Saturday, May 4, 2013

Ghost of Costello haunts Swan's budget

If you're a rusted-on supporter of the Coalition there can't be a shadow of a doubt that all the budget problems we're hearing about are the product of the Gillard government's incompetence. And if you don't think much about economics, it's perfectly believable.

After all, the budget had been in surplus for eight years straight when the Howard government lost office in late 2007. In that time Peter Costello not only paid back the $96 billion net public debt he inherited from Labor, he clocked up a credit balance of $45 billion.

In marked contrast, Labor's first budget went straight into deficit and has stayed there ever since, despite its solemn promise to get back to surplus this year. Wayne Swan soon chewed up all the money the Libs left him and racked up a net debt of about $140 billion and counting.

What more do you need to know?

Well, a bit of economics would be nice. Failing that, a bit of commonsense. The good guys/bad guys story I've just told rests on two silly assumptions.

First, everything that happens to the federal budget happens because of the actions of the government. Nothing happening in the rest of the economy - or the rest of the world - could possibly affect the budget balance. In other words, nothing happens that's beyond the treasurer's control.

Second, from the day a new treasurer takes over, everything that happens must be in consequence of his actions. Nothing his predecessors had done could still be having an effect on the budget long after they'd been tossed out.

Clearly, life - and budgeting - is a little bit messier than that. Economists well know that things beyond the treasurer's control actually have a bigger effect on the budget than things that are within the government's control.

That's true regardless of whether you're Labor or Liberal and whether what the economy does to your budget is good or bad.

It's equally true that some of the decisions made by a treasurer can still be affecting his (we've never had a female treasurer) successors many years later.

So, as with everything else in work or life, the budgetary performance of a government is some combination of luck and management.

Costello's management was good in many respects but, as we'll see, not as good as many have assumed. Swan's management has been the opposite: far from perfect, but not as bad as it has suited many people to claim. As for luck, there's no contest: Costello's luck was great; Swan's has been lousy.

To a partisan of the right, the trouble Swan is facing in getting the budget back to surplus any time in the foreseeable future is explained solely by Labor's chronic inability to stop spending. All the recent talk of "structural" (that is, long-lasting) problems on the revenue side of the budget is just excuse-making.

It's true Labor has trouble controlling its urge to splurge. But it's also true that the slowness of tax collections to return to their normal healthy rate of growth as the economy grows is partly the result of weaknesses that go back to decisions made by the Howard government.

Increasingly, economists are realising our governments mishandled the revenue windfall from the first phase of the resources boom, spending too much of it and saving too little.

Not only did John Howard allow government spending to grow at Labor-like rates in the noughties, but Costello responded to the temporary boost in collections from company tax by cutting income tax eight years in a row (though, to be sure, the last three of his cuts were actually delivered by Labor).

Usually, income tax is cut only every three years or so, and cut close to an election so voters haven't forgotten it happened. Does it surprise you that cutting income tax so much can reduce its revenue-raising power today and in coming years? It shouldn't.

The Australia Institute has used the well-regarded Stinmod micro-simulation model to estimate that, had the income-tax scale for 2004-05 still been in use last financial year, 2011-12, collections from the tax would have been almost $39 billion higher.

Now, you may object that we couldn't have gone for all that time without any tax cut. Since our tax scales aren't indexed for inflation, we need regular tax cuts just to counter the effect of bracket creep.

Fair point. So next the institute compared the actual tax scale in 2011-12 with the 2004-05 scale with its tax brackets indexed up to allow for all the inflation in between. It found the indexed scale would have raised an additional $25 billion. So Costello's many tax cuts cut the real rate of income tax - on the strength of a surge in company tax collections that proved to be temporary.

Think how much smaller the budget deficit (and the accumulated debt) would be now had he limited himself to offsetting the effect of bracket creep. (Remember too that, particularly in the years before the global financial crisis, his decisions to spend rather than save the tax windfall from the resources boom obliged the Reserve Bank to raise interest rates higher than otherwise, to prevent this recycling from causing inflation.)

It's worth noting that the successive tax cuts were biased in favour of the better-off, with the cut-in point for the top tax rate trebled to $180,000 a year. As a result, the value of tax cuts going to the top 10 per cent of income earners exceeded that of the cuts going to the bottom 80 per cent.

If that doesn't convince you responsibility for the present and future state of the budget has to be shared between Labor and the Coalition, remember the other irresponsible revenue decision Costello made when the government was temporarily flush with funds: making income from superannuation totally tax free for people 60 and over.

Even at the time, economists warned this handout to the better-off was unsustainable - and so it has proved.