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Taxing and spending

August 11th, 2003

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.

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  1. Me No No
    August 11th, 2003 at 18:15 | #1

    To me the biggest mystery is: how we got to love the current account deficit. In the late 80s we pulled our hair out about it. Now with similar levels we don’t care.

    I know the’s the Pitchford thesis and so on, but why are commentators so relaxed about it these days? We used to be regularly told: “this means every man, woman and child owes $XX. Australia must start paying its way.”

    The flipside is the “abysmal” rate of private saving. That doesn’t matter anymore either.

    Praps the answer is: look at America, if they can do it, so can we.

    But Howard govt gets away with murder on current account/BoP front, compared to Hawke/Keating.

  2. Uncle Milton
    August 11th, 2003 at 21:46 | #2

    *why are commentators so relaxed about it these days?*

    Because economic fashions come and go.

  3. August 11th, 2003 at 23:17 | #3

    The biggest mistake this government has made has been in not vigorously properly promoting hi-tech. Our trade deficit, brain drain and obsession with housing can be traced to our inadequate productive grasp of technology.
    Evidently targetted generous tax-breaks and massive subisidies are needed, in return for committed FDI and cast iron guarantees for licesing and patents.
    We missed the info-tech revolution, other states are kicking our butt in nano-tech and bio-tech may be sunk through pandering to holy alliance of bio-conservative Greenies, Goddies, Girlies and Envies.
    Since Australia’s average age is about 36 years,
    and life expectancy is around 77 years, our state has barely 40 more years before more than half of registered voters/tax-payers are utterly dead. That’s alot of profitable human capital gone to waste and undiminishable human utility unsatisfied.
    Forty Years – Then Death. That’s all there is.

  4. James Farrell
    August 12th, 2003 at 11:21 | #4


    You are proving to be a bit more alarmist about the fiscal balance than I would have predicted.

    What exactly are you worried about? Is it the current account and exchange rate volatility? Or is it just that national saving is too low?

    If the latter, don’t you want to take more care in distinguising current from capital expenditure? For me, tertiary education is naturally the example that springs to mind.

    Years ago Amanda Vanstone was insisting that the education sector needs to ‘contribute its share’ to raising national saving, and I remember you making the point very forcefully that it makes no sense to count education cuts as saving.

    From the point of view of national wealth, investment in education is justified by the returns on it. If you are worried about public sector net worth per se then of course we can raise fees and taxes, but we shouldn’t expect to balance the budget right now.

  5. John Quiggin
    August 12th, 2003 at 15:49 | #5

    James, my main concern is that an active fiscal policy requires a willingness to shift the budget balance sharply towards deficit in the event of an economic downturn. This is consistent with stable public sector net worth only if the government runs surpluses during booms.

    If you read the entire piece though, I don’t think I’m being unduly alarmist. As I observe

    “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. “

  6. Homer Paxton
    August 12th, 2003 at 21:21 | #6

    One small note John,
    Costello rightly didn’t like the headline budget figure as it could be easily manipulated yet the underlying budget figure is just as bad.

    He adopted it as it was the only one which showed the Keating years in a bad light compared to his.
    He should have adopted the structural budget figure however he knew he would have never topped Keatin’s surplus.
    Australian fiscal policy is the poorer for this. As is economic journalism.

  7. August 13th, 2003 at 15:47 | #7

    The problem with structural budget figures is that they are very subjective. Using cash and accrual balances as they do allows commentators to estimate the structural balance, but holds governments to some level of budget honesty.

    This government hasn’t been fiscally responsible since the first budget. They have squandered their surpluses and have in large part ridden on the benefits of the micro reform done by the Hawke/Keating governments. They in no way deserve to be called a liberal government and as John point out – the real difference between the ‘left’ and ‘right’ now is spending priorities, not the level of spending.

    We live in a social democracy. The ALP believe in social democracy by principle, and the conservatives believe in conserving the status quo. The ALP is lost because their ideological agenda no longer requires fundamental reform. Basically, the ALP has won the idelogical war – but the Libs just happen to be running it better (according to the elections).

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