Monday, June 9, 2014

Why Hockey's budget is unsustainable

Coalition governments have been banging on about the need for "smaller government" since Malcolm Fraser started echoing Maggie Thatcher and Ronald Reagan. They've talked without doing anything. Until now.

Few have noticed, but the goal of this budget is to reduce government spending by 1.1 per cent of gross domestic product (GDP), from 25.3 per cent this financial year to 24.2 per cent in 2024-25.

If that doesn't impress you, this may: Joe Hockey's plan is to cut government spending to 0.7 percentage points below its 30-year average of 24.9 per cent.

That makes this the most ideologically driven budget we've seen - not that Hockey or Tony Abbott will admit it. They claim the budget's harsh measures are needed simply to get the budget back to surplus and start paying down the public debt.

They don't admit it was their choice to do this in a way that achieved savings more by cutting spending than by cutting tax expenditures. They cut the real growth in pensions, but left high-income-earners' absurdly generous superannuation tax concessions untouched.

They tightened up the family allowance and cut young people's access to the dole, but didn't tackle the concessional taxation of capital gains, negative gearing or company cars, while ignoring the miners' diesel fuel rebate and other business welfare. They imposed a co-payment on GP visits, but didn't abolish the private health insurance rebate.

The intended effect of this bias against spending and in favour of tax breaks is to make the budget significantly less redistributive. That's because, particularly with our tightly means-tested welfare system, government spending tends to benefit the less well-off, whereas tax expenditures go disproportionately to people at the top.

So it's the "end of entitlement" for people in the bottom half, but no change to the entitlements of the well-off, save for a small three-year tax levy.

It's true the government's 10-year "medium-term budget projection" sees tax collections rising as a proportion of GDP from 21.6 per cent this year to 23.9 per cent in 2019-20, at which point it would be prevented from rising further. (This cap is based on the average tax ratio to GDP between 2000-01 and 2007-08.)

This seems to indicate Hockey is relying more on higher taxes than lower government spending to get the budget back to a surplus of 1.5 per cent of GDP. But this impression is misleading.

At 25.3 per cent of GDP, government spending at present is only a little above its long-term average of 24.9 per cent, whereas at their present 21.6 per cent, tax collections are well below Hockey's benchmark of 23.9 per cent.

It's no secret why tax collections are unusually weak at present: because the fall in mineral export prices is causing real national income to grow more slowly than real GDP and because of the continuing revenue loss from the eight income-tax cuts in a row we enjoyed when the Howard government assumed the resources boom (and its inflated company-tax collections) would run forever.

To get tax collections back to a more normal proportion of GDP, the government is relying mainly on allowing another six years of bracket creep. The 23.9 per cent cap after 2019-20 is supposed to allow the resumption of regular tax cuts (though who will benefit most from those cuts is another matter).

What we do know is that, whereas the eight successive tax cuts weren't particularly "progressive" in their effect on the income-tax scale, its particular shape at present means the following eight years of bracket creep will be highly "regressive", causing average tax rates towards the bottom to rise a lot further than those at the top.

So even the recovery in tax collections will come mainly at the expense of the less well-off.

It's clear the government will have much trouble getting many of its more controversial measures through the Senate. What the 10-year projection will end up looking like is anyone's guess.

But even if the budget passes intact, it contains the seeds of its own destruction.

Pensions heading inexorably below the poverty line? Pressure throughout the public sector for wages - including for nurses, teachers, childcare and age-care workers - to rise no faster than inflation, while private sector wages continue rising in real terms with productivity growth?

The vice-chancellor herd given total control over how high uni fees (and graduate debts) rise, including whether they make training for jobs as nurses, teachers and even government lawyers financially untenable?

This budget is unsustainable because the wider implications of its measures haven't been thought through. By knocking back its worst features, the Senate will be doing the Coalition (and the nation) a favour.