Taxing and spending
Regular commentator Jack Strocchi has sent me several pieces criticising the Howard government for being fiscally lax. The one that comes closest to my assessment, though not on every point, is from John Edwards of HSBC. Key points:
Costello’s biggest reform, by contrast, has been the goods and services tax. It was a substantial political achievement, but as an economic reform it makes very little difference. The same is true of the sale of half of Telstra. He dramatically reduced Commonwealth debt, but since he did so mostly on the proceeds of Telstra the Commonwealth’s net liabilities are not much changed.
Costello deserves credit for formalising the independence of the central bank to pursue an inflation objective … and above all for not making mistakes which threatened growth.
As several readers have commented, my draft section on macro policy didn’t give the government due credit for simply not making big mistakes, and I’ll try to fix this.
Costello is not the evangelical conservative committed to small government and low taxes he purported to be in opposition. He is just another Victorian Liberal, carrying on the tradition of ample spending from ample taxes while pretending to do the opposite.
As I’ve said previously, I’m all for more taxing and spending, provided the priorities are sensible. My problems with the Howard government’s fiscal policies relate to budget balance (we really should have a surplus at this point in the cycle) and poor priorities. The draft section of my chapter follows.
The 1996 budget cuts were justified, in part, by the claim that the outgoing Labor government had left a large burden of public debt that needed to be reduced. Since then, the government has greatly reduced public debt, to the extent that it has raised the possibility of ceasing to issue government bonds.
However, the main source of debt reduction has been asset sales, mostly involving the privatisation of profitable government business enterprises or the sale and leaseback of government facilities. As was shown in the discussion of privatisation, such transactions typically reduced the net worth. The measures of net worth adopted by the government do not capture this loss. Nevertheless, they give a more realistic view of the government’s actual progress, or lack of it, in improving the fiscal position of the Commonwealth. Because of a change in definitions at the end of 1997-98 no continuous data series has been published. However, with the exception of this break, the net worth of the Commonwealth has remained roughly constant and negative over the Howard government’s term in office. In 2002-03, Commonwealth net worth was estimated at negative $47 billion.
The failure to achieve any significant improvement in measured net worth reflects the absence of sustained, and substantial, budget surpluses. The government cut expenditure substantially in the 1996 Budget, producing a rapid return to budget surplus. The surplus peaked at 2 per cent of GDP in 1999-00. However, subsequent decisions, including tax cuts introduced as part of the GST package and in the leadup to the 2001 election eliminated the surplus.
The government has now, implicitly at least, adopted a target of zero budget balance, on whichever of the various accounting systems seems most appealing in any given year. Assuming, as seems likely that the current level of economic activity is above average for the economic cycle, this implies that the budget is in structural deficit, with balance being achieved only because we are in the boom phase of the cycle.
This policy ensures that an economic downturn will produce large budget deficits and a substantial reduction in public sector net worth. If the government took its own rhetoric about fiscal prudence seriously it would be running surpluses to prepare for such an event. Instead, the government has reduced public debt primarily through asset sales. In many cases, such as the privatisation of Telstra, assets were sold for less than their value in continued public ownership, thereby reducing the net worth of the public sector.
It should be noted that the fiscal position of the Australian public sector as a whole is very strong. The Commonwealth’s negative net worth is small in comparison to its revenue-raising power and is more than offset by the positive net worth of the states. Hence, the government’s failure to live up to its own rhetoric on this issue should not be a cause of major concern.
The main damage done by the government’s erratic performance on fiscal policy relates to the setting of priorities. Cuts made in the name of fiscal probity have adversely affected core functions of government, such as health and education. On the other hand, the largesse of recent years has allocated substantial funds to policies that are little more than political stunts, such as the Alice-Springs Darwin railway and the abandonment of indexation for petrol excise.