Frydenberg's budget: if it looks too good to be true . . .

What a wonderful world we live in now our politicians have discovered the cure for opportunity cost. In his first budget, Josh Frydenberg is doing a Gladys: he wants us to believe “we can have it all”.

Over the next 10 years, he can give us: tax cuts worth $302 billion, new infrastructure worth $100 billion, sundry other goodies, and a budget that’s back in the black and stays there, so that the net debt falls to zero. Yeah? How?

But first, a flashback. Labor’s Wayne Swan ended up a laughing stock after he began his 2012 budget speech with the immortal words: “The four years of surpluses I announce tonight . . . this budget delivers a surplus this coming year, on time, as promised, and surpluses each year after that, strengthening over time.”

Here's what Frydenberg said seven years later: “Tonight, I am pleased to announce a budget surplus of $7.1 billion . . . In 2020-21, a surplus of $11 billion. In 2021-22, a surplus of $17.8 billion. In 2012-23, a surplus of $9.2 billion. A total of $45 billion of surpluses over the next four years.”

Oh dear. This year even the media knew not to fall into their usual trap of treating the government’s estimate of next year’s budget balance as an already accomplished fact. Actually, we won’t know the “actual” for another 18 months.

But, as usual, the media took little notice of the expected budget balance for the year just ending – a truth the Finance Department’s creative accountants have long exploited to improve the new year’s expected balance at the expense of the old year’s.

Some have questioned why Frydenberg didn’t try harder to turn the old year’s small deficit into a small surplus so that, should the Coalition lose the election, it would have avoided going into the history books as a government that was in power for six years without ever recording a surplus.

Short answer: it couldn’t afford to. Reading the budget papers’ fine print makes it clear the creative department had to put in much furniture shifting to come up with the predicted surplus of $7.1 billion – an amount Frydenberg has been able to assert is “substantial” rather than “wafer thin”.

Think about this: in the old year, government spending is expected to leap by 4.9 per cent in real terms, whereas in the new year it will grow by just 0.1 per cent real. Do you reckon that discontinuity happened by chance?

My colleague Shane Wright has noted the government’s decision to bring forward to the old year $1.3 billion in grants to local councils due to be made in the new year. He could have added that two new one-off cash grants, one to help recipients of residential aged care and another to help pensioners with their energy bills, with a total cost approaching $700 million, will be paid in the old year rather than the new.

The government’s been promising to have the budget “back in the black” by 2019-20 since Joe Hockey’s time. And for some years has been “reprofiling” the timing of payments and receipts to ensure this target is met.

Wright reminds us that a change in the timing of tobacco excise collections announced in last year’s budget will, purely by chance, yield a one-off boost of several billions in the new financial year.

Why are we so anxious to get the budget back in black? Because we want to start reducing the government’s debt. Trouble is, since Peter Costello’s day, successive treasurers have drawn our attention to the underlying cash deficit and away from the ironically named “headline” cash deficit.

That’s a problem because it’s actually the higher headline deficit that has to be funded by borrowing – or, if it’s in surplus, can be used to pay off debt. Guess what? The budget estimates that we’ll still be in headline deficit of $4.4 billion in the coming year, and won’t be in surplus until 2021-22.

The discrepancy is explained mainly by successive governments using an accounting loophole to exclude their spending on the NBN, the second Sydney airport, the inland railway and other projects from the underlying deficit.

Even so, Frydenberg assures us the government’s net debt will have been fully repaid by June 2030 – and he has a lovely graph that proves it. How is our path to a debtless Nirvana achieved?

By assuming that government spending grows with almost unprecedented slowness despite the ageing of the population, that the economy grows strongly for another 10 years without missing a beat and with productivity improving each year at a rate faster than we’ve achieved in decades, and – get this – that the government’s financial assets will grow by almost 3 percentage points to 12.8 per cent of gross domestic product.

When it comes to creativity, Australia’s politicians are second to none.

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The budget's getting better, but the economy's getting worse

Why would a government that boasts of its superior economic management be entering an election campaign with a budget warning of harder economic times ahead? Because it has no choice.

It will turn this admission of a bleaker economic outlook – with a slowdown in the global economy and, domestically, the risk that falling house prices could further weaken consumer spending – into a warning that now is just the wrong time to turn the economy over to those bunglers in the Labor Party, but this will be making the best of a bad deal.

There’s nothing new about a big give-away pre-election budget, but the budget we’ll see on Tuesday night will be different in several respects. For one thing, it’s not often you get a full budget that’s timed to be the kick-off of a six-week election campaign.

It will be more like an election policy speech than a budget, since none of its measures will have been legislated, let alone put into effect. Unless the Coalition wins, it’s a budget we’ll never hear of again.

For another thing, it’s reasonable to expect that strong economies and strong budgets go together, as do weak economies and weak budgets. The state of economy determines the state of the budget balance.

Not this time. As Deloitte Access Economics’ Chris Richardson has observed, “the economy is getting worse, but the budget is getting better”. Let’s start with the budget.

Politically, this budget is built on a fiction: that its centrepiece, a further round of tax cuts (and possibly one-off cash grants to pensioners) on top of last year’s three-stage, seven-year tax cuts costing $144 billion over 10 years, is the fruit of the government’s success in returning the budget to surplus, not a sign of its political desperation.

In truth, the government’s budgetary record is hardly anything to boast about, particularly when you remember the confident promises it made while in opposition about how quickly and easily it could eliminate “debt and deficit”.

The deficit may be gone, but there's still a lot of debt - which the Coalition seems in no hurry to pay back.

We know the government will budget for a decent surplus in the coming financial year, but it’s so close to balance in the present year that it would take only minor creative accounting to produce a “surprise” surplus a year earlier than promised.

When you remember how close to balance Labor’s Wayne Swan got in 2012-13, however, it’s surprising it’s taken the Coalition all of two terms to get us to where we now are.

You can blame this on lack of political will, but it’s now more apparent than it has been that the delay is a product of the economy’s slowness to recover from the Great Recession we supposedly didn’t have.

Even since Swan’s day, the econocrats – including the Reserve Bank – have each year been forecasting an early return to strong economic growth and a greatly improved budget balance.

And, each year, their forecasts have proved way too optimistic, particularly for a return to strong wage growth. A return to economic business as usual has repeatedly eluded us.

It’s not the econocrats’ fault, it’s the slowness of all of us to realise that the “secular stagnation” that’s dogged the United States and the other advanced economies is also dogging us. But with the economy’s unexpected slowing to growth of just 2.3 per cent over 2018 – or 0.7 per cent when you subtract population growth – it’s now a lot harder not to realise.

Few remember that Tony Abbott’s ill-fated first budget in 2014 was carefully designed to do little to reduce the budget deficit for the first three years because the economy was still too weak withstand a move to contractionary fiscal policy.

The surprising fact is, little has changed in all the years since then. This is the macro-economic justification for Tuesday’s purely politically motivated announcement of further tax cuts. The economy’s still too weak to withstand contractionary fiscal policy as the budget heads into surplusland.

But, in that case, how have we finally got back to surplus? Partly, through surprisingly limited real growth in government spending. But, mainly, through years of bracket creep, the exhaustion of companies’ prior tax losses, more effective anti-avoidance measures and, above all, the good luck of a (probably temporary) recovery in coal and iron ore prices and, thus, mining company profits.

Treasurer Josh Frydenberg will be hoping to convince us the budget improvement is lasting, but the weak economy is temporary. It’s more likely to be the other way round.

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Find parenting tough? Be glad you're not American

I have a news flash: being a grandad beats being a parent. Parenting is now a much tougher gig, whereas grandparenting is all care and no responsibility. And it’s a lot cheaper.

These thoughts are prompted by an article in the New York Times, in which Claire Cain Miller writes that parenthood in the United States has become much more demanding than it used to be.

“Over just a couple of generations,” she writes, “parents have greatly increased the amount of time, attention and money they put into raising children. Mothers who juggle jobs outside the home spend just as much time tending their children as stay-at-home mothers did in the 1970s.”

(How does she know how much time mothers spend on their kids? Because the US government conducts regular surveys of how people use their time. We used to do so too, but have since decided we can’t afford to keep it up. Great decision, guys.)

“The amount of money parents spend on children, which used to peak when they were in high school, is now highest when they are under 6 and over 18 and into their mid-20s,” she writes.

The most momentous social change in my lifetime came sometime in the 1960s when Australia’s parents decided (as did parents in most advanced economies) that their daughters were just as entitled to a good education as their sons.

That simple attitudinal change has had huge economic and social ramifications, to which we and our governments are yet to fully adjust.

These days, most kids go to year 12, and most of those go on to uni. But girls outnumber boys in year 12 and at uni. When girls (and their parents and the taxpayer) have invested so much time and money in attaining a good education, it’s hardly surprising most of them want to put that education to work, so to speak, to gain the monetary reward but also to gain more intellectual (and social) stimulation than they would staying at home.

This “economic emancipation of women” has greatly increased the rate at which women participate in the (paid) labour force, making Australians a lot more prosperous, including by creating a lot of jobs for women performing services most women formerly performed for themselves at home, such as childcare.

The rise of the two-income family is one factor contributing to higher house prices. Governments have had to do a lot of work (and spend a lot of money) renovating the institutions of the labour market which, over the centuries, were designed exclusively to meet the needs of male breadwinners.

They’ve had to spend a lot more on high school and university education, legislate to ensure women (and later men) keep their places when they go on parental leave, receive at least some payment while on that leave, and receive big subsidies for a greatly expanded and heavily regulated system of childcare – in which childcare workers are better trained and much better paid.

Now there are strengthening efforts to ensure women get a much bigger share of the top jobs (with pay equal to the top men) – including in parliament.

Meanwhile, however, the nature of parenting has changed. Two-income families have more money to spend on fewer kids, and spend it they do – partly, I suspect, because mothers feel guilty about the time they don’t spend with their kids (I’m not saying they should, just that many do).

Parents, mainly mothers, put much time and money into taking their kids to after-school sporting and cultural training and (particularly in NSW) exam coaching. Many imagine sending their kids to expensive private schools will buy them a better education.

We’ve entered the era of “intensive parenting”, which brings us to Miller’s point that modern American mothers spend just as much time parenting as their stay-at-home mothers or grandmothers did. They just do different things.

As yet, however, it’s not nearly as bad in Oz as it is in the US. The gap between rich and poor has widened so much in America (with a bigger cost and status gap between government-funded universities and private Ivy-League colleges), that parents worry their kids won’t be able to live as well their parents did. In the States, parenting has become a lot more competitive.

Nor is it nearly as true here that children are most expensive before they get to school and after they leave it and head to uni. Our childcare is much more heavily subsidised than America’s. And our HECS-HELP “income-contingent loans” for uni tuition fees are much more concessional than what the Yanks do.

We have no need to worry about our kids being loaded up with HECS debt.

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Long way to go to get banks back in their box

Have we learnt from the mistakes of the global financial crisis, now 10 years ago? Yes, but not nearly as much as we should have.

Of course, the answer is different for the Americans and the other major advanced economies to what it is for us, who managed to avoid bank failures and the Great Recession.

Globally, much has been done under the Basel rules to strengthen requirements for banks to hold more capital and liquidity, reducing the likelihood of them getting themselves into difficulties.

It would be naive, however, to imagine this has eliminated the possibility of any future financial crisis. Recurring financial crises are a feature of capitalist economies through the centuries.

All we can do is work on reducing their frequency and severity. On that score, the rich countries could have done a better job of rationalising the division of responsibility between the various buck-passing authorities supposed to be regulating their financial system.

The root cause of the GFC was ideological: the belief that the more lightly regulated the banks and other financial players were, the better they’d serve the wider economy’s interests, allied with the belief that their greater freedom wouldn’t tempt them to take excessive risks because that would be contrary to their interests.

Wrong. This badly misread the perverse incentives bank executives faced – heads I win big bonuses; tails my shareholders do their dough – and the way the heat of competition can induce business people to do things they know they shouldn’t, not to mention the “moral hazard” of knowing that, should the worst come to the worst, the government will have no choice but to bail us out.

As actually happened. In the North Atlantic economies, politicians and central bankers did the right thing in rescuing failing banks. Had they not, the whole financial system would have collapsed and the loss of wealth and employment would have been many times greater than it was.

But don’t try telling that to a public that watched governments racking up billions in debt to save banks and bankers, who then proceeded to turn out on the street people who could no longer afford the mortgages they should never have been granted.

The US authorities’ mistake was failing to draw a clear distinction between saving banks to protect their customers and stop the system collapsing, and punishing the failed banks’ managers and shareholders for screwing up.

Why didn’t they? In short, because the banks are too powerful politically.

Which brings us to Australia’s response to the GFC and how we escaped the Great Recession. Our big banks didn’t fall over because our econocrats never believed the banks wouldn’t be silly enough to take risks that could endanger their survival. Our banks didn’t buy toxic assets because our prudential supervisors wouldn’t let ‘em.

That didn’t stop the GFC dealing a blow to business and consumer confidence, such that real gross domestic product contracted by 0.5 per cent in December quarter 2008. That we avoided recession is thanks to the quick action of the Reserve Bank in slashing interest rates and the Rudd government in applying huge fiscal stimulus, which stopped the economy unravelling.

At another level, however, the econocrats did believe the banks should be lightly regulated in their relations with customers, and could be trusted not to mistreat them. Outfits such as the Australian Securities and Investments Commission had their funding cut and were given the nod not to be overactive.

The absence of a crash meant our governments didn’t learn that, in the non-textbook world, market forces can cause, as well as limit, the mistreatment of customers. Our own banks’ great political influence reinforced this naivety, prompting governments to wave aside the mounting evidence of bank misconduct and the public’s mounting disquiet and distrust.

So, in a sense, the banking royal commission is the product of our earlier failure to learn what we should have from the GFC.

But there’s a much broader lesson we’ve yet to learn from the crisis, one that applies to all the advanced economies. It’s that the banking and “financial services” sector is far bigger than we need, is bloated by rent-seeking, involves many times more trading between banks (a form of gambling) than trading between banks and real-economy customers, and is thus a waste of economic resources.

When financial services’ share of our economy (and most other advanced countries’) was expanding rapidly in the decades preceding the crisis, economists told us we were benefiting from financial innovation and advances in the management of financial risk.

The GFC revealed that rationale as about 95 per cent bulldust. To misquote Keynes, the economy would be better off if most of the people making big bucks in finance got useful jobs such as being dentists.

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Morrison optimistic we’ll get much bracket creep

The mystery revealed. Consider this: how does the Morrison government cut income and company taxes and avoid big cuts in government spending, but still project ever-rising budget surpluses and ever-falling net public debt over the next decade?

With publication of the Parliamentary Budget Office’s report on the May budget’s medium-term projections, we now know. Short answer: by assuming loads more bracket creep between now and then.

You may remember that, at the time of budget, I was highly critical of the rosy forecasts and assumptions used in the budget’s “forward estimates” from 2018-19 to 2021-22, and then in its “medium-term projections” out for a further seven years to 2028-29.

They showed the budget’s underlying cash balance returning to a tiny surplus in 2019-20, then the surplus growing steadily to about 1.3 per cent of gross domestic product by the end of the decade.

As a consequence, the government’s net debt would peak in June this year at 18.6 per cent of GDP, then fall sharply to just 3 per cent in 2028-29 as the annual surpluses were used to repay debt.

There you go. Big cuts in company tax and a plan for three cuts in income tax, but we’ll soon be back in the black and eliminating the debt. I thought then it sounded too good to be true.

The budget office, which is independent of the government, is required by its Act to accept the government’s forecasts and macro-economy assumptions for its projections. But the budget papers gave no details of how, according to the government’s projections, the budget surplus would grow from 0.8 per cent of GDP in 2021-22 to 1.3 per cent in 2028-29.

This is what the office’s report tells us. It does so using its own modelling of each of the main taxes and 23 big spending programs, while sticking to the government’s macro-economy assumptions.

The report’s projections show total receipts ending the seven years where they began, at 25.5 per cent of GDP, while total spending grows more slowly than GDP so that it falls from 24.7 per cent to 24.1 per cent.

This implies that all the projected improvement in the budget surplus is expected to come from many years of amazingly disciplined spending restraint. But such a conclusion misses an obvious question: how can total receipts stay growing as fast as the economy is projected to grow when the government is planning to cut the rate of company tax by a sixth (from 30 to 25 per cent) and have three cuts in income tax?

Ah, that’s the report’s big reveal. Its projections show company tax collections declining as a proportion of GDP and “other receipts” also declining, but with this being exactly offset by the growth in income tax collections.

And that would be made possible by the fiscal magic of bracket creep. Remember bracket creep? It was the justification for the tax cuts and, according to then-treasurer Scott Morrison, the tax cuts would “eliminate bracket creep for the middle class”.

Or not. Turns out, according to the report’s projections, there’ll be so much continuing bracket creep as to more than wipe out the benefit from the promised tax cuts.

Taken over the full 10 years – and remembering that the first of the tax cuts began in July this year - income tax collections are projected to rise from 11.2 per cent to 12.5 per cent as a proportion of GDP, a huge jump of 1.3 percentage points.

Over the same decade, the average tax rate across all taxpayers is projected to rise from 22.9¢ in every dollar to 25.2¢. But here’s another important revelation by the report: some people do much better from the tax cuts than others, while bracket creep doesn’t affect everyone equally, either.

The report ranks everyone paying income tax according to their income, then divides them into five groups of about 2.9 million each - “quintiles” – from lowest to highest. It then looks at the way the average tax rate in each quintile is affected by the tax cut and by bracket creep. It looks at the change from 2017-18 to 2026-27.

On average, the three-stage tax plan will cut the average tax rate paid by people in the bottom quintile by just 0.3¢ in the dollar. Those in the second and third quintiles will save 0.9¢, while those in the fourth quintile save 1.1¢ and those in the top quintile save 2.1¢ in every dollar.

(This, BTW, is the proof that the three-stage tax plan does change the progressive income tax scale in a regressive direction, making it significantly less progressive.)

Now, the effect of bracket creep (before allowing for the tax cuts). It raises the bottom quintile’s average tax rate by 1.1¢ in the dollar, then the second and third’s by 5.4¢, but the fourth’s by 3.7¢ and the top quintile’s by just 2.9¢ in the dollar.

Leaving aside the bottom quintile (where most people rely on benefits and earn little income), the big net losers - bracket creep less tax cut – are those in the second and third quintiles. That is, those earning between 30 percentage points below the median income and 10 points above it.

Another name for such people is “low to middle income-earners” – the very people Morrison claimed his cuts were aimed at helping most.

But before you get too steamed up, remember that the budget office is merely exposing the previously hidden implications of the government’s medium-term projection and the rosy assumptions it depends on.

The key assumptions are “above-trend economic growth for much of the period” – which contains a hidden assumption that our record of 27 years without a severe recession will roll on for another 10 – and, in particular, “a return to trend wage growth”.

That is, it will take only a few years before wages are back to growing by 3.5 per cent a year – a percentage point faster than prices – and will stay growing that fast for the duration.

It’s this strong wage growth that does most to produce the bracket creep. So, if you’re not as optimistic about wages grow, you don’t need to be as concerned about bracket creep. By the same token, however, we wouldn’t be making as much progress reducing public debt.

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We have debts to pay before we give ourselves tax cuts

How much should we worry about leaving government debt to our children and grandchildren? A fair bit, though not as much as some people imagine.

The central claim of this year’s budget is that we can have our cake and eat it.

We can award ourselves personal income tax cuts worth $144 billion over 10 years, but still halt the growth in the federal government’s net debt at $350 billion by the end of June next year, and then have it fall away as the proceeds from successive, ever-growing annual budget surpluses are used to pay off the debt.

I’ve devoted much space to explaining how Treasurer Scott Morrison was able to conjure up this seeming fiscal miracle, by staging the tax cuts over seven years and by resorting to overly optimistic forecasts and projections.

So how worried should we be by the possibility that the debt will keep growing despite ScoMo’s unbounded optimism?

Well, the first thing to remember is that the federal government isn’t like a household. A household or family has to be careful about how much it borrows because it has a finite life. Eventually, the kids leave home and mum and dad die.

Of course, many families borrow amounts that are several multiples of their annual salary to buy the home they live in. They’ll take 20 or 30 years to pay off their mortgage, but few people regard this as terribly worrying.

Why not? Because the home they buy provides them with a flow of service for as long as they need it to: somewhere to live. It saves them having to pay rent.

Buying your home is an investment in an asset and, provided the family can fit the mortgage payments within their budget, no one would accuse the family of “living beyond its means”.

It would be living beyond its means, however, if it was regularly spending more on living expenses than its after-tax income.

By contrast, the government has an infinite life. It provides services for about 9 million households, who pay taxes that are usually sufficient to cover the cost of those services. As the people in those households die, their place is taken by others.

If the households aren’t paying enough tax to cover the government’s spending, the government can always increase taxes. How many households do you know that can solve their money problems by imposing a tax on other households?

This is why it’s a mistake to imagine the rules that apply to your family also apply to the government. The government’s power to raise taxes means there’s never any shortage of people willing to lend it money.

Even so, there are some valid analogies between households and governments. A government can rightly be said to be living beyond its means if it’s not raising enough tax even to cover its day-to-day expenses.

This happens automatically when the economy turns down, and isn’t a bad thing: it helps to prop up the 9 million households when times are tough. But when the economy improves, the government needs to ensure its income exceeds its ordinary spending so the debt incurred isn’t left to burden people who gained no benefit from it.

And, just as a household shouldn’t be said to be living beyond its means because it’s borrowed to buy a home, so a government that’s borrowed to build worthwhile infrastructure – roads, rail lines, airports etcetera – shouldn’t be thought to be living beyond its means.

Why not? Because, like a house, that infrastructure will deliver a flow of services for decades to come.

If the children and grandchildren who inherit that debt also inherit the infrastructure it paid for, they don’t have a lot to complain about.

So, how much of the net debt can be attributed to living beyond our means while the economy’s been below par, and how much to investing in infrastructure that’s a valuable inheritance for the next generation?

This year’s budget statement four proudly informs us that the financial year just ending is expected to be the last in which the government will have to borrow to fully cover its “recurrent” spending to keep the government working for another year.

The government had to begin borrowing for recurrent expenses (including “depreciation” - the cost of another year’s wear and tear on the physical assets the government uses in its recurrent operations) from the time of the global financial crisis in late 2008.

Updating the figures provided in last year’s statement four allows us to calculate that the cumulative recurrent deficit over the 10 years is roughly $200 billion, although you’d have to add interest costs to that.

In principle, the rest of our total net debt of about $340 billion by the end of this month has been incurred to build infrastructure, which will deliver a flow of services to the present and future generations extending over many decades.

So we need be in no hurry to pay off that part of the debt – it will do our offspring no harm.

But two qualifications. First, though economic theory indicates no level to which it’s prudent to borrow – it’s a judgment call – it is prudent to borrow less than the full cost – say, 80 or 90 per cent – of the infrastructure we build each year.

Second, it’s likely that a fair bit of the federal government’s spending on capital works has been selected more for political than economic and social reasons, and so won’t deliver much in the way of valuable services to the next generation.

If so, we should probably regard it as more in the nature of consumption or recurrent spending, and so pay for it ourselves rather than lumber our kids with it.

All of which says, yes, there is a fair bit of the total debt we should be getting on with paying off – and do so before we start awarding ourselves big tax cuts.

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Whatever Tuesday’s budget holds, it’s sure to be fudged

It’s a sad truth that treasurers and finance ministers almost never avoid using creative accounting to make their budgets look better – or less worse – than they really are. But this fudging often costs taxpayers a lot more.

Governments of both colours, federal and state, have been doing this forever, after the bureaucrats show them how. It’s one of the less honourable services public servants provide their honourable masters.

The move from cash accounting to accrual accounting at the turn of the century should have made fudging harder, but federal Treasury solved that problem by sticking to cash while Finance moved to accrual.

Focusing public attention on the cash budget balance has kept alive the oldest and simplest form of fudge. You can make the new year’s budget deficit look smaller than it really is by taking a payment due sometime in the new year and paying it in the last days of the old year.

Pre-paying a bill of $1 billion in this way makes the comparison between years look $2 billion better than reality.

But such tricks are chicken feed. The most wasteful one is the way state governments have tried to retain their AAA credit ratings by using “public-private partnerships” to conceal the extent of their borrowing for infrastructure.

No one can borrow more cheaply that government, but paying a private developer a premium to do the borrowing at a higher interest rate ensures the government-initiated debt appears on the developer’s balance sheet, not the government’s.

The state “asset recycling programs” promoted and subsidised by the Abbott-Turnbull government are also a product of the states’ worries about their credit ratings. You sell off existing government businesses and use the proceeds to fund new infrastructure spending without having to borrow.

Sounds innocent enough, but in practice state governments haven’t resisted the temptation to maximise the sale price of their businesses by attaching to the sale the right to overcharge their state’s businesses and consumers.

This does much to explain the doubling in the retail price of electricity. The states allowed the private purchasers of their poles-and-wires businesses to abuse their natural monopoly, and let three big companies own generators as well as retailers.

Tuesday night’s budget will be affected by two relatively new forms of creative accounting. One is the way the Turnbull government exaggerates its success in reducing the size and cost of the public service by giving people redundancy payouts, then hiring them back as “consultants” on greatly inflated salaries.

Then there’s the Abbott government’s invention of “zombie measures”. You announce cuts in spending, fail repeatedly to get them legislated, but leave them in the budget’s forward estimates, thus making the projected budget balance look better than it is.

But the biggest zombie measure distorting the budget numbers we’ll see on Tuesday is the government’s repeatedly rejected plan to extend the cut in the company tax rate to big business. This one, however, makes the projected budget balance look worse than it is. The biter bit.

But by far the biggest budget fiddle – one we’ll see more of on Tuesday – is the loophole Treasury built into the budget at the time of the laughably named Charter of Budget Honesty in 1996, when the focus of attention was switched to the “underlying cash budget balance”.

The ostensible purpose was to stop wicked Labor governments understating their deficits by counting the proceeds from asset sales as a reduction in the deficit rather than an alternative way of funding the deficit. Rather than sell a government bond, you sell some of the family silver.

But Treasury defined “assets” narrowly to include physical assets (say, real estate) but exclude financial assets (such as shares in government-owned businesses).

What this means in practice is that spending on an infrastructure project doesn’t have to be counted in the budget deficit provided you set it up as a new business which, once it’s profitable, you intend to sell off.

Great trick, which the Rudd-Gillard government was happy to use to hide the then-expected $49 billion cost of its National Broadband Network.

Trouble is, the contortions NBN Co had to go through to sustain the pretence it would be profitable were sufficient to blight the project long before Malcolm Turnbull began fiddling with it, as my colleague Peter Martin has explained.

But this wasn’t sufficient to dissuade Scott Morrison from using the same trick in last year’s budget to hide the cost of the second Sydney airport and the inland railway by claiming that, in some imaginary world, they’ll be profitable businesses.

Trouble is, you can keep the spending out of your carefully fudged version of the budget deficit, but you can’t keep your additional borrowings out of the government’s accumulated debt. Watch out for more fudging on Tuesday night.

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Will tax cuts boost the economy? Yes - and no

When politicians seek to win elections by promising tax cuts, they invariably cloak the inducement by claiming it will do wonders for the economy. You’re not accepting a bribe, you’re helping improve things for all of us.

Treasurer Scott Morrison has said that next week’s budget will include cuts in income tax for low and middle income-earners – presumably, to be delivered sometime after the next election. Labor will also be promising tax cuts at the election.

According to Morrison: “Lower taxes will further strengthen our economy to create more jobs.”

But can you believe it? In a narrow, immediate sense, yes.

Particularly at a time when the growth in wages is so weak, low and middle income-earners are likely to spend much of any tax cut that comes their way.

Since the tax cut will be unfunded – that is, it will cause the budget deficit to be higher than otherwise – this increase in consumer spending is likely to add to employment.

But that’s not saying much. If the same increase in the deficit was caused by an increase in government spending, that too would create jobs somewhere in the economy.

So it’s a higher deficit, not lower taxes, that does the trick. It does so at the cost of higher government debt and interest payments, which will have to be paid for later.

As a solution to weak growth in wages, it’s a Band-Aid.

But Morrison’s on about more than just giving the economy a temporary kick-along. He’s arguing that lower taxes make the economy grow better, whereas higher taxes slow it down and cause it to malfunction.

Because, as well as its version of a tax cut, Labor has plans to reduce various tax concessions and so increase tax collections overall, Morrison is arguing that whereas his tax plan would improve the economy’s functioning, Labor’s plan would worsen it.

Now, can you believe that? Well, it makes perfect sense to many big taxpayers. Surely higher taxes discourage people from working as much and from saving as much.

But though it seems obvious, the empirical evidence in support of the theory is surprisingly limited, as the former senior econocrat, Dr Michael Keating, and Professor Stephen Bell, argue in their new book, Fair Share.

They say it’s reasonable to suppose that if taxation is increased beyond a certain limit, it could reduce the rate of economic growth and thereby reduce the government’s capacity to pay for its present activities.

However, they say, “there is little evidence to suggest that most countries are close to the limit after which tax increases would impact negatively on economic growth and be counterproductive”.

If you compare all the developed countries in the Organisation for Economic Co-operation and Development over the last 25 years, you find no simple relationship between the level of taxation and their rate of improvement in productivity.

Despite very big differences in levels of taxation as a percentage of the economy, rates of productivity improvement are similar – suggesting worldwide advances in technology are far more influential that tax levels.

As well, the authors say, taxation’s effect on economic growth depends not just its level, but on the “mix” of different taxes (some are better than others) and also on what you spend the tax revenue on. Spending on education and training, innovation and productive infrastructure could be expected to increase productivity.

Next, if we look more directly at the impact of rates of income tax on willingness to work, the evidence of an adverse effect isn’t strong, they say.

Simple observation reminds us that, in Australia and many other countries, where the top “marginal” tax rate has been cut markedly over the past three or four decades (I used to pay 60¢ in the dollar in the early 1980s), there’s been no noticeable effect on participation in the workforce, nor on the number of hours worked by top people.

Formal economic studies reach similar conclusions. Much US research has found that tax has a weak effect on hours worked by those already in jobs, though the effect on decisions to work is a little stronger.

The US research shows male rates of participation and hours worked are especially insensitive to tax rates, with the strongest effects on married women. This is generally supported by the limited Australian research.

And whereas everyone assumes it's people on the highest marginal tax rate who’ll be most affected, research shows the impact is small. The biggest effect is on mothers deciding when to return to work, or whether to move from part-time to full-time.

Why? Because "secondary earners" (including Mr Mums) have more choice than "primary earners".

As for the effect of tax rates on the desire to save, it too is small. Since different ways of saving are taxed differently (a bank account versus superannuation versus geared investments), the main effect of a tax change is on people’s choice of those different ways.

The main reason popular opinion differs so much from empirical reality is that changes in tax rates have two effects, which work in opposite directions.

Economists call the one everyone focuses on the “substitution effect”. Raising the tax on doing an hour of work makes it less attractive relative to an hour of not working (“leisure”). This creates a monetary incentive to work less (or save less, for that matter).

What people forget is the “income effect”. Raising the tax on a given amount of work means it now yields less income. This creates a monetary incentive to work more so as to stop your income falling. (Or save more to stop your savings growing more slowly.)

Whether the substitution effect is stronger than the income effect is an empirical question – it can’t be answered from theory. The income effect is strong when people have targets for how much they want to earn or to save (for their retirement, say).

We’ll spend coming weeks hearing a lot about the disincentive effects of higher taxes. Much of it will be hot air.

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Turnbull's economic luck: more forecast than actual

It's usually in the interests of us followers to have a leader who is lucky. Malcolm Turnbull has had his share of bad luck but, of late, his fortunes seem to have changed. Latest proof is the mid-year budget update.

According to Scott Morrison and Mathias Cormann, everything is much improved. Although previous mid-year updates have revealed less progress than expected at budget time, this time the budget deficit is expected to be $5.8 billion lower than forecast in May.

The overall budget balance is still expected to be back in (a slightly larger) surplus in 2020-21, and this financial year is expected to be the last one in which the government needs to borrow to cover the day-to-day activities of government (as opposed to its spending on infrastructure), a year earlier than expected.

This means the Commonwealth's gross public debt is now projected to be $23 billion lower than expected by June 2021.

As for the economy, the Turnbull government's unwavering pursuit of Jobs and Growth has turned this from slogan to reality, we are told.

The economy is steaming on, but growth in employment – particularly full-time jobs – has been remarkable.

Well, yes – up to a point. There's good luck in the hand, and there's forecast good luck. Federal governments have been forecasting good results since the days of Wayne Swan and Julia Gillard – so far without much luck.

I would say we can give a fair bit of credibility to what is expected to happen between now and June, but forecasts and projections out another three years to June 2021 remain just that – forecasts.

The fact is that the government has had to revise downward its forecasts for the economy this financial year, but has left its forecasts for the following three years largely unchanged. Well, maybe, maybe not.

The government's forecast in May of a return to budget surplus by 2020-21 rested heavily on its prediction that, despite the extraordinary weakness in wage growth over the past four years, over the coming four years it would steadily return to boom-time rates.

Now these highly optimistic expectations have been shaved back, but only a little. I hope they come to pass, but I wouldn't bet much on it.

But what of the government's attempt to claim credit for the remarkably strong growth in employment over the past year?

I hate to shock you, but governments have been known to claim the credit for improvements that came to pass on their watch, even though the seeds of that improvement were sown before their time.

The surge in full-time jobs is explained largely by the delayed rollout of the National Disability Insurance Scheme (initiated by Gillard) and by the NSW and Victorian governments' increased spending on road and rail infrastructure (for which Joe Hockey can share some credit).

But if some of Turnbull's newfound air of success and optimism rubs off on the rest of us that, at least, will be no bad thing.

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Why we needn't worry about our massive foreign debt

When you consider how many people worry about the federal government's debt, it's surprising how rarely we hear about the nation's much bigger foreign debt. When it reached $1 trillion more than a year ago, no one noticed.

That's equivalent to 60 per cent of the nation's annual income (gross domestic product), whereas the federal net public debt is headed for less than a third of that – about $320 billion – by June.

Similarly, when you consider how much people worry about the future of the Chinese economy, American interest rates and all the rest, it's surprising how little interest we take in our "balance of payments" – a quarterly summary of all our economic transactions with the rest of the world.

Note, I'm not saying we should be worried about our foreign debt. We already do more worrying about the federal government's debt than we need to.

No, I'm just saying it's funny. Why do we worry about some things and not others?

Short answer: the politicians don't want to talk our "external sector" because it sounds bad. The economists don't want to talk about it because they know it isn't bad.

But since we're on the subject – and since Reserve Bank deputy governor Dr Guy Debelle gave a speech about it this week – let's see what's been happening while our attention's been elsewhere.

If you're unsure of the difference between the two debts, it's simple. The federal net public debt is all the money owed by the federal government to people, less all the money people owe it (hence that little word "net").

According to Debelle, about 60 per cent of all bonds issued by the feds is owed to foreigners and 40 per cent to Australian banks and investors. About a quarter of all bonds issued by the state governments is held by foreigners.

In contrast, the nation's net foreign debt is all the money Australian businesses and governments (and any other Aussies) owe to foreigners, less what they owe us. (For every $1 we owe them, they owe us 52¢.)

But how did we rack up so much debt?

Long story. Let's start with the balance of payments, which is divided into two accounts. The "current" account shows the money we earn from all our exports of goods and services, less the money we pay for all our imports, giving our "balance on trade".

Our imports usually exceed our exports, giving us a trade deficit. This deficit has to be funded (paid for) either by borrowing from foreigners or by having them make "equity" (ownership) investments in Australian businesses or properties.

Of course, when we borrow from foreigners, we have to pay interest on our debts. And when foreigners own Australian businesses, they're entitled to receive dividends.

The interest and dividends we pay to foreigners, less the interest and dividends they pay us (actually, our superannuation funds and Australian multinationals), is the "net income deficit".

We've been running trade deficits for so long, and racking up so much net debt to foreigners, that the net income deficit each quarter is much bigger than our trade deficit.

But add the trade deficit and the net income deficit (plus some odds and ends) and you get the deficit on the current account of the balance of payments.

The money that comes in from various foreign lenders and investors to cover the current account deficit is shown in its opposite number, the "capital and financial account".

Because the price of our dollar (our exchange rate) is allowed to float up and down until the number of Aussie dollars being bought and sold is equal, the deficit on the current account is at all times exactly matched by a surplus on the capital account, representing our "net [financial] capital inflow" for the quarter.

It turns out that, in the years since the global financial crisis of 2008-09, the current account deficit has narrowed.

In the 14 years to then, it averaged 4.8 per cent of GDP. In the years since then it's averaged 3.5 per cent. And in calendar 2016 it was just 2.6 per cent.

Why has it narrowed? Well, Debelle explains it's mainly a reduction in the net income deficit component of the overall deficit, which is at its lowest as a percentage of GDP since the dollar was floated in 1983.

The rates of interest we're paying on our foreign debt are lower because Australian – and world – interest rates are a lot lower since the crisis. And our dividend payments to foreign owners of Australian companies fell as the fall in coal and iron ore prices hit mining company profits.

That's nice. But while ever we have any deficit on the current account, our foreign debt will grow, and it already exceeds $1 trillion. Isn't that a worry?

Not really. It's not growing faster than our economy (GDP) is growing, and thus our ability to afford the interest payments.

More to the point, the current account deficit is just the counterpart to all the foreign capital flowing into Australia and helping us develop our economy faster than we could without foreign help.

The proof that such a massive debt doesn't mean we're "living beyond our means" is, first, that the nation – households, businesses and governments combined – saves a high proportion of its income rather than spending it on consumption.

Everything the nation saves each year is used to fund new investment in houses, business structures and equipment, and infrastructure. This investment is further proof we're not living beyond our means.

In fact, the nation invests more each year than we save. Huh? Well, the extra funding is borrowed from foreigners.

You can call it the surplus on the capital account of the balance of payments, or the "net foreign capital inflow" or – get this – the current account deficit.

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Reserve Bank chief gently reproves Turnbull’s failings

Reserve Bank governor Dr Philip Lowe's economic policy to-do list for 2017 contains a lot more implied criticism of the Turnbull government's weak performance than it has suited some in the national press to report.

It's true that, in his speech last Thursday, Lowe was clear in his support for a cut in the company tax rate and, by implication, the government's plan to cut the rate from 30 per cent to 25 per cent over 10 years, at a cumulative cost to revenue of $48 billion, and then a continuing net cost of $8 billion a year.

Last among the four items on Lowe's to-do list was "rebuilding our fiscal buffers", by which he meant getting the budget back into surplus.

Our former good record of successive surpluses and negligible net government debt "provided us with a form of insurance", he said.

"It meant that when difficult times did strike last decade, fiscal [budgetary] policy had the capacity to play a stabilising role. We had options that not all other countries enjoyed."

Note to the government's media cheer squad, Treasury revisionists and Professor Tony Makin: this leaves little doubt about Lowe's rejection of your minority view that fiscal policy is ineffective in stabilising the economy during downturns.

Lowe went on to say that the task of returning the budget to surplus is complicated by our simultaneous "need to make sure that our tax system is internationally competitive".

"One example of this complication is in the area of corporate tax, where there is a form of international tax competition going on in an effort to attract foreign investment," he said.

"Like other countries, we face the challenge of responding to this, while achieving a balance between recurrent spending and fiscal revenue."

Since Labor is using its senators to oppose passing the government's tax cuts to big businesses, one Australian newspaper headlined this "Reserve Bank chief slams Labor on company tax block". Some slam.

I'm unpersuaded by the need to cut the company tax rate at a time when many multinational companies have already found ways to pay far less than 25 per cent, but that's for another day.

A point to note, however, is that whereas the government argues cutting company tax would do wonders for "jobs and growth", Lowe's argument is more negative: if we don't do it while other countries are doing it we'll lose foreign investment – and, presumably, jobs and growth.

Not nearly such an attractive selling proposition.

Another point worth noting is Lowe's implication that the budget needs to achieve balance in spite of the huge cost of cutting company tax.

Maybe we should headline this: Reserve Bank chief slams Coalition's failure to show how company tax cut will be paid for, and so not further delay our return to surplus.

Note, too, Lowe's reference to "achieving a balance between recurrent spending and fiscal revenue" (my emphasis).

This isn't the first time he's quietly taken issue with Treasury's longstanding practice of exaggerating the size of budget deficits by lumping spending on capital works in with recurrent spending – unlike the state governments.

Borrowing part of the cost of building infrastructure that will deliver economic and social benefits for 30 or 50 years is in no way "living beyond our means".

And, indeed, one place higher on Lowe's to-do list than achieving budget surplus in spite of company tax cuts is the task of "providing adequate high-quality infrastructure to help our citizens be as productive as they can be and enjoy a high quality of life".

He notes we've got a strongly growing population which, if we fail to invest in sufficient infrastructure, including transport infrastructure, can "impair our ability to compete and be as productive as we can be".

It's surprising how many people are great advocates of high immigration levels, but won't countenance the increased spending and borrowing needed to provide the additional infrastructure – roads, public transport, hospitals, schools – used by all the extra people.

Then they wonder why our productivity performance is weak.

Which brings us to the first item on Lowe's to-do list: "reinvigorate productivity growth".

"There is no shortage of things that could be done to lift our performance. The challenge is that most of these ideas require difficult political trade-offs." Just so.

Lowe's second issue on the list is "how best to capitalise on the opportunity that the economic development of the Asian region provides".

I'd have thought the answer was obvious: our business people should sit round waiting until our hopeless politicians provide them with tax incentives sufficient to induce them to get off their arses.

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Lord save us from being governed by bankers

With Our Glad Berejiklian – the archetypal girl who works harder than the boys – replacing pin-up boy Mike Baird as Premier of NSW, should the citizens of other states be envious? Don't be too sure.

True, Berejiklian, like Baird before her, came to public office from a job in banking, rather than a post-uni career as a political apparatchik, though she did spend time as a ministerial staffer. Baird didn't even have that.

Politics is becoming a priesthood – a lifetime calling, culminating in elected office – with ever fewer politicians having spent most of their lives working in a normal job with normal people.

I doubt we're better governed under this development.

One thing making NSW different from other states is that, until Baird's resignation, it was a state governed by former bankers: premier, treasurer and Treasury secretary Rob Whitfield, shipped in after a 29-year career as a deal maker at Westpac.

With Baird gone, NSW may seem one banker down. Except that Berejiklian's successor as Treasurer, Dominic Perrottet, was a solicitor specialising in "banking restructuring".

I suppose one good thing about having a government dominated by bankers is they can be relied on to keep the budget shipshape. They'd be the last pollies to send us bankrupt.

Indeed, Berejiklian's proudest boast is that the NSW government (narrowly defined) is now debt free.

But is that the highest achievement of a government? You'd expect bankers to know better than to regard an institution like NSW without any debt as a joy to behold.

What about all the infrastructure the state still needs? Why boast about having no debt at time when debt is exceptionally cheap and governments' size and taxing powers make them ideally placed to borrow?

Though the fashionable fatwa against debt is atypical of bankers, what it does reveal is a weak grasp on the tenets of economics.

It's a mistake to imagine bankers and economists think alike. That's been my greatest reservation about the financially virtuous Baird government and my greatest fear about its Berejiklian successor.

Its only leading light who can be counted on to have a better grasp on the ways the powers and obligations of governments differ from those of a business is the secretary of the Premier's Department, Blair Comley, a former top federal Treasury officer.

Historically, state governments have had responsibility for owning a lot of profitable businesses, which have been government-owned only because they're natural monopoly networks – electricity, gas and water – as well as managing huge service-delivery organisations: public transport, roads, hospitals, schools and prisons.

This has led to the common notion that running a state government is pretty much about running a collection of businesses. The main thing you need is efficiency.

Sorry, wrong.

First, where governments deliver services with "public good" characteristics – services whose supply would be insufficient if customers had to pay market prices – the quality of the service, reflecting the multiple objectives in supplying it, is just as important as the cost of supplying it.

Second, when you're owning – or selling – a profitable business, profit should never be maximised at the expense of the wider community. You have to take an "economy-wide" perspective.

I fear a banker-dominated government is too likely to adopt a simple, business approach towards an endeavour that that has much wider objectives and obligations; to see the state budget as akin to a business's profit and loss account – as an end in itself rather than just a means to an end; to imagine that maximum benefit to the state's finances equals maximum benefit to people of the state and their economy.

Every instinct of a deal-making banker tells them the object of the exercise is to privatise a business for the highest price possible, this being in the best interests of taxpayers.

You do this by packaging the business up with government-conferred competitive advantages.

But this comes at the disadvantage of taxpayers-as-customers of the business, any present or potential private competitors, and business customers of the privatised business.

Rod Sims, boss of the Australian Competition and Consumer Commission, has been highly critical of the NSW government's privatisation of its ports which, of course, enjoy a degree of geographic monopoly.

I supported privatisation of NSW's electricity "poles and wires" mainly because ownership of a key natural monopoly presented the government with too much temptation to look the other way while its trading enterprises fattened their profits by gouging their customers.

Damaging the state's economy in the interests of improving the state government's finances is something only an ill-educated banker could think was a good idea.

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Why I wish we'd had our credit rating downgrade this week

You can tell by when a government releases its midyear budget update how well it's going with the budget. If it's doing well, it publishes as early in December as possible.

If it's doing badly, it publishes as close to Christmas as it thinks it can get away with, when normal people are busy with parties and preparations and not paying much attention.

This year we got the update just six sleeps before Santa's arrival. Draw your own conclusions.

And this year the government was worried, we're told, that the continued slippage in its efforts to repair the budget would prompt the credit rating agencies to downgrade our AAA status.

Labor was already salivating at the prospect, with finance spokesman Jim Chalmers confidently predicting a downgrade would "smash confidence in our economy" and "push up borrowing costs for households and small businesses".

You beauty! If that doesn't improve Labor's chances of beating the Coalition at the next election, what will? A little damage to the economy in the meantime? A price Labor would be happy for us to pay.

In the event, however, all three ratings agencies announced the update had done nothing to change their views.

But the government isn't off the hook. The most aggressive publicity seeker of the three, Standard & Poor's, didn't confirm our AAA rating, it said the update gave it no reason to change its "negative outlook" for that rating.

So the agency's supposed fiscal sword of Damocles remains hanging over Scott Morrison's head at least until the budget in May.

To tell you the truth, I'm sorry it didn't fall this week. That's not because I bear the government any ill will, but because the sooner we're downgraded, the sooner the public will realise there's little to fear from a downgrade. The ratings agencies are toothless tigers.

In any case, there is no good reason any sovereign Australian government – federal or state – should allow a few American for-profit businesses to dictate how much it should or shouldn't borrow (nor engage in hugely expensive ways of disguising the true extent of its liabilities).

The ratings agencies' credibility has been destroyed by their part in the global financial crisis. Not only did these all-wise experts fail to see it coming, they contributed to the conflagration by awarding AAA ratings to the promoters of "collateralised debt obligations" – for the small fee – that soon turned into "toxic debt".

It's long been questionable whether the agencies were leaders or followers in identifying the risks attached to the bonds issued by businesses and governments, but since the GFC there's little doubt the financial markets don't need their advice.

When Standard & Poor's downgraded US government bonds in 2011, the financial markets took no notice and the two other agencies left it hanging out to dry.

S&P downgraded Greece's government bonds only months after its budget cover-up became public in 2009.

All three agencies downgraded Britain's bonds immediately after Brexit, but market yields (interest rates) on those securities actually fell.

So it's not at all clear that a downgrading of our credit rating would do anything much to increase the interest rate at which our government can borrow.

And while it's technically true a downgrading of Australia's "sovereign" credit rating would flow on to the ratings of our banks, it's not clear this would increase their borrowing costs abroad, nor that there would be any flow-on to home buyers and small businesses.

While Labor's Chalmers was telling anyone who'd listen of the disaster about to befall everyone with a mortgage, the chief executive of ANZ Bank, Shayne Elliott, was telling his shareholders that a downgrade had already been priced into the funding costs for Australian banks.

Should the banks actually pass on that increase on to their customers, it would tell us less about the Turnbull government's budget failings than about the failure of successive governments – Labor included – to do enough to encourage greater competition between the big four banks, generous party donors that they are.

It suits neither the government nor the opposition to admit that the rating agencies' pressure on us to cut government spending is diametrically opposed to the advice we're getting from the two genuine international economic authorities, the International Monetary Fund and the Organisation for Economic Co-operation and Development.

Their advice is that, with our economy weaker than it should be, we still have plenty of "fiscal space" to strengthen the economy by borrowing to finance increased spending on worthwhile infrastructure.

All this is why I say that, these days, the economic significance of our credit rating is long gone.

It retains much political significance, however.

Governments – federal and state – still live in fear of a downgrade simply because they know their political opponents would parade this as a disaster for the government, the economy and public and private borrowers, as well as objective, authoritative proof that they are utterly hopeless economic managers.

Credit ratings are now little more than something the politicians use to slag each other off.

This is why I'm sorry we weren't downgraded this week. Only when the public experiences the ratings agencies' inability to have much effect on the interest rates we pay will they lose their power over our governments, and the pollies lose credit ratings as a political football.

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How we've grown for so long: safety valves and buffers

How has poor little Oz managed to keep our economy growing continuously for 25 years while, in the same period, other economies have suffered a recession or even two? We've had good insurance policies.

That's the answer the new Reserve Bank governor, Dr Philip Lowe, gave in a speech this week. As he explains it, however, it's a detailed story.

Actually, there are two parts to his explanation for our economic success: the first is our good "fundamentals" and the second is our ability to ride out the various "economic shocks" that hit every economy from time to time.

Lowe lists our good fundamentals as including our abundance of natural resources, our well-educated workforce, our "generally favourable demographics" (I think he means our growing population and that our ageing population isn't too aged), our openness to international trade and investment, our links with the fast-growing Asian region, and our demonstrated ability to reform the structure of our economy to boost its productivity.

Lowe adds that the reforms of the 1980s and '90s have given us a more flexible economy, one better able to roll with the punches than it used to be. He nominates three key areas of greater flexibility: our exchange rate, our conduct of monetary policy and our labour market.

Since we allowed our dollar to float in 1983, it has generally moved up or down in response to developments in ways that tend to limit inflation pressure and to stabilise growth.

Since we decided in the mid-1990s to let the central bank - rather than the politicians - make decisions about when to increase or decrease interest rates, as guided by the target of keeping inflation between 2 and 3 per cent on average over the medium term, we've kept the inflation rate reasonably stable and minimised swings in unemployment.

Since we ended the centralised wage-fixing system and moved to collective bargaining at the enterprise level in the first half of the 1990s, we've avoided wage inflation, kept real wages rising in line with improvements in productivity (until recently, anyway) and made employers less inclined to respond to downturns with mass layoffs.

These great areas of flexibility - the floating exchange rate, the independent, target-based approach to monetary policy (interest rates), and enterprise-based wage-fixing - have helped us avoid being derailed by economic shocks.

And it's not as if there's been a shortage of such shocks that could have derailed us, Lowe says.

First, there was the Asian financial crisis of 1997-98, which did derail some of our Asian trading partners. Then there was the bust of the US tech boom - the Tech Wreck of 2001 - then the global financial crisis of 2008-09.

 As well, there's the resources boom. With its once-in-a-century surge and then collapse in coal and iron ore prices and consequent surge and falloff in mining construction, the resources boom was a massive, decade-long shock to our economy.

Australia's economic history is littered with commodity booms soon leading to recessions, but not this one (except in Western Australia, thanks to mismanagement by its state government).

But all that's just by way of background. Lowe's main point is to draw attention to the way our possession of certain "buffers" absorbs some of the blow when shocks hit.

We build up and hold these buffers as a kind of insurance policy against the day when trouble arises. Like all insurance policies, they come at a cost. There's a premium to be paid.

So where do you find these buffers? On the balance sheets of banks, governments and households. They're about ensuring your assets exceed your liabilities by a decent safety margin, in case some unexpected problem arises.

In the years leading up to the global financial crisis, our banks maintained higher ratios - of their shareholders' capital to their lending to borrowers - than did banks in America and Europe.

That's why our banks were able to keep lending after the crisis, whereas the others weren't. Their inability to keep lending amplified the original shock.

In the years since then, international authorities have imposed higher levels of capital adequacy and liquidity on the world's banks, including ours.

These greater restrictions make banks safer, but also reduce their profitability. We're still waiting to see how the cost of this insurance premium will be shared between our banks' customers and their shareholders.

At the time of the financial crisis, our government had "positive net debt" - it had more money in the bank than it owed to people holding its bonds.

This made it a lot easier for our government to support the economy by borrowing and spending. Now, Lowe argues, we need to gradually move the budget from deficit back to surplus, rebuilding our fiscal buffer for the next time it's needed.

The total debts of our households have risen to 185 per cent of their annual disposable income. This is a lot higher than for other rich countries, but that's partly because unusual distortions in our tax system encourage borrowing for rental properties to be done by individuals rather than big companies.

More to the point, households have been building up buffers by using mortgage offset and redraw facilities to reduce their net debt by 17 per cent of the gross debt, in the process getting a collective 2½ years ahead of their scheduled repayments.

More than half of all households with mortgage debt, at each level of income, are ahead on their repayments.

If you subtract from our households' debt all the money they hold in currency and bank deposits, the nation's households' net debt falls to about 100 per cent of their annual disposable income.

Our household debt is high, but we've got a fair bit of buffer.

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We shouldn't feel bad about leaving public debt to our kids

There are a lot of nice people in the world, people who worry about all the debt we're leaving to our kids and grandkids. I know this from the letters I get from people.

I got an email from a retired couple who said they'd be happy to pay more – a 15 per cent goods and services tax, medical co-payments or even a 10 per cent increase in income tax – if only it was guaranteed that the money was spent "to pay down debt, not rack up more with populist promises".

Unfortunately, there are no nice people in politics. Or, if a few start out that way, they soon get it beaten out of them.

Last week, in his first big speech since he was re-elected – the one so rudely interrupted by some woman who thought the mistreatment of asylum seekers on remote islands was something worth drawing to our attention – Malcolm Turnbull decided to tug on the heartstrings of nice people everywhere.

"We sing Advance Australia Fair," he said, "but there's nothing more unfair than saddling our children and our grandchildren with mountains of debt that we have created because our generation could not live within its means.

"If we aren't prepared to make the tough choices today – younger Australians, future generations, will be forced to pay back the debt through a combination of higher taxes and a lower quantity or diminished quality of government services. In short, through lower living standards than they would otherwise have enjoyed."

Sorry, but that's not true. It's roughly the opposite of the truth. And I don't believe someone as smart as Turnbull actually believes it.

But before we go on, how's this for one of the "tough choices" about fairness Turnbull wants our elected representatives to agree to in this year's budget: cutting the dole – which is a princely $38 a day – and other welfare payments by $4.40 a week, while agreeing to tax cuts of $6 a week for people earning more than $87,000 a year.

The justification for the cut in benefits is that it represents the belated removal of the "energy allowance" originally paid in compensation for the carbon tax. Since Tony Abbott abolished that tax, the allowance is no longer needed.

Now that is a tough choice. Is it fair to cut the benefits of low income-earners because we're "living beyond our means" while we cut the taxes of high income-earners?

But are we living beyond our means? What does that phrase mean, anyway?

Is any person or government that's borrowing money living beyond their means? That's what the politicians who keep repeating that line hope we'll assume.

A moment's reflection reveals its weakness. Say your offspring borrow a frighteningly large amount so they can live in a home of their own. Does that mean they're living beyond their means?

No, of course not. Not if they can afford the repayments. And not when you remember that the house they've bought will deliver them a flow of services for as long as they own it.

What service? It's providing them with somewhere to live – and thus relieving them of the expense of renting.

If I told you of a couple with a debt of $600,000, would you automatically assume they had nothing to show for that debt? No, you'd assume they must have bought a house and may well have made a sound investment.

But when politicians tell us the government owes many billions of dollars, many of us assume there's nothing to show for all that spending and borrowing. Which is just what game-playing politicians hope we'll assume.

But it's usually not true. What do governments have to show for all their borrowing? Public infrastructure – roads and motorways, bridges, railways and bus fleets, hospitals and schools, prisons and police stations and all manner of other facilities.

All those things contribute to our standard of living and to the efficiency of our economy. Do you think we'd be better off had the money not been borrowed and those things not been built?

Since we worry about our children and grandchildren, what kind of physical Australia do we want them to inherit? One with rundown and inadequate public facilities – one where it's really hard to get around, where roads and trains and hospitals and schools are grossly overcrowded?

If we continue letting our politicians demonise public debt, that's the world we'll be leaving for our descendants.

It's true we'll be leaving debt to our children. But we'll also be leaving them a better equipped, better educated and healthier Australia. Does this add up to something to worry about or feel guilty over?

According to the federal budget papers, almost all of the expected underlying cash deficit of $37 billion this financial year will be spent on infrastructure.

Most infrastructure spending is done by the state governments. Much of what they spend each year building facilities that will serve the community for 30 or 40 years or more is covered by that year's tax revenue (including federal grants), the rest is borrowed – to be serviced and repaid by the people who'll still be using those facilities.

It's the self-same bargain that was made with our generation. Sounds a fair and sensible way to keep building a better future.

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Why Treasury is wrong on deficits and debt

The last speech of the retiring Reserve Bank governor, Glenn the Baptist, was a touch biblical. Whatever your point of view, you could find a verse here or there that seemed to back you up.

If, for instance, you accept the conventional view that the budget deficit is way too high, that the government should be more daring in seeking to cut the deficit, and its opponents should be less opportunist and more responsible in agreeing to spending cuts, Glenn Stevens offered a verse for you to quote.

He observed that "when specific ideas are proposed that will actually make a difference [to the budget deficit] the conversation quickly shifts to rather narrow notions of 'fairness', people look to their own positions, the interest groups all come out and the specific proposals often run into the sand.

"If we think this rather other-worldly discussion will not have to give way to a more hard-nosed conversation, we are kidding ourselves.

"That will occur should there be a moment of crisis, but it would be better if it occurred before then," he said.

A treasury secretary couldn't have said it better. But look at the totality of Stevens' remarks and he's actually challenging the conventional wisdom.

"As would be clear from my utterances over the past couple of years, I have serious reservations about the extent of reliance on monetary policy around the world."

The problem is that what central banks do could never be enough to fully restore demand after a period of recession associated with a very substantial debt build-up.

"In the end, the most powerful domestic expansionary impetus that comes from low interest rates surely comes when someone has both the balance sheet capacity and the willingness to take on more debt and spend," he said.

"The problem now is that there is a limit to how much we can expect to achieve by relying on already indebted entities taking on more debt.

"In some countries there may be no safe way of [increasing] borrowing and spending because debt, both public and private, is just too high.

"In Australia, gross public debt, for all levels of government, adds up to about 40 per cent of gross domestic product. We are rightly concerned about the future trajectory of this ratio.

"But gross household debt is three time larger – about 125 per cent of GDP. That is not unmanageable – but nor is it a low number."

Get it? He's saying that monetary policy is out of puff. Lowering interest rates is no longer very effective in encouraging households to take on even more debt. (He noted later that he'd never believed cutting rates had much effect on businesses' decisions to increase investment spending.)

So which sector has the most capacity to increase its deficit spending "in the event that we were to need a big demand stimulus"?

The public sector. Sorry, but that's not what a treasury secretary would say.

Stevens was quick to add: "I am not advocating an increase in deficit financing of day-to-day government spending. The case for governments being prepared to borrow for the right investment assets – long-lived assets that yield an economic return – does not extend to borrowing to pay pensions, welfare and routine government expenses, other than under the most exceptional circumstances.

"It remains the case that, over time, the gap in the recurrent [my emphasis] budget has to be closed, because rising public debt that is not held against assets [my emphasis] will start to be a material problem."

Now that's something no secretary to the treasury would say. Unlike all its state counterparts, federal Treasury has long opposed the drawing of a distinction between government recurrent spending and government investment in "long-lived assets that yield an economic return" and add to national productivity.

Treasury wants little old ladies to feel as guilty about borrowing to improve the Pacific Highway as they do about borrowing for "routine government expenses".

So, let's worry about getting the recurrent budget back to surplus (as most state governments did long ago), but not about borrowing for infrastructure. Agreed?

Except that when you read the budget papers carefully enough to find the info Treasury has hidden on page 6-17, you discover that the expected underlying cash deficit for this financial year of $37 billion includes capital spending of $36 billion.

Get it? We're already back to a balanced recurrent budget. So why so much hand-wringing? And why aren't we getting on with planning the infrastructure pipeline we could expedite "in the event that we were to need a big demand stimulus"?

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Oh no, not a credit rating downgrade

Sorry, but I've put Standard and Poor's and the two other big American credit rating agencies on a negative watch.

For me, the rating agencies' involvement in the global financial crisis has destroyed their credibility forever. I can no longer take their solemn pronouncements seriously, nor hear them with the reverence or contrition they imagine themselves entitled to.

The rating agencies were one of the private sector institutions charged with upholding standards of behaviour in America's financial markets, putting investors' interests ahead of their clients' and their own.

They were supposed to be a bastion against crisis and collapse, but they betrayed their trust.

The way their system works is that institutions wishing to borrow money by issuing bonds or other securities have to pay rating agencies to give those securities a rating of their credit worthiness.

The agencies' job pre-crisis was to be the hard-headed wise men who could see through the smoke and mirrors created by "innovators" on the make. They failed.

While everyone else in Wall Street was making money hand over fist, they didn't resist the temptation to get in for their cut.

They obliged their paying customers by awarding AAA credit ratings to securities subsequently exposed as "toxic debt".

In the process, they exposed the obvious conflict of interest involved in the common practice of governments attempting to protect the interests of investors and others by requiring businesses to buy "independent" certification from other businesses.

To an extent, governments around the world give the rating agencies a captive market by requiring certain organisations to hold only those securities certified as AAA.

This was how some Australian local councils got sucked into America's toxic debt crisis.

Trouble is, with this monumental blot on their record, we can no longer be sure what game the ratings agencies are playing and in whose interests they act.

In the case of government ("sovereign") borrowers, the agencies take it upon themselves to issue ratings. They then have the temerity to present the government with a bill for their services, though no self-respecting treasury pays up.

They seem to be pretty tough on government borrowers, though the lines they draw between safe and unsafe levels of debt seem pretty arbitrary.

What I wonder is if they have higher and holier standards for government than they have for their private sector fellows.

Why not? Everyone in business (and a lot of people in treasuries) know that governments, because their actions are not the product of market forces, are therefore non-rational and prone to being either mad or bad.

The agencies want us to believe their deliberations are highly scientific and sophisticated, applied consistently across the world.

But it's open to doubt how true that is.

After all, many of us believed the line that the whole towering edifice of ever-multiplying derivatives and synthetics built up before the financial crisis was the product of amazing advances in statistics and the science of finance, which had rendered us far smarter than we used to be at "managing risk".

When it comes to signalling changes in the riskiness of particular borrowers, the agencies purport to be the leaders: their vigilance causes them to be the first to see the problems looming, with the market following their lead.

But it's common for the market to turn against some borrower, leaving the agencies scrambling to adjust their ratings to fit. Are they just purveyors of conventional wisdom?

Whenever a downgrading of one of our governments is threatened, the media unfailingly assure us this would be a bad thing because the government would have to pay higher interest on its debt.

If this is still true, it's much less so than it used to be. And if there is still a premium to be paid, it's smaller than it's made to sound.

The rating agencies' loss of authority since the financial crisis is evident.

When, in 2011, in a rush of blood to the head – or maybe a touch of the megs​ – Standard and Poor's announced it had cut the US Government's credit rating to AA+, the other two did not follow suit and the market took not a blind bit of notice.

The yield (interest rate) on US Treasury bonds continued falling. Moral: don't try to get smart with the world's reserve currency.

But something similar happened when the three agencies downgraded Britain to AA- in the wake of the Brexit vote. Yields on British bonds have since fallen, along with those of other "sovereigns", including us.

Sometimes there are forces more powerful than a bunch of for-profit rating agencies.

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What not be believe in the budget

Like every budget, Tuesday's will be a combination of measures and arguments, each with political and economic dimensions and motivations.  Distinguishing the politics from the economics will be the hard part.

It promises to be a budget in which the government does a lot of crying poor. That's partly because Malcolm Turnbull is likely to call an election within a week of the budget, but is prevented mainly for political reasons from making many big spending promises.

Politically, this government made so much fuss about debt and deficit while on its way to power that, though it's made little progress in reducing the budget deficit and halting the growth in debt, it dare not be seen consciously adding to it.

Economically, returning to surplus isn't urgent, and increased borrowing for worthwhile infrastructure would make much sense.

As part of the crying poor, when state politicians hit the feds for more money, federal ministers reply that they can't help because, though the states are running surpluses, the Commonwealth is still in deficit.

Don't believe it. When the states say they're in surplus, they're referring to their "operating" balance, which is their revenue less their recurrent spending. When the feds say they're in deficit, they're subtracting from revenue not just their recurrent spending, but also their infrastructure spending.

Add the states' infrastructure spending to their operating surpluses and you find that – measuring it the way the feds do – they're still in heavy deficit. (Which is as it should be. If anything, they should be investing more.)

Or, to put it a better way, by insisting on their antiquated practice of including capital spending in their measure of the deficit, the feds are exaggerating the size of their deficit problem.

This financial year's budget papers forecast a deficit of $35 billion (since revised to $37 billion), which included capital spending of about $21 billion.

Further capital spending of $17 billion (including on the National Broadband Network) is hidden in the "headline" deficit, meaning capital spending accounted for 8 per cent of headline spending. Last year it was 9 per cent.

Another thing we'll hear a lot of on Tuesday night is that the government is "living beyond its means" and must mend its ways and live within its means, just as households do.

This is nonsense. It's Scott Morrison doing his best Joe Hockey impression. If you measure them the way Morrison does for the government – that is, by including borrowing for investment in with day-to-day expenses – our households are living way beyond their means.

Indeed, Australia's households have one of the highest debt ratios in the developed world.

Do you think it's a crazy, irresponsible thing for so many households to borrow many multiples of their annual income to buy the home they live in?

Of course not. For most it makes lots of sense. Is a government – state or federal – that borrows to build public infrastructure that will serve the community for decades, adding to our productivity, living beyond its means? Of course not.

National governments may be said to be living beyond their means when their recurrent spending exceeds their revenue, but even that is too simplistic.

Why? Because governments aren't the same as households and it's ignorant to pretend they are. Governments have responsibilities households don't have and also have powers households don't have – such as the ability to impose taxes and even, for national governments, to print money.

One highly relevant government responsibility is to help limit economic slowdowns by running operating deficits – by allowing their recurrent spending to exceed their revenue – while spending by the private sector is weak.

Does that sound too Keynesian for a Coalition government? Too Keynesian for Turnbull who, while opposition leader in 2008, vigorously attacked Kevin Rudd's fiscal stimulus?

Don't believe it. It's clear we'll hear a lot of the argument that Turnbull and Morrison can't cut government spending much at present because the economy is "in transition" and so not yet growing strongly.

That's a Keynesian argument, the antithesis of an austerity policy – though both men would die before uttering the K-word. And it's a sound argument – which is why we've been hearing it since Labor was in power. It was just excuse-making then, but it's true now, apparently.

Of course, it's also true that no politician wants to cut spending just weeks before an election.

Economically, there's no problem with continuing recurrent budget deficits. A better question to ask on Tuesday night is whether the spending that makes up the deficit is going on good programs or poor ones.

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