And so, the surplus imbroglio marches on. From the AFR over the weekend:
Treasurer Chris Bowen has overruled concerns of colleagues and will unveil swingeing spending cuts and tax increases on the cusp of the federal election in a bid to achieve a surplus in four years.
Despite an estimated four-year revenue write-down of between $20 billion and $30 billion since the May budget, the Treasurer broke from a meeting of a Cabinet’s expenditure review committee on Friday to reiterate that the government intends to achieve a surplus by 2016-17 as outlined in the budget.
“Difficult decisions need to be made, revenue decisions, saving decisions need to be made,” he said.
The measures under consideration include increases in tobacco excise, abolishing loss carry-back tax provisions for business, and tightening family tax benefits and so-called middle-class welfare.
The first point to note is that the May Budget committed to a 2015/16 surplus of $800 million so that looks like it’s going to get dumped. I have no issue with the aim to return to surplus. As I’ve said many times, we’ve no choice. In the same article S&P repeated why:
Ratings agency Standard & Poor’s put the government on notice it is counting on a return to surplus if Australia is to retain its AAA credit rating.
Analyst Craig Michaels said he continued to “expect the government would remain committed to prudent fiscal policy and returning the budget to balance over the medium term.”
…Moody’s lead analyst for Australia, Steven Hess, said his current AAA rating was still appropriate.
“The Australian government still has a financial position that is strong relative to other triple AAA-rated countries. “So if marginally it turns out to be not as good as forecast, it’s still relatively healthy compared to other AAA sovereigns,” Mr Hess said from New York.
Losing the AAA would normally not be such a big deal. In fact, you might argue that when you’ve been through a period of international irrational exuberance about Australia, driving up its currency to ludicrous levels, losing it could be an advantage. But the budget implicitly guarantees offshore bank liabilities these days so the AAA also prevents banks’ cost of funds from jumping. Lose it and the entire nation will cop a rate hike.
But note the wriggle room offered by S&P as well. It has said before that in circumstances where counter-cyclical deficits are required it is acceptable. And that is now where we are.
Consider. To overcome the latest revenue hits, Chris Bowen’s cuts and tax hikes will represent some $6 billion per annum. At our current GDP, around $1.5 trillion, that will remove roughly 0.4% of GDP per annum. Labor and Treasury appear to be cognisant of weakening growth so no doubt they’ll back load the cuts where possible. The RBA’s John Edwards is also out this morning warning Labor:
…against deep spending cuts or large tax rises because of the economy’s fragility.
…With cabinet due to meet in Canberra after the committee meeting, Dr Edwards indicated the government’s fiscal strategy would have an important bearing on whether official interest rates are cut next month.
“The stance of fiscal policy is always a consideration for monetary policy,” Dr Edwards told The Australian Financial Review.
Speaking with just over a week to go before the Reserve Bank holds its August rate meeting, Dr Edwards highlighted that economic growth had slowed to “below trend”, normally considered to be just above 3 per cent, and that employment was “not very strong”.
Even taking the optimistic view in Treasury’s growth forecasts more fiscal drag is a problem. Treasury currently forecasts 2.75% growth in 13/14 and 3% in 14/15. We know that a part of the revenue downgrades will be cutting these growth rates back so let’s say Treasury extends 2.75% to 14/15 and then returns us to 3% the following two years.
Treasury will fill the fiscal drag growth hole by fiddling stronger growth in tradables and consumption via lower interest rates and currency. That is, they’ll assume some Panglossian return the Howard/Costello era of public spending cuts boosting private sector activity.
But they’ll be wrong (again) for a couple of reasons. Unless APRA abandons its financial stability brief there won’t be enough credit – even if there is demand for it (which is itself doubtful) – to boost consumption growth by enough. The non-mining tradables rebound is going to be the slowest and most hard fought in our recent history given we’ve just deliberately shed as much of its structure as we could in the mistaken belief that the mining boom was permanent. And don’t look to mining either. The great likelihood is that the terms of trade will fall further, substantially so, as iron ore enters the correction already underway in coal.
All of these factors will feed back as more fiscal instability and, if we continue down the Howard/Costello path of responding with ad hoc changes (in their case to the upside), each round of missed forecasts and band aid cuts will bleed the private sector of confidence anew, ensuring no hand-off of growth no matter who is in power.
This is Sisyphian madness.
What is needed instead is a paradigm shift. There must be a long term acknowledgement of the structural deficit problem in the context of a fading mining boom. The budget must be based upon conservative terms of trade and growth assumptions as well as phasing in the required spending cuts and tax increases needed to stabilise it. But crucially, the unwind of the structural deficit over time must be offset by new spending that lifts Australia’s growth potential. That is, infrastructure.
If it is done on the government’s balance sheet, it much must be couched within a sensible narrative of supporting growth through counter-cyclical spending specifically dedicated to raising long term growth potential through de-bottlenecking infrastructure. A 1% of GDP spend for four years would do the trick and be acceptable to CRAs I reckon, as well as providing the much needed growth boost to offset the mining investment downdraft.
But it need not be done exclusively through the budget. An off balance-sheet infrastructure fund committed to spending on productivity raising investment and run by the Productivity Commission could do the work. It could issue its own bonds. (Or it could use some of the money we’ve got stashed away in the sovereign wealth fund we built using the mining tax. Oh, that’s right, we forgot to do that!)
Fact is, in all likelihood we will have to run “unexpected” deficits anyway just to keep growth reasonably below trend. And if China has a bad quarter or two we’ll be scrambling for sugar-hit stimulus, pissing more money up against the wall. If the money is going to be spent anyway, why don’t we plan to spend it wisely?
It is a sophisticated pitch to voters and does mean shared sacrifice. But it also means shared benefits as our cities are unclogged by a deliberate program of infrastructure renewal. The neglect that has made this a priority is another element of the Howard/Costello legacy that’s got to go.
Let’s face it. Households are ready to hear it. They know something has gone wrong with the economy. That’s why they’re saving their butts off.
If coupled with measures to ensure a real depreciation happens as the dollar falls, when the infrastructure build winds down four years hence the growth baton could be passed back to a more deleveraged, more efficient and more competitive private sector. The public surplus would be restored and the public debt stock still more than manageable. Households budgets would be more solid (though still very leveraged and prudent) and the banking sector would be further weaned from guarantees. The economy would be growing via net exports into the Asian century.
We may even begin to see our standards of living rise once more.
