It’s the Government’s Spending, Stupid

In this article, Lachlan Clarke contextualises and disseminates the findings of the IPA’s research into Australia’s level of government spending and how that affects Australia’s economic freedom and prosperity. The IPA has been dedicated to preserving and strengthening the foundations of economic freedom through research and analysis since its inception in 1943.

Casting an eye over the headlines from the federal budget, one may assume that the anticipated budget surplus is a direct result of the federal government tightening its belt. Do not be fooled. As is always, the devil is in the detail.

The Budget Papers reveal that federal government spending is expected to reach its highest level since 1993, with spending expected to reach 27 per cent of GDP by 2025. This level of increased spending amounts to an annualised growth rate of 5 per cent, compared to expected real GDP growth of 2.3 per cent over the same period.

As basic economic theory teaches us, an environment whereby spending outweighs production is inherently inflationary. This is because there is more being demanded whilst there is less being produced. The claims from the government that its budget will have a deflationary effect, given its increase in net spending, economically defies gravity.

Inflation is the tax Australians must pay to finance government spending. In December last year the Consumer Price Index, the metric which measures inflation, reached 7.8 per cent, its highest level since 1990.

Australians would be spared the unsustainable price rises and cost of living pressures if the government made the decision to spend less. But there is no indication that they have any plans to do so.

The last three years can be viewed as nothing else but a federal government spending spree. Spending blew out from $478 billion in 2019 to $616 billion 2022, with the forward estimates forecasting even more to come. The Albanese government has made commitments to further increase its spending, which is expected to reach $771 billion by 2027. It is therefore no coincidence that record high government spending is occurring at the same time as record high inflation, they are entwined.

Make no mistake, unprecedented high price rises are a direct result of the unprecedented high levels of government spending.

Recently published research by the Institute of Public Affairs highlights the impact government spending has on cost of living. The report found that one percentage increase in government spending causes a 0.35 percentage point increase in annual inflation, and that a one percentage point increase in annual inflation causes average household mortgage rates to increase by 0.42 percentage points. During the ‘Covid era’ of 2020-22, government spending increased by 9.6 per cent per year, which is estimated to have caused the typical monthly mortgage repayment to rise by as much as $554 a month, or $6,643 per annum.

Across the Tasman, the government rhetoric is refreshing yet a stark contrast to what is being said domestically. ‘Inflation from fiscal policies were skewed to the upside…’ were recent comments made by the Reserve Bank of New Zealand, which acknowledged that the New Zealand government’s spending is contributing towards their inflation. Honest assessments of this nature are unheard of by the RBA in recent times, perhaps due to Governor’s upcoming re-appointment due in September or remaining gun shy from his no rate rises until 2024 snafu.

Our federal government is cleverly using the anticipated budget surplus to burnish its credentials as responsible budget managers. Yet, the anticipated budget surplus is rather a combined result of strong commodity prices and a strong domestic labour market.

Both these factors result in an increase in tax revenue that the government collects. Strong commodity prices in iron ore, coal, and gas are translated into increased tax revenue. Australia’s unprecedented worker shortage has led to record low unemployment, which translates into increased income tax revenue. Therefore, the anticipated surplus will not have a deflationary effect, as it is the result of increased tax revenue and not decreased spending.

Given the uncharted inflationary environment at hand, the need for a smaller government has never been more so. Yet, the federal government continues to stubbornly proceed in the opposite direction. It continues to expand in size, increasingly spend, and intervene deeper into the economy. As a result, Inflation and rising living costs will continue to be a problem for all Australians.