Australia is running out of booms

Every director understands the importance of sound financial management as a cornerstone of good governance. It is the same for government, or at least it should be. After all, the maintenance of our national living standards depends on government putting fiscal governance at the forefront of its policy considerations.

This article appeared in The Australian Financial Review on 8 January 2018 (subscription may be required).

Yet, a decade of budget deficits has now been incurred since the global financial crisis. The federal government deployed extensive fiscal stimulus back then to support the economy as the Reserve Bank simultaneously slashed interest rates to then-record lows.

While the then-government’s fiscal stimulus played a role in helping the economy avoid a technical recession, as did the sharp fall in Australian Dollar, the extended duration of the measures deployed left the nation’s public finances in very poor shape. In fact, our national finances have never recovered. Almost a decade on from the crisis, Treasury still predicts budget deficits until 2020/21 and even this looks optimistic, framed on upbeat macroeconomic assumptions.

The release of MYEFO late last year served to highlight the optimism on which our budget forecasts are based. The Treasury did revise down its expectations for wages growth, a key determinant of PAYE tax collections, but the forecasts still look optimistic, particularly with wages currently growing at the slowest pace in a generation.

As things stand, without urgent remedial policy action, Australians face a choice between two unpleasant options. The first is that more people pay more. In essence, that many more taxpayers pay a higher marginal tax rate as a result of inevitable bracket creep as their incomes rise, although this process has slowed somewhat thanks to sluggish wages growth.

The second option is worse. Australian households will, over time, have to accept fewer and a lower standard of government services, including in health and education. Government simply will not be able to maintain the level of services we have come to expect, while also delivering fiscal sustainability.

Reform now is the only way out, and the 2018 Budget provides a golden opportunity to make the changes necessary to prolong Australia’s unprecedented, uninterrupted of period of economic growth. Failure to make the necessary decisions now will see an even heavier financial burden fall upon our children and even our grandchildren.

Reform needs to address the insufficient incentives in the existing tax structure for firms to invest and hire. This is contributing to Australia’s poor productivity outcomes. There also are financial disincentives for employees to work harder and for longer hours, and for people to make the sometimes challenging journey from welfare back to work. This needs to change as well.

However, the emphasis of budget repair should fall most heavily on the expenditure side. While comprehensive tax reform has an important role to play, its focus should be to drive growth over the longer term. An improved tax mix can create better incentives for success for Australians and boost economic growth. Lifting taxes without embarking on spending reform, which has been the recent experience, merely boosts government revenue to match an elevated level of spending.

There is scope, both on budget repair and equity grounds, to further pare back so-called middle-class welfare, including the family tax benefits system. We can also achieve further efficiency dividends across government by targeting duplication between jurisdictions. It is also past time to cut industry assistance where funding is based on protecting inefficient industries.

The Australian Institute of Company Directors has recommended that annual growth in government spending be restricted to 1.5 per cent in real terms, on average over the business cycle. This will require a new level of much-needed fiscal discipline from both sides of politics.

Our ageing population is a constraint on potential growth, meaning only by lifting productivity will Australia’s living standards be sustained over the long term. With the demands on Australia’s public purse growing over time, particularly in health and welfare as the population ages, the current fiscal position is not sustainable. We as a nation are placing too heavy a burden on future generations to pay for the current generation to live beyond our means.

We have been exceedingly lucky for more than two decades now in having been able to ride a succession of booms, from soaring commodity prices, to record housing construction, to the China boom and, most recently, an unprecedented rise in mining investment.

But, we are running out of booms. Australian governments no longer can wait for optimistic assumptions about growth in wages and the economy, alongside higher commodity prices, to do the heavy lifting to return the budget to surplus. MYEFO still predicted a surplus by 2020-21, but the predicted fiscal buffer is wafer-thin and prone to disappointment.

Our political leaders must take the tough decisions needed now so that Australia can afford its future aspirations. Failure to act risks more abrupt economic pain and even social dislocation in the future.