gross Commonwealth debt from $59 billion in December 2007 to $267 billion in December 2012.

The government’s economic narrative consists of an inter-related set of claims that are superficially attractive but cannot stand any serious scrutiny. Fortunately for the government, most of Australia’s senior journalists concentrate on politics and political messages and ignore economics. With some honourable exceptions, many economic journalists tend to parrot official government lines. While many working Australians may feel that something is not-quite-right with the economy, they would struggle to find an explanation for their unease in the mainstream media. Indeed, the ABC and Fairfax Press are likely to tell them all is well with the world and they have no reason to be uneasy.

John Howard was a big spender—his government massively expanded middle-class welfare. He will take exception to that characterisation—his argument being that his government had a social vision of assisting families with children. But the important thing is that Australians realised that his was a big spending government and Kevin Rudd struck a chord with ordinary voters when he proclaimed, ‘This reckless spending must stop’. The other important thing was that John Howard’s government was running a budget surplus.

The incoming Rudd government was manifestly unprepared for office. They ratified Kyoto and dismantled Australia’s tough border controls but had little idea what else to do. This is evidenced by the 2020 Summit. By April 2008 the government had no idea what to do next. This would not normally be a problem if the government had decided to do nothing but provide good stable governance. But the US economy had already slipped into recession in December 2007.

The storm clouds had been gathering for some time—with obvious problems being noticed from about mid-2007. That didn’t stop the Reserve Bank from raising interest rates during the 2007 election campaign and twice more in 2008 until the collapse of Lehman Brothers. Between September 2008 and February 2009, official interest rates were lowered 4 per cent. In that time, two stimulus packages were hastily crafted, the first one spending $10.4 billion and the second $42 billion. The budget went from a surplus of some $19.7 billion in 2007-08 to an unknown amount for 2012-13 at the time of writing.

The notion of an unknown budget deficit should strike us as being somewhat unusual. Each year the government is required to post a budget, which is debated and discussed in the Parliament and popular media. Half way through the year the government posts a mid-year update that provides more information as to the state of the nation’s finances. Since the midyear update was posted this year, the government has indicated that it is unlikely that the forecasted budget surplus will be achieved. Yet, the government has been unable to indicate what the now expected deficit will be. To compound things further, one government backbencher has suggested the government might still achieve a surplus.

So we cannot be sure what the state of the national finances is—or even what the government’s strategy toward those finances might be. To be sure, things could be worse; the United States Congress hasn’t passed a budget in three years. We cannot afford such recklessness—as a small open economy reliant on imported capital we would quickly run out of other peoples’ money.

It is at this point that we have been subjected to a lot of nonsense. For example, we’re told that a small budget surplus or deficit doesn’t really matter. There is little difference between a surplus of $1 billion and a deficit of $1 billion. Well, yes. If all we were talking about was a deficit of $1 billion then it wouldn’t matter much. Yet the smallest budget deficit Wayne Swan has delivered was $27 billion in his first year. Last year the deficit was forecast to be $22 billion and it turned out to be $43 billion.

Without a strong political constraint on government spending democracies would tend towards permanent deficits—if that were possible. This is because there are an infinite number of good causes that call for more government spending. The Australian electorate has an implicit understanding that budgets should be in surplus—that is why maintaining a budget surplus, on average, over the economic cycle is bipartisan policy. That is why Wayne Swan has told anyone and everyone who would listen that the budget would return to surplus. Come hell or high water, we were told, it would happen this financial year.

That often repeated promise has now been broken.

There is an argument that the surplus was a ‘political promise’ somehow unrelated to the economy. This is an argument that politics doesn’t matter. But politics is how we as individuals make joint collective choices that impact upon our lives. The importance of that ‘political promise’ lies in the fact that the Australian electorate has an aversion to debt and deficit. At the same time the electorate is reasonable—it does happen that circumstances beyond anyone’s control results in a deficit. The government will be trying to make those arguments.

Finance Minister Penny Wong argues that the government has been receiving less taxation revenue than expected. In fact revenue this year is down $20 billion on 2010 expectations. The word to keep a close eye on is ‘expectations’. The government is collecting a lot more tax revenue now than it did when coming to office. It just isn’t collecting as much as it would like.

So the question we should be asking is ‘how reasonable were those expectations?’ Well, in retrospect, not so reasonable at all. But that isn’t a fair test. To determine reasonableness we need to look at the record of predictions.

Here is the thing; at the height of the global financial crisis, in early 2009, the government was busy preparing its 2009-10 Budget. That Budget forecast taxation revenue out to 2012-13—this financial year. At that time the government expected to raise some $321 billion in tax revenue this financial year. The latest mid-year review indicates that the government now expects to raise some $339 billion in tax revenue this year.

So, in fact, tax revenue is above expectations that were formed at the depths of the global financial crisis.

The 2009-10 Budget forecasts some $365 billion in spending for this financial year. The latest mid-year review indicates that the government now expects to spend some $363 billion this financial year. So the tough spending cuts we keep hearing about work out to be $2 billion or so (with rounding errors) on expectations. To be fair, that $2 billion isn’t nothing—but quite clearly it isn’t nearly enough.

The government likes to point to the global financial crisis when being criticised on its spending decisions. But the first thing to remember is that the US recession that sparked the crisis ended in June 2009—three and a half years ago. The second point is that the forecasts that the government made at the time of the crisis—especially for the current financial year—were quite accurate. So any argument that expected tax receipts are down on expectations due to the global financial crisis or tough spending cuts have had to be made is simply not correct.

Expected tax revenue was ramped up in the 2010-11 Budget and again in the 2011-12 Budget. While actual tax revenue grew in those years, it didn’t meet expectations. Yet the government based spending decisions on expected tax revenues that disappointed two years in a row. So the government didn’t learn from its mistakes. Those mistaken expectations were formed after the global financial crisis—so it is a bit difficult to blame them on the crisis itself.

It is hard to form any view other than we have a government that lacks the discipline required to balance a budget. Actual tax revenue has increased over time—just not as much as inflated expectations. Actual spending cuts have been quite minimal. The budget remains in deficit because we have a government that only failed to end the ‘reckless spending’ but added its own reckless spending to the mix.