The main reason for reviewing the present state of economic policy is, of course, the election of the Abbott government in September 2013. Often a new government will introduce a new approach to economic policy, with the rationale for the changes spelt out in the first set of budget papers following the election. But the explanatory material in this year’s budget papers was little different from previous years. From this I deduce that, at the level of macroeconomic policy, the differences between the old and new governments are more rhetorical than actual.
If this judgement surprises you, it’s probably because you’re thinking not about macro policy as such but about the nature of the measures announced in the 2014 budget and who they would affect. The Year 11 course tells us all budgets affect the economy in three different ways: first, the effect on demand (ie macro management), second, the effect on the allocation of resources (ie microeconomic policy) and, third, the effect on the distribution of income (ie fairness or equity). This year’s budget was the classic example of a budget that needed to be analysed by dividing issues into that three-part framework to make sure people’s reactions to the budget didn’t get muddled up. Teaching your students to discipline their thinking about the budget in this way is good training in how to analyse issues logically.
Looking beyond straight macro management, the Abbott Coalition government’s policy preferences are obviously quite different from the Labor government’s in various respects, and those differences are now far clearer than they were before the election. They’re the preferences you’d expect of a Coalition government, though the measures proposed in the budget were harder-line than anything from the Howard government. Some may be tempted to regard this as an ‘ideological’ government, but all politicians (and all economists) have ideology in their kitbag and it’s not a label I’d apply.
If this was a highly ideological government there would be far more written expositions of that ideology than there have been. I certainly wouldn’t accuse the government of being dominated by the doctrines of economic rationalism. Some of its proposals may seem to fit that label but, as we will see, many don’t. No, I think this is a prime minister and government more of strong likes and dislikes, friends and foes. So many of its actions depart from the principles of economic rationalism to benefit particular big businesses - the miners, the banks, the coal-fired power generators. And the government is not above a little agrarian socialism at the behest of its National Party colleagues.
MACROECONOMIC POLICY
Monetary policy
The Abbott government has affirmed its commitment to the existing ‘framework’ for monetary policy. Monetary policy - the manipulation of interest rates to influence the strength of demand - is conducted by the RBA independent of the elected government. It has been assigned the objective of achieving internal balance. The 2012 budget papers said monetary policy plays ‘the primary role in managing demand to keep the economy growing at close to capacity, consistent with achieving the medium-term inflation target’. Monetary policy is conducted in accordance with the inflation target: to hold the inflation rate between 2 and 3 pc, on average, over the cycle. The primary instrument of monetary policy is the overnight cash rate, which the RBA controls via market operations.
Fiscal policy
Similarly, the 2014 budget papers give no reason to believe there has been any change to the framework in which fiscal policy operates. Fiscal policy - the manipulation of government spending and taxation in the budget - is conducted according to an unchanged medium-term fiscal strategy: ‘to achieve budget surpluses, on average, over the medium term’. The 2012 budget papers nominated a new and different role for fiscal policy: ‘the primary objective of fiscal policy is to maintain the budget in a sustainable position from a medium-term perspective’. That is, the primary objective of fiscal policy is now maintaining ‘fiscal sustainability’.
However, it has also been made clear the budget retains an important role in assisting monetary policy achieve internal balance. How? By allowing the budget’s automatic stabilisers to be unimpeded in doing their job of helping to stabilise demand as the economy moves through the business cycle. The stabilisers bolster aggregate demand when private demand is weak and restrain aggregate demand when private demand is strong. The latter process is known as ‘fiscal drag’ - which is, of course, a helpful thing when you’re trying to keep the growth rate stable. You would never hear Mr Hockey using those Keynesian terms, but it’s still how fiscal policy is expected to work under this government. And the 2014 budget is clearly consistent with it.
This year’s budget papers do set out a Budget repair strategy, which is designed to deliver budget surpluses building to at least 1 per cent of GDP by 2023-24, consistent with the medium-term fiscal strategy.
The repair strategy sets out that:
• new spending measures will be more than offset by reductions in spending elsewhere within the budget;
• the overall impact of shifts in receipts and payments due to changes in the economy will be banked as an improvement to the budget bottom line, if this impact is positive; and
• a clear path back to surplus is underpinned by decisions that build over time.
The Budget repair strategy will stay in place until a strong surplus is achieved and so long as economic growth prospects are sound and unemployment remains low.
The 2014 budget
Mr Hockey’s first budget was quite remarkable and absolutely fascinating for a connoisseur of budgets like me. So I’m going to describe it as it was delivered and intended to be enacted, even though we know that various of its more controversial measures have been abandoned or modified in their passage through the Senate, while some - the $7 GP co-payment, the changes to university fees - remain in limbo.
The most notable feature of the budget as planned was that it was our first ‘decadal’ budget. The government continued Labor’s recent practice of publishing not just the figures for the budget year and the forward estimates for the following three years, but also projections of the budget balance out 10 years on the assumption of unchanged policies. The projection to 2024-25 showed that the measures announced in the budget could be expected to return the budget to balance in 2018-19 and to an ever-growing surplus of more than 2.5 pc of GDP by 2024-25. However, this assumed 10 years of unrelieved bracket creep. If instead the growth in tax collections was capped at 23.9 pc of GDP from 2019-20 by means of tax cuts, the surplus would still reach a healthy 1.4 pc in 2024-25.
So, the budget announced measures which, though many didn’t take effect until the 2017 budget following the next election, and others would take years before their effect on the budget became significant (eg the restoration of indexation of fuel excise), would get the budget firmly back on track over the coming decade and do it in just one go. Our first ever ‘decadal’ budget. It was the budget of an incoming government, confident of its ability to stay in office for ages. A budget with high political costs up front, but a big payoff way into the future.
How was this remarkable feat to be achieved? Mainly through fiddling with indexation arrangements, adjusting them in any way that favoured the budget. Few people noticed how obsessed this budget was with indexation. It proposed to change the indexation of pensions from average weekly earnings to the CPI, it reduced the indexation of grants to the states for public schools and public hospitals, it paused the indexation of certain family benefits, it changed the indexation of overseas aid from gross domestic income to the CPI, it changed the indexation of HECS debt from the CPI to the long-term bond rate and it restored the indexation of fuel exercise.
As well as all these indexation adjustments the budget proposed to increase the user charges for pharmaceuticals and university students, plus the new $7 co-payment for GP visits and tests. So the budget isn’t about cost cutting so much as cost-shifting: to people on pensions, to the young jobless, to university students, to the sick and, to the tune of $80 billion, to the states. Some opponents of the GP co-payment are referring to it as the ‘GP tax’. This is simply wrong, but it gives you the opportunity to make sure your students understand the difference between a tax and a user charge.
Budget’s effect on demand
From a macro management perspective, the budget had three key features:
1) A slow pace of fiscal consolidation. The new measures and revisions to forecasts were expected to improve the budget balance by just $4 billion in the budget year and by $7 billion in each of the following two years, but by $26 billion in 2017-18. This slow start was intended to avoid the budget having a dampening effect on growth while the economy was expected to be growing at a below-trend rate.
2) A switch in the composition of government spending. While spending on transfer payments leading to consumption was reduced, spending on infrastructure investment was increased by $12 bil. Half of this was spent on an ‘asset recycling initiative’ intended to encourage the states to increase their own infrastructure spending. The goal was to help fill the vacuum left by the fall in mining investment.
3) Headroom for tax cuts. The government’s 10-year budget projections assume that tax revenue is capped at 23.9 pc of GDP (the average level between 2000 and 2008) after 2019-20, with spending cut so hard that budget surpluses are still projected to reach 1.5 pc of GDP in 2024-25. The cap is intended to make room for tax cuts to counter the effect of bracket creep.
So, clearly, this was not a highly contractionary budget. Indeed, in terms of the first two or three years it wasn’t contractionary to any significant degree. The contraction was designed to come only after the economy was expected to have returned to above-trend growth. Thus no matter how much people may object to some of its measures, it’s quite wrong - quite ignorant - to describe the budget as pursuing a policy of ‘austerity’. Austerity doesn’t mean acting to improve the budget balance (the term for which is ‘fiscal consolidation’), it means doing so while private demand is still very weak and thus running a high risk that efforts to reduce the deficit backfire and actually make it worse. This is just what Mr Hockey tried not to do.
When the mid-year review is published in December, we will see the effect on the projected budget balance of those budget measures the government has been obliged by Senate opposition to modify or abandon (although those it has yet to put up to the Senate may remain in the forward estimates). We also know that greater-than-expected falls in export commodity prices and low wage growth will necessitate a continuation of the downward revisions to budget revenue estimates than became so frequent under the previous government. We also know that, consistent with his rejection of austerity policy, Mr Hockey will not announce further budget savings intended to offset the effect of the downward revisions to revenue. So the budget’s return to surplus will now be even later than projected at budget-time.
It’s clear that, despite all the Coalition’s criticism of Labor while in opposition, and its various promises to get the budget back to surplus much earlier than Labor could, it’s not having much success, and this does not seem to worry it greatly. The measures it proposes may be very different to those Labor would propose, but its approach to fiscal policy turns out to be remarkably similar to Labor’s.
Budget’s effect on allocation
Viewed as an instrument for raising allocative efficiency - as a vehicle for microeconomic reform - the budget was not an impressive document. Its proposed measures did a lot to shift costs from the federal budget onto state budgets and household budgets, but little to raise the efficiency of government spending. Far from increasing spending on preventive health programs (with beneficial effects on employment, wellbeing and the budget) it cut such spending.
The budget could have done a lot to reduce distorting subsidies to business (‘business welfare’) but, apart from eliminating subsidies for the production of ethanol, it didn’t. Its real cuts to public school funding and eventual discontinuation of spending on the Gonski equity program may well have the effect of reducing the employability, skills and productivity of disadvantaged young people. While many economic rationalists believe imposing a $7 user charge on previously ‘free’ (bulk-billed) doctor visits and tests would reduce their unnecessary use, empirical studies suggests it would do more to discourage poor people from seeing a doctor when they needed to than to discourage frivolous visits.
Many economic rationalists believe that deregulating university fees would eventually do a lot to force greater efficiency on universities. But this is debatable because the market in which the universities would operate is far from perfect. They would remain government-owned and regulated and they enjoy a degree of monopoly in granting access to the best jobs in the labour market.
Budget’s effect on distribution
The budget was widely judged by the public to be unfair, even by people who themselves weren’t greatly affected by it. It was seen that poor people would be hit a lot harder than the better-off. This was, in fact, an almost inevitable consequence of the government’s unusual decision to return the budget to surplus largely by cuts in spending rather than increases in taxes. This is because our system of tightly means-tested transfer payments comes on the spending side, whereas various questionable ‘tax expenditures’ - such as the superannuation tax concessions, negative gearing, family trusts and the 50 pc discount on capital gains - heavily favour high income-earners.
The plan to withhold access to the dole to people under 30 for six months would clearly have hit low income-earners. The $7 co-payment would be regressive. Because we measure relative poverty, the plan to index age, invalid and sole-parent pensions to the CPI rather than average earnings, would cause the rate of pension payment to fall over time below the poverty line.
Even without any increase in the level of university fees, the proposal to index HECS debt to the government bond rate rather than the CPI - that is, to impose a real interest rate on the debt - would leave people who didn’t complete their degrees and those with breaks in their full-time employment (particularly married women) with significant levels of debt and interest charges. The HECS scheme was designed to allow students to be required to pay a proportion of the cost of their tuition in an equitable way, but this would rob the scheme of much of its fairness.
By contrast, I believe the proposal to deregulate uni fees, which would no doubt permit significant increases in those fees over the years, while being highly unpopular, would be a progressive rather than regressive measure. Why? Because the great majority of uni students come from well-paid homes and go on to themselves have well-paid jobs. Those who attended the higher-status sandstone universities would be obliged to pay a lot more for that status.
It’s important to note that, though the government’s rhetoric focused on getting savings from the spending side, in truth a high proportion of the projected improvement in the budget balance would come from the revenue side. That’s not just because of the temporary ‘deficit levy’ imposed on high earners nor the restoration of fuel excise indexation, but because the budget projections imply six years without another income-tax cut and thus six years of bracket creep. And it’s worth remembering that the particular shape of our tax scale at present means bracket creep is regressive, hitting low income-earners proportionately harder than high earners.
Over the years I’ve seen incoming Coalition governments bring down some pretty unfair initial budgets without drawing much public outcry over that unfairness. Why was the reception to this budget so different? Partly because the treatment of the young unemployed was so obviously excessive. But also because I never expected to see a government of any colour getting so tough with age pensioners. When a Coalition government gets tough with the aged it’s getting tough with its own heartland. The same goes for its plan to permit big increases in university fees and debts. Remarkable politics.
MICROECONOMIC POLICY
One of the ways the Coalition kept itself a ‘small target’ in the 2013 election campaign was to avoid promising controversial reforms in key economic policy areas by promising to establish inquiries and take any reform proposals arising from those inquiries to the next election. There is a belief among politicians that it’s easier to bring about reforms from government than from opposition. As yet, few of those inquiries have delivered their final reports and had the government announce which of their recommendations it was accepting. So it is too soon to have a clear picture of how reformist the Abbott government has proved to be, how rationalist it is and how brave it is. Although the initial signs haven’t been encouraging, it’s not yet clear whether it is pro-market or just pro the interests of influential industries.
Even so, while it waits for the many inquiry reports the government has been getting on with keeping its election promises. It has succeeded in abolishing the minerals resource rent tax and the carbon tax/emissions trading scheme. It has claimed that this will lead to faster economic growth, but it’s hard to take such claims seriously. It has sought considerable publicity for its red-tape-cutting ‘repeal days’, but though some of these measures are genuine, much is window-dressing.
Throughout its term the Labor government had been negotiating free-trade agreements with South Korea, Japan and China, without much sign of progress. The new trade minister was given the task of completing those agreements within his first year, and he completed it within about 14 months. The agreements with Korea and Japan will deliver modest gains in market access to certain categories of Australian agriculture, but the surprise agreement with China involves wide-ranging cuts in Chinese tariffs and other trade restrictions, making it a far more significant advance.
The interim report of the inquiry into competition reform, chaired by Professor Ian Harper, implied than various competition-promoting changes would be recommended, but we have yet to see his final report and the government’s response to it.
The interim report of the inquiry into financial regulation, chaired by David Murray, drew a favourable reaction from economists but, again, it’s too early to be confident of what will finally emerge from it. In the meantime, the government has sought to water down the consumer protections in the Labor government’s Future of Financial Advice legislation in response to pressure from the big banks and insurance companies, but the Senate has reversed its initial support for the government’s changes.
The Coalition has yet to initiate its promised inquiry by the Productivity Commission into industrial relations. The delay reinforces suspicions Mr Abbott has little enthusiasm for radical reform, particularly anything his opponents could portray as an attempt to restore Work Choices. And, assuming he will take proposals for controversial reform in some policy area into the 2016 election, by this stage he may be keen to ensure he isn’t fighting on too many fronts.
Mr Abbott is also yet to initiate the promised inquiries into tax reform and federalism, which he has linked. In a recent speech on federalism he raised the possibility of tax reforms, ‘including changes to the indirect tax base’, calling for ‘mature debate’ and ‘rational discussion about who does what’. He wants to reverse the creeping centralisation, reaching a rational division of roles that would make each level of government ‘sovereign in its own sphere’. I find it hard to believe the federal government could ever reach an agreement with the premiers on a more rational division of responsibilities.
And though Mr Abbott’s remarks imply that, as part of a wider tax reform package, he’d support a joint plan to increase collections from the (withering) GST and give all the proceeds to the states, such joint agreement - virtually all premiers supporting a more onerous GST - is hard to imagine. Apart from that, the arithmetic isn’t adding up. Mr Abbott has stressed that any reform package including a higher GST would not involve any increase in the tax burden overall. Mr Hockey says in the context of reform that the government ‘wants taxes that are lower, simpler and fairer’. In which case, it’s hard to see how raising GST collections could solve the budget-balancing problems of both the federal and state governments. And that’s before you remember that the Business Council and other vocal business advocates of tax reform have been hoping the proceeds from a higher GST would be used to cover cuts in the rate of company tax and/or the top personal tax rate. The path to a tax reform package that even the government and influential lobby groups could agree on, to then put before voters, at an election is long and rocky.
We will have a clearer idea this time next year, but it won’t surprise me if, in practice, the Abbott government proves to be much less radical than its rhetoric to date has led many to expect.
