Paying tax is good and, for better government, we should pay more

On Friday, a former top econocrat did something no serving econocrat is allowed to do, and no politician is game to do: he set out the case for us to pay higher, not lower, taxes.

For years, politicians have sought our votes by promising smaller government and lower taxes. This often helped get them elected, but it hasn’t worked as promised.

They’ve reduced the size of government by privatising government-owned businesses and outsourcing the provision of many government-funded services. But though they’re always announcing tax cuts, the hidden tax of bracket creep means there’s been no real reduction in the tax we pay. Great.

The man advocating a radically different approach is Dr Mike Keating. He laid out the case for bigger government and higher taxes in a speech to the Australia Institute’s revenue summit at Parliament House in Canberra.

The pollies seeking election by promising lower taxes take it as obvious that taxation is a bad thing – a “burden” which, like all burdens, needs to be minimised.

But Keating says we should remember the purpose of taxation. It’s to pay for a wide range of services that governments provide to us either directly (education, healthcare, child care, aged care, pensions and payments) or collectively (defence, law and order, roads). Some services we get while we’re young, some when we’re middle-aged, and many when we’re old.

Keating says there’s a wide consensus among Australians about the things we expect the government to do for us. “We recognise that all Australians are entitled to basic levels of education, healthcare, income support and shelter, and that governments have a responsibility to ensure the provision of these essential services,” he says.

Recent Coalition governments promising us lower taxes always added the promise that this could be done without reducing “essential services”.

Keating says there’s now widespread acknowledgement that these services that we pay for collectively are critical to building our community and to our sense of community.

So taxation reflects our mutual obligation to one another as citizens. Taxation underpins an inclusive society and is an efficient way of paying for those services that are consumed collectively. Many of the services paid for by taxation add to our quality of life.

Indeed, he says, history suggests that our demand for these services, such as education and health, tends to rise rapidly as economic growth causes our incomes to grow. They’re what economists call “superior goods”. The better off we get, the more of our income we devote to them.

The problem for governments – which politicians themselves have worsened – is the disconnect in people’s minds between our demand for government services and the taxation needed to pay for them. We refuse to join the dots.

“We want increased access to more and better services on the one hand, and less taxation on the other,” Keating says.

So, let’s stop kidding ourselves. If we want more and better services from government, we’ll have to pay for them with higher taxes, just as when we want more or better in a shop or a restaurant, we know we’ll have to pay more.

But assuming we accept that truth, why do we already want the government to be bigger and better?

One way the previous government sought to square the circle of maintaining “essential services” while cutting taxes – including next July’s stage-three tax cuts – is by underspending on those services and hoping no one would notice.

Keating has thought of no less than seven areas where there’s little doubt that we need to spend more.

First, although the previous government acted on the scandals exposed by the royal commission into aged care, and governments have spent more on childcare, both remain underfunded. What’s more, increases in the availability and quality of care services are likely to lead to higher costs because higher wages will be needed to attract the extra workers.

Second, the Albanese government’s increased spending on “social housing” (what in the olden days was called the housing commission) is widely considered to be much less than needed.

Third, federal government grants for public hospitals will probably have to grow a lot faster than presently expected to reduce excessive waiting times. And the Medicare payments to GPs are still too low, risking shortages of doctors, particularly in the country.

Fourth, federal funding for universities hardly grew in real terms over the nine years of the Coalition government, and actually fell per student. Labor will be pressured to make this up. As for vocational education and training – TAFE – the new National Skills Agreement requires the feds to cough up more.

Fifth, unemployment benefits – this week labelled JobSeeker, maybe something else next week – are very low compared with most other rich economies. And the recent leap in rents means the rent assistance paid to pensioners and others on benefits is now far too mean.

Sixth, it’s clear we’ll need to spend a lot more on the AUKUS nuclear submarines and other defence capabilities. This could increase annual defence spending by at least 1 per cent of gross domestic product over the next decade.

Finally, measures to reduce carbon emissions and to fully develop Australia’s potential as an exporter of renewable energy will almost certainly require greater funding than the government is presently planning.

The Grattan Institute estimates that if present tax arrangements aren’t changed to cover the expected additional growth in government spending, the “structural” (underlying) budget deficit will be close to 3 per cent of GDP in 10 years. Keating thinks it’s more likely to be 4 per cent – or $100 billion a year in today’s dollars.

Continuing deficits of this size would be quite unrealistic, he says. He suggests not another review of the tax system, but a major, authoritative inquiry to assess how much revenue is needed to adequately fund all government services.

When the public has a better understanding of what we’d get for our money, then maybe we’ll be more prepared to accept the need for higher taxes.

Read more >>

How to make sense of Treasury's latest intergenerational report

Our sixth intergenerational report envisages an Australia of fewer young people and more elderly, with slower improvement in living standards, climate change causing economic and social upheaval, aged and disability care becoming our fastest-growing industry, and home ownership declining, while we spend more defending ourselves from the threat of a rising China, real or imagined.

That does sound like fun, but remember this: just as I hope many of the predictions I make will be self-defeating prophecies – because people act to ensure they don’t happen – so it is with Treasury’s regular intergenerational reports.

They say, here’s the pencil sketch of the next four decades that we get when we assume present economic and demographic trends keep rolling on for 40 years, and that present government policies are never changed.

Get it? Intergenerational reports are Treasury’s memo to the government of the day, saying things will have to change. The memo to you and me says: you may hate change, but unless you let our political masters make changes, this is how crappy life may become.

Every intergenerational report comes to the same bottom line: if you think you won’t be paying more tax in future you must have rocks in your head.

The media can’t stop themselves from referring to the report’s findings as “forecasts”. Nonsense. Forecasts purport to tell you what will happen. These reports are “projections”: if we make a host of key assumptions about what will happen, plug them in the machine and turn the handle 40 times, this is what comes out.

Remembering that Treasury demonstrates almost annually its inability to forecast in late April what its own budget balance will be in just two months’ time, June 30, let’s not imagine that anything it tells us today about 2063 could prove close to the truth, except by chance.

This is no attack on Treasury. No one’s forecasts are less wrong than theirs. It’s just saying don’t let the false confidence of the economics profession fool you. Only God knows what the world will look like in 2063 – and she’s not telling.

We’re all peering through a glass darkly, doing the best we can to guess what’s coming around the corner. How many pandemics in the next 40 years? Treasury’s best guess: none. How many global financial crises? Best guess: none.

We know from experience that the economy rarely moves in straight lines for long, but the nature of Treasury’s mechanical projections is that most curves stay straight for 40 years. Unexpected things are bound to happen. Some will knock us off course only briefly; some may change our direction forever. Some will be bad; some will be good.

The report’s single most important assumption is the rate at which the productivity of labour will improve. Until now, Treasury has avoided argument by assuming that the average rate of improvement over the next 40 years will be its rate over past 30 years.

The first report in 2002 assumed a rate of 1.75 per cent, but in later reports it was cut to 1.5 per cent. Now it’s been cut to the seemingly less unrealistic 20-year average of 1.2 per cent.

This shift makes a big difference. The first report had living standards – measured as real gross domestic product per person – climbing 90 per cent in 40 years. This report has them climbing by only 57 per cent in the next 40.

Since this is only the second of the six intergenerational reports produced under a Labor government, it’s only the second that takes climate change seriously. The other four looked into the coming 40 years and didn’t see any consequences of climate change worth taking into account.

Labor’s first report, in 2010, had a lot to say about climate change, but this report attempts to measure its effect on the economy and the budget. It estimates that climate change will cause the level of real GDP in 2063 to be between $135 billion and $423 billion less than it would overwise have been, in today’s dollars.

The report’s title has always been a misnomer. If it lived up to its name, it would deal with the intergenerational transfer of income and wealth from the young to the old – an issue that deserves much more attention than it gets.

It would talk about the way our treatment of housing favours the elderly, and how the tax, spending and superannuation decisions of the Howard government, in particular, shifted income from the young to the old.

But no. The real reason it’s called the intergenerational report is that its main purpose is to bang on about the huge effect the ageing of the population – the rise in the population’s average age – will have on the federal budget (while ignoring any effects on the states’ budgets).

It’s here, however, that Rafal Chomik, of the ACR Centre of Excellence in Population Ageing Research at the University of NSW, has noted this overhyped story being toned down over the six reports. In 2002, the first report projected that, by 2023, the share of the population aged 65 and over would climb from 12.5 per cent to nearly 19 per cent.

Actually, it’s only up to 17.3 per cent. And the projection for 2063 is 23.4 per cent, less than the 24.5 per cent originally projected for 2042.

Another factor on which the report was too pessimistic at the start is the effect of ageing on participation in the labour force (by having a job or actively seeking one). Whereas it was expected to dive as the Baby Boomers retired, it’s now expected just to glide down.

Participation actually reached a record high of 66.6 per cent this year – who knew our response to a pandemic would return us to full employment for the first time in 50 years? – and is now projected to have fallen only to 63.8 per cent by 2063. If so, that would be higher than it was in 2002.

Chomik says the first report projected government spending on health care to reach more than 8 per cent of GDP by 2042. Now it’s projected to reach just 6.2 per cent by 2063. But, thanks to the royal commission, the cost of aged care is now expected to grow faster, to 2.5 per cent of GDP by 2063.

Which brings us to Treasury’s bottom line, the federal budget. Treasury projects that, as a percentage of GDP, the budget deficit will decline steadily until 2049, before ageing causes it to start heading back up.

Note, however, that while government spending is projected to rise by almost 4 per cent of GDP, tax collections are assumed, as always, to be unchanged.

Get the (unchanged) commercial message from Treasury? Taxes will have to rise.

Read more >>

Grim Reaper is catching up with the Baby Boomers, waving bills

Having witnessed the last days of my parents and in-laws, I don’t delude myself – as they did – that I’ll be able to avoid being carted off to an old people’s home. Sorry, an aged care residential facility.

Actually, I dream of dying in the saddle. My last, half-finished column would be the announcement that I’d finally made way for the bright young women coming up behind me. That’s assuming they hadn’t already found a chance to push me under a bus.

Speaking of bright young women, Anthony Albanese’s Minister for Aged Care and Sport, Anika Wells, seems to be attacking her job with much more enthusiasm than her Coalition predecessors.

In a speech to the National Press Club last week, she noted that Labor inherited a system that a royal commission had characterised with a single word – “neglect”. She’d spent the past 12 months engaged in “triage” and “urgent reform” and was now able to think about the future.

And what’s she been thinking? “I don’t want Australians to be scared about the care they will be provided in later life,” she said. “I don’t want daughters and sons worried about the treatment their parents will receive.”

The Howard government’s Aged Care Act of 1997 was aimed at saving money by turning aged care over to community and for-profit providers. It was focused on how the providers were to run their services, setting out their obligations and responsibilities.

But, as recommended by the royal commission, the government planned to introduce a new act next year, this time focused on the rights of older people, with “a clear statement that the care provided to residents is safe and of high quality”.

Labor had already done much to fix the system, she said, but there were more challenges ahead, and “we must act now”. Why? Because “the Baby Boomers are coming”. (I’d have thought they’d come some time ago, and the real problem was their looming departure.)

But I imagine the Boomers (present company excepted) will be living a lot longer than previous generations – thanks to advances in medical science and being the first generation to realise that exercise was something to be sought and enjoyed, not avoided.

But though their arrival in aged care may be at a later age, their later lives won’t be trouble-free and certainly not doctor-free.

One change we’ll be seeing is more in-home care. Almost everyone would prefer to keep living at home rather than go off to a “facility” (sounds like a toilet block). The previous government did introduce the home-care package, but it was expensive and so was limited in how many people were given it.

Wells is introducing a new Support at Home program in July 2025 which, by delaying or eliminating people’s move to facility care, should save money.

But her big announcement last week was the setting up of an aged care taskforce – chaired by her good self – to answer the royal commission’s “great unanswered question”: How to make aged care equitable and sustainable into the future?

Which is a politician’s way of saying, “How we gonna pay for all this?”

One of the commissioners wanted a new aged care tax levy of 1 per cent of everyone’s taxable income (which, in practice, would be added to the present 2 per cent Medicare levy), whereas the other wanted some unspecified combination of a levy and a means-tested contribution from users.

Wells notes that, within a decade, we’ll have, for the first time ever, more people aged over 65 than under 18. And the proportion of people aged 15 to 64 – the people working and paying income tax – will shrink.

Now, this is the point where we need to remember that we’ve gone for decades stacking the financial rules against the younger generation and in favour of the oldies. We’ve kept handing tax breaks to the ageing. Old people can have good incomes that are largely untaxed, whereas young people on the same money have to pay up - and pay for their tertiary education.

It’s not true that every Boomer’s rolling in it – there are poor people in every generation – but most have done pretty well. Most were able to climb aboard the home-ownership gravy train when homes were still affordable. Many have been able to buy an investment property or two on the top.

And though the compulsory superannuation scheme hasn’t applied to the whole of their working lives, they’ll be retiring with a lot more, hugely taxpayer-subsidised super than any previous generation.

So, the idea of spreading the entire cost of the Boomers’ aged care – whether in-home or in-facility – across all those people young enough to still be working and paying income tax ought to be unthinkable.

If Labor doesn’t summon the courage to ask those Baby Boomers who’ve done OK to help pay directly for the cost of their highly privileged lives’ last stage, it will just prove what a rotten world Albo and the rest of us have left our offspring.

Read more >>

Avoiding a tax-cut backlash will be harder than Albanese thinks

Anthony Albanese, who never impressed me when a warrior of the NSW Labor Left, has impressed me greatly by the way he’s conducted himself since becoming prime minister. He wants to raise the standard of political behaviour. Everyone gets listened to with respect, and every election promise he made not to do this, and not to do that, is honoured, no matter how inconvenient.

Having lumbered himself with those promises, Albo is taking the long view. His first term will be used to win voters’ respect and trust, creating a foundation for him to be more comfortably re-elected, with a program of more controversial reform.

Which brings us to the much-debated stage three tax cuts, designed by his political opponents to favour high-income earners at the expense of low and middle earners, something anathema to a Labor government but already put into law.

Many have been urging Albanese and his Treasurer Jim Chalmers to rescind the tax cuts or at least cut them back. But it now seems clear Albanese has made up his mind that the cut, no matter how deleterious, must go ahead. A clear promise was given, and must be kept. Can you imagine the outcry if it wasn’t? Peter Dutton would never let it rest.

Well, I can imagine it. But if Albanese thinks that keeping the promise will mean no outcry, he’s sadly deluded. Once the punters see how little they’re getting compared with how much the fat cats (including a particularly fat economics journo) are getting – once everyone sees the official “what-you-save tax table” published by every masthead – there’ll be a lot of anger.

And guess who’ll be leading the cry. Do you really think Dutton won’t have the front to turn on his own government’s tax cuts? He was trying it out in his budget reply speech last week: “Labor’s working poor”. How about “the struggling middle class”?

Albanese needs to do two things: get Treasury to give him an advance look at that what-you-save table, and get some pollie with a better memory to remind him how “bracket creep” works and how resentful middle income-earners get when they see more and more of every pay rise disappearing in tax.

Because the income tax scale isn’t indexed for inflation, every pay rise you get increases the average rate of tax you pay on the whole of your income – whether or not it literally lifts you into a higher tax bracket. And because the brackets are closer together at the bottom of the scale, bracket creep hits lower incomes harder than middle incomes. But middle incomes are hit harder than high incomes because those people already in the top tax bracket can’t be pushed any higher.

Bracket creep gets greater as inflation increases. The inflation rate’s been unusually high, which has led to higher pay rises, even if they haven’t been big enough to match the rise in prices. Even so, your latest pay rise is having slightly more tax taken out of it than the previous one. So bracket creep is another, hidden reason you’re having trouble keeping up with the cost of living.

If we never got a tax cut, the average rate of tax we pay on all our income would just keep going up and up forever – unless, of course, we never got another pay rise.

This is why every government knows it must have a tax cut every few years if it wants to stop the natives getting restless. But the stage three tax cut we’re due to get from July next year hasn’t been designed to compensate people at the bottom, the middle and the top proportionately to the degree of bracket creep they’ve suffered since 2017-18, when the staged, three-step tax cuts were announced.

Quite the reverse. According to estimates by Paul Tilley, a former Treasury officer, people earning up to roughly $70,000 a year will get tax cuts too small to fully reverse the rise in their average tax rate over the period.

Those earning between $70,000 and $120,000 a year will have their average tax rate cut back to what it was in 2018, whereas those earning more than that – that is, more than 1.5 times the median full-time wage – will get their average tax rate cut to well below what it was in 2018.

Now let’s look at what you save in dollars per week. Albanese says the tax cuts begin at $45,000 a year. The national minimum full-time wage is $42,250. So, people on very low wages, and many with part-time jobs, will get nothing.

On $55,000, you’ll get a saving of $2.40 a week. On the median full-time wage of about $80,000 you’ll get $16.80 a week – that is, no “real” saving. On $120,000, it’s $36 a week.

Meanwhile, me and my mates (and members of parliament), struggling to get by on $200,000 and above, will get a saving of $175 a week, or $25 a day.

Good luck selling that lot, Albo.

Read more >>

The taxman's sneaky trick that will quietly pick our pocket

I’ve seen some sneaky tax tricks in my time, but nothing that compares with this. It could go down in history as the perfect fiscal crime – except that many people won’t notice that some politician has taken money out of their pocket. Which, of course, is what makes it the perfect crime.

All most people may notice is that the cost of living’s got even worse, but they won’t quite realise why. That’s partly because most of the media won’t be making a song and dance about it.

Why not? Because nothing’s been announced. Because you have to know a fair bit about the tax system to understand what’s happening. Because neither side of politics wants to talk about it. There’s no controversy. And neither side’s spin doctors are keen to confirm to inquiring journalists that the strange story they read in this august organ is right.

Since the trick first became apparent to the experienced eye, in Scott Morrison and Josh Frydenberg’s budget in March last year, just before the election, my colleague Shane Wright and I have been determined to make sure our readers were told.

Wright was at it again on Saturday, and now I’m making sure you got the message. Don’t say we didn’t tell you, even if others have been far less vocal about it.

It’s a complicated story, hard to get your head around and, particularly because it’s about something that isn’t happening now but will happen later, one that’s easily forgotten.

As you see, the move was initiated by the Coalition, but will have its effect under Labor. The opposition may try to blame it on the government, but it’s probably too complicated.

This is a story about the misleadingly named Low and Middle Income Tax Offset, known to tax aficionados as “the LAMIngTOn”. It began life as stage one of the three-stage income tax cuts announced in the budget of May 2018, to take effect over seven years.

The previous government kept changing the amount of the offset – a kind of tax refund – over the years. It started out as “up to” $530 a year, but was increased to $1080 a year just before the 2019 election.

It was to have been absorbed into the second stage of the tax cuts, but it was decided to keep it going. Then, in last year’s pre-election budget, it was decided to increase it by $420 to “up to” $1500 a year. Yippee, we said. Good old Liberals!

By then, people earning up to $37,000 a year got a refund of $675 a year. It then slowly increased to be the full $1500 for those earning between $48,000 and $90,000 a year. Then it started cutting out, reaching zero when income reached $126,000.

This meant more than 10 million taxpayers – almost 70 per cent of the total – got a rebate on top of any other refund they were entitled to.

But here’s the trick. Unlike a normal tax cut, which goes on forever, the lamington was a temporary measure. If it were to be continued for another financial year, a decision had to be made. Morrison and Frydenberg’s last budget contained no such decision.

Why not? Because, in the days leading up to the budget, cabinet decided to increase it, but not to continue it beyond June 2022. Decisions not to do things don’t have to be announced, and this one wasn’t. For obvious reasons.

You really had to be in the know to realise that this constituted a decision to increase the tax 10 million people would pay in 2022-23, by up to $1500 a throw.

Wright and I were at pains to point this out in our coverage of the budget. We thought that, especially with an election imminent, people might find it pretty interesting. But, with neither side of politics wanting to talk about it, few people took much notice. Perhaps they didn’t believe us.

The other strange thing about the lamington is that, whereas a normal tax cut flows through immediately to increase your fortnightly take-home pay, you don’t get a tax cut delivered in the form of a tax offset until after the relevant financial year has ended and you’ve submitted your tax return. The taxman just adds it to any other refund you’re entitled to.

This means the last-ever lamington, for 2021-22, was served up between July and October last year.

It also means that the only way many lamington eaters will get a hint that they paid a lot more tax in the year to June 2023 is when, some time after July, they notice that their refund cheque is a lot smaller than last year’s and wonder why.

Note, I don’t disagree with the two-party cartel’s decision to be rid of the lamington. It was a stupid way to cut tax, born of creative accounting. But when they tacitly collude to conceal what they’ve done, it’s supposed to be the media’s job to point it out. We’ve done our bit.

Read more >>

Why I'm happy to bang the drum for higher wages

I’ve long believed that no government – state or federal, Liberal or Labor – should be in office for more than a decade before being put out to pasture. But I can’t say the demise of the 12-year-old Perrottet government in NSW filled me with joy.

Liberal-led governments have been falling like ninepins. But this one happened to be the only one genuinely committed to limiting climate change, improving early childhood education and care, and getting more women into politics (even if its party members weren’t playing ball).

The best thing about Dom Perrottet’s departure is the end of his cap on the size of public sector pay rises. Its removal will add to pressure for higher public sector wages in the other states – particularly Victoria – and at federal level.

It will even put a bit of upward pressure on wage rates in the private sector.

If you wonder why pay rises have been so small over the past decade, government wage caps – in Labor states as well as Liberal – are part of the reason. They’ve reduced the price competition for workers throughout the economy.

But don’t take my word for it. When he was desperate to get inflation up to his 2 to 3 per cent target range, Reserve Bank governor Dr Philip Lowe said the same.

In NSW, public sector wage rises were capped at 2.5 per cent in 2011. Only when the inflation rate started heading to 8 per cent was it lifted to 3 per cent.

There’s never a shortage of people predicting that higher wage rates will lead to death and destruction. Many Canberra lobbyists make a good living crying poor on behalf of the nation’s employers.

I’m sure there must be some businesses somewhere doing it tough, but you don’t see much evidence of it in the business pages of this august organ. The reverse, in fact.

But won’t higher wages just lead to higher prices? Yes, but not to the extent it suits business groups to claim. Wages and other labour costs don’t account for anything like the majority of the costs most businesses face.

If all firms do is pass on their higher labour costs, all it will do is slow our return to low inflation. It’s when firms use the cover of the highly publicised rises in their costs to add a bit extra to their price rises that inflation takes off.

But that’s less likely now the Reserve Bank is jacking up interest rates to slow the economy down. It won’t say so, but it’s hitting the brakes precisely because businesses were getting a bit too willing with their price rises.

Certainly, it’s not because wage rises have been too high. Few if any workers have been getting – or are likely to get – wage rises anything like as high as the rise in prices.

That’s likely to be true even for the “frontline” nurses and teachers in NSW, whose unions will be celebrating the end of the wage cap by hitting Premier Chris Minns for big increases.

It will be least true for the bottom quarter of workers dependent on the national minimum wage and the range of minimum wage rates set out in awards, who are likely to be awarded decent pay rises by the Fair Work Commission, as they were last year.

We can’t possibly afford that? Really? Nah. “If you made a list of all the things that are giving us this inflation challenge in our economy, low-paid workers getting paid too much wouldn’t be on that list,” Treasurer Jim Chalmers has said.

Why am I happy to bang the drum for higher wages? Because, as any year 11 economics student could tell you, the economy is circular.

Business people may begrudge every cent they pay their workers, but they’re pretty pleased to have all those dollars back when the nation’s households front up at their counters.

A big part of managing a capitalist economy involves saving short-sighted business people from their folly.

As for minuscule public sector pay caps, ask yourself why it’s fair enough to expect people who work for the government to accept lower rates of pay. Because they’re second-class citizens? Because they stand around leaning on shovels?

Because they’re not as smart as the rest of us? Well, if you go on doing that for long enough, you probably do end up with the cream of the crop going to higher-paying jobs in the private sector.

Which means it’s not just a matter of fairness. Underpay your nurses and teachers and then wonder why you can’t get enough recruits.

Yes, but how will Minns possibly pay for those higher wages? He could cut the number of nurses and teachers he can afford to employ, but I doubt he will.

No, he’ll do what a business would do: raise his prices. Except that, in government, prices are called taxes. You want the workers? You pay the going rate. It’s the capitalist way.

Read more >>

Much prosperity comes from government and the taxes it imposes

The Productivity Commission’s job is to make us care about the main driver of economic growth: productivity improvement. Its latest advertising campaign certainly makes it sound terrific. But ads can be misleading. And productivity isn’t improving as quickly as it used to. We’re told this is a very bad thing, but I’m not so sure.

The commission’s latest report on our productivity performance, “Advancing Prosperity”, offers a neat explanation of what productivity is: the rise in real gross domestic product per hour worked. So it’s a measure of the efficiency with which our businesses and government agencies transform labour, physical capital and raw materials into the goods and services we consume.

The economy – GDP – can grow because the population grows, with all the extra people increasing the consumption of goods and services, and most of them working to increase the production of goods and services.

It also grows when we invest in more housing, business machinery and construction, and public infrastructure. But, over time, most growth comes from productivity improvement: the increased efficiency with which we deploy our workers – increasing their education and training, giving them better machines to work with, and organising factories and offices more efficiently.

Here’s the ad for productivity improvement. “There has been a vast improvement in average human wellbeing over the last 200 years: measured in longer lives, diseases cured, improved mobility [transport and travel], safer jobs, instant communication and countless improvements to comfort, leisure and convenience.”

That’s all true. And it’s been a wonderful thing, leaving us hugely better off. But here’s another thing: neither GDP nor GDP per hour worked directly measures any of those wonderful outcomes. What GDP measures is how much we spent on – and how much income people earned from – doctors, hospitals and medicines, good water and sewerage, cars, trucks and planes, occupational health and safety, telecommunications, computers, the internet, and all the rest.

The ad man’s 200 years is a reference to all the growth in economic activity we’ve had since the Industrial Revolution. We’re asked to believe that all the economic growth and improved productivity over that time caused all those benefits to happen.

Well, yes, I suppose so. But right now, the commission’s asking us to accept that our present and future rate of growth in GDP and GDP per hour worked will pretty directly affect how much more of those desirable outcomes we get.

That’s quite a logical leap. Maybe it will, maybe it won’t. Maybe the growth and greater efficiency will lead to more medical breakthroughs, longer lives, cheaper travel etc, or maybe it will lead to more addiction to drugs and gambling, more fast food and obesity, more kids playing computer games instead of reading books, more time wasted in commuting on overcrowded highways, more stress and anxiety, and more money spent on armaments and fighting wars.

Or, here’s a thought: maybe further economic growth will lead to more destruction of the natural environment, more species extinction and more global warming.

Get it? It doesn’t follow automatically that more growth and efficiency lead to more good things rather than more bad things. It’s not so much growth and efficiency that make our lives better, it’s how we get the growth, the costs that come with the growth, and what we use the growth to buy.

Trouble is, apart from extolling growth and efficiency, the Productivity Commission has little to say about how we ensure that growth leaves us better off, not worse off.

Economics is about means, not ends. How to be more efficient in getting what we want. The neoclassical ideology – where ideology means your beliefs about how the world works and how it should work – says that what we want is no business of economists, or of governments. What we want should be left to the personal preferences of consumers.

The Productivity Commission has long championed neoclassical ideology. It wants to minimise the role of government and maximise the role of the private sector.

It would like to reduce the extent to which governments intervene in markets and regulate what businesses can and can’t do. It has led the way in urging governments to outsource the provision of “human services” such as childcare, aged care and disability care to private, for-profit providers.

It wants to keep government small and taxes low to maximise the amount of their income that households are free to spend as they see fit, not as the government sees fit.

Fine. But get this: in that list of all the wonderful things that economic growth has brought us, governments played a huge part in either bringing them about or encouraging private firms to.

We live longer, healthier lives because governments spent a fortune on ensuring cities were adequately sewered and had clean water, then paid for hospitals, subsidised doctors and medicines, paid for university medical research and encouraged private development of pharmaceuticals by granting patents and other intellectual property rights to drug companies.

Governments regulated to reduce road deaths. They improved our mobility by building roads, public transport, ports and airports. Very little of that would have been done if just left to private businesses.

Jobs are safer because governments imposed occupational health and safety standards on protesting businesses. The internet, with all its benefits, was first developed by the US military for its own needs.

The commission says that when we improve our productivity, we can choose whether to take the proceeds as higher income or shorter working hours.

In theory, yes. In practice, all the reductions in the working week we’ve seen over the past century have happened because governments imposed them on highly reluctant employers. Ditto annual leave and long-service leave.

I don’t share the commission’s worry that productivity improvement may stay slow. It won’t matter if we do more to produce good things and fewer bad things. But that, of course, would require more government intervention in the economy, not less.

Read more >>

How about sharing the economic pain arround?

If you don’t like what’s happening to interest rates, remember that although the managers of the economy have to do something to reduce inflation, it’s not a case of what former British prime minister Maggie Thatcher called TINA – there is no alternative.

As Reserve Bank governor Dr Philip Lowe acknowledged during his appearance before the House of Representatives Standing Committee on Economics last week, there are other ways of stabilising the strength of demand (spending) and avoiding either high inflation or high unemployment, which are worth considering for next time.

So, relying primarily on “monetary policy” – manipulating interest rates – is just a policy choice we and the other advanced economies made in the late 1970s and early 1980s, after the arrival of “stagflation” – high unemployment and high inflation at the same time – caused economists to lose faith in the old way of smoothing demand, which was to rely primarily on “fiscal policy” – manipulation of taxation and government spending in the budget.

The economic managers have a choice between those two “instruments” or tools with which smooth demand. The different policy tools have differing sets of strengths and weaknesses.

Whereas back then we were very aware of the weaknesses of fiscal policy, today we’re aware of the weaknesses of monetary policy, particularly the way it puts a lot more pain on people with home loans than on the rest of us. How’s that fair?

Lowe says the conventional wisdom is to use monetary policy for “cyclical” (short-term) problems and fiscal policy for “structural” (lasting) problems, such as limiting government debt.

But it’s time to review what economists call “the assignment of instruments” – which tool is better for which job. The more so because the government has commissioned a review of the Reserve Bank’s performance for the first time since we moved to monetary policy dominance.

It’s worth remembering that the change of regime was made at a time when Thatcher and other rich-country leaders were under the influence of the US economist Milton Friedman and his “monetarism”, which held that inflation was “always and everywhere a monetary phenomenon” and could be controlled by limiting the growth in the supply of money.

It took some years of failure before governments and central banks realised both ideas were wrong. They switched back to the older and less exciting notion that increasing interest rates, by reducing demand, would eventually reduce inflation. There was no magic, painless way to do it.

Macroeconomists long ago recognised that using policy tools to manage demand was subject to three significant delays (“lags”). First there’s the “recognition lag” – the time it takes the econocrats and their bosses to realise there’s a problem and decide to act.

Then there’s the “implementation lag” – the delay while the policy change is put into effect. Lowe described the cumbersome process of cabinet deciding what changes to make to what taxes or spending programs. Then getting them passed by both houses, then waiting a few weeks or months for the bureaucrats to get organised before start day.

He compared this unfavourably with monetary policy’s super-short implementation delay: the Reserve Bank board meets every month and decides what change to make to the official interest rate, which takes immediate effect.

He’s right. While the two policy tools would have the same recognition lag, monetary policy wins hands down on implementation lag.

But on the third delay, the “response lag” – the time it takes for the measure, once begun, to work its way through the economy and have the desired effect on demand – monetary policy is subject to “long and variable lags”.

Lowe said it took interest rate changes 18 months to two years to have their full effect. But I say most budgetary changes – particularly tax changes – wouldn’t take nearly that long. So, that’s a win for fiscal.

The sad truth is that measures to strengthen demand by cutting interest rates, or cutting taxes and increasing government spending, are always popular with voters, whereas measures to weaken demand by raising interest rates, or raising taxes and cutting government spending, are always unpopular.

This meant politicians were always reluctant to increase interest rates when they needed to, Lowe said. This is a good argument for giving the job to the econocrats at the central bank and making them independent of the elected government.

This became standard practice in the rich economies, although we didn’t formalise it until the arrival of the Howard government in 1996. Lowe advanced this as a good reason to stick with monetary policy as the dominant tool for short-term stabilisation of demand.

Against that, using monetary policy to get to the rest of us indirectly via enormous pressure on the third of households with mortgages shares the burden in a way that’s arbitrary and unfair.

What’s more, it’s not very effective. Because such a small proportion of the population is directly affected, the increase in interest rates has to be that much bigger to achieve the desired restraint in overall consumer spending.

But if the economic managers used a temporary percentage increase in income tax, or the GST, to discourage spending, this would directly affect almost all households. It would be fairer and more effective because the increase could be much smaller.

Various more thoughtful economists – including Dr Nicholas Gruen and Professor Ross Garnaut – have proposed such a tool, which could be established by legislation and thus be quickly activated whenever needed.

A special body could be set up to make these decisions independent of the elected government. Ideally, it would also have control over interest rates, so one institution was making sure the two instruments were working together, not at cross purposes.

Another possibility is Keynes’ idea of using a temporary rate of compulsory saving – collected by the tax office – to reduce spending when required, without imposing any lasting cost on households.

They say if it ain’t broke, don’t fix it. It’s obvious now that macroeconomic management needs a lot of fixing.

Read more >>

Who knew? The price of better government is higher taxes

Have you noticed? Since the change of government, the politicians have become a lot franker about the budgetary facts of life. And now the Parliamentary Budget Office has spelt it out: it’s likely that taxes will just keep rising over the next 10 years.

The great temptation for politicians of all colours is to make sure we don’t join the budgetary dots. On one hand, they’re going to improve childcare and health and education, do a better job on aged care and various other things. On the other, they’ll cut taxes.

In short, they’ve discovered a way to make two and two add to three.

The attraction of that relatively new institution, the Parliamentary Budget Office, is that it reports to the Parliament, meaning it’s independent of the elected government. Each year, sometime after the government has produced its budget, the office takes the decisions and figurings and examines whether they are sustainable over the “medium term” – an econocrats’ term for the next 10 years.

They do this by accepting the government’s present policies and mechanically projecting them forward for a further six years beyond the budget’s published figures for the budget year and the following three financial years of “forward estimates”.

Note that these mechanical projections are just projections – just arithmetic. They’re not forecasts of what will happen. No one but God knows what will happen to the economy over the next year, let alone the next 10.

No one putting together the Morrison government’s pre-election budget of April 2019 – the one saying the budget would soon be “back in black” – foresaw that the arrival of a pandemic 11 months later would knock it out of the ballpark, for instance.

Projections don’t attempt to forecast what will happen. Rather, they move the budget figures forward based on plausible assumptions about what the key economic variables – population growth, inflation, for instance – may average over the projection period.

So, projections are not what will happen, but what might happen if the government left its present policies unchanged for 10 years. They give us an idea of what changes in policy are likely to be needed.

Media reporting of the budget office’s latest medium-term projections focused on its finding that, if there are no further tax cuts beyond the stage three cuts legislated for July 2024, the government’s collections of personal income tax may have risen 76 per cent by 2032-33.

The average rate of income tax paid by all taxpayers is projected to reach 25.5 cents in the dollar before the stage three tax cut drops it to 24.1 cents. But then it could have risen to 26.4 cents by 2032-33 – which would be an all-time high.

Why? Bracket creep. Income is taxed in slices, with the slices taxed at progressively higher rates. So, as income rises over time, a higher proportion of it is taxed at higher rates, thus pushing up the average rate of tax on all the slices.

Like the sound of that? No. Which is why the media gave it so much prominence. But there’s much more to be understood about that prospect before you start writing angry letters to your MP.

The first is that, according to the projections, even with such unrestrained growth in income tax collections, the rise in total government revenue wouldn’t be sufficient to stop the budget deficit growing a bit, year after year.

Why not? Because of the strong projected growth in government spending. That’s the first thing to register: the reason tax collections are likely to rise so strongly is that government spending is expected to rise so strongly.

Why? Because that’s what we want. The pollies know we want more and better government services – which is why no election passes without both sides promising to increase spending on this bauble and that.

What neither side ever does in an election campaign is present the bill: “we’re happy to spend more on your favourite causes but, naturally, you’ll have to pay more tax to cover it”. Indeed, they often rustle up a small tax cut to give you the opposite impression: that taxes can go down while spending goes up.

The budget office’s projections suggest that total government spending will rise from 26.2 per cent of gross domestic product in the present financial year to 27.3 per cent in 2032-33. This may not seem much, but it’s huge.

Nominal GDP – the dollar value of the nation’s total production of goods and services, and hence, the nation’s income – grows each year in line with population growth, inflation and any real increase in our average standard of living. So, for government spending to rise relative to GDP, it must be growing faster even than the economy is growing.

Briefly, the spending growth is explained by continuing strong growth in spending on the National Disability Insurance Scheme, the growing interest bill on the government’s debt, and the rising cost of aged care.

This being so, there seems little doubt we’ll be paying a bit more tax – a higher proportion of our income – most years over the coming 10, and probably long after that.

But that’s not to say things will pan out in the way described by the budget office and as trumpeted by the media. For a start, it’s unlikely any government would go for six years without a tax cut.

It’s true that governments of both colours rely heavily on bracket creep – aka “the secret tax of inflation” – to square the circles they describe during election campaigns; to ensure two and two still add up to four.

But they’re not so stupid as never to show themselves going through the motions of awarding a modest tax cut every so often – confident in the knowledge that continuing bracket creep will claw it back soon enough.

The next point is that the overall average tax rates the budget office quotes are potentially misleading. Every individual taxpayer has their own average rate of tax, with high income-earners having a much higher average than people with low incomes.

But when the budget office works out the average for all taxpayers – the average of all the averages, so to speak – you get a number that accurately described the position of surprisingly few people. It’s like the joke about the statistician who, with his head in the oven and his feet in the fridge, said that, on average, he was perfectly comfortable.

There are plenty of things a government could do to reduce the tax concessions for high income-earners (like me) and to slant any tax cuts in favour of people in the bottom half, which would allow it to raise much the same revenue as the budget office envisages without raising the average tax rate paid by the average (that is, the median) individual taxpayer by nearly as much as the budget office’s figures suggest.

Fearless prediction: just such thinking will be what leads the Albanese government to make a start next year by rejigging the size and shape of the stage three tax cuts.

Read more >>

Labor will struggle with deficit and debt until it raises taxes

There’s something strange about last week’s federal budget. It reveals remarkably quick progress in getting the budget deficit down to nearly nothing. But then it sees the deficit going back up again. Which shows that, as my former fellow economics editor Tim Colebatch has put it, Rome wasn’t built in one budget.

Let’s look at the figures before explaining how they came about. The previous, Coalition government finally got the budget back to balance in the last full financial year before the arrival of the pandemic, 2018-19.

The government’s big spending and tax breaks in response to COVID’s arrival in the second half of the following year, 2019-20, saw the budget back in deficit to the tune of $85 billion. Next year’s deficit was even higher at $134 billion.

But in the year that ended soon after the change of government in May, 2021-22, the deficit fell to just $32 billion. And in last week’s second go at the budget for this year, 2022-23, the deficit is expected to be little changed at $37 billion – which would be $41 billion less than what Scott Morrison was expecting at the time of the election six months ago.

But the changes in these dollar figures don’t tell us much as comparing the size of the deficit with the size of the economy (nominal gross domestic product) in the same year. Judging it this way allows for the effect of inflation and for growth in the population.

So, relative to GDP, the budget deficit has gone from zero in 2018-19, to 4.3 per cent, then a peak of 6.5 per cent in 2020-21, then crashed down to just 1.4 per cent last financial year. This year’s deficit is now expected to be little changed at 1.5 per cent.

We all know why the deficit blew out the way it did, but why did it come back down so quickly?

Three main reasons. The biggest is that it happened by design. All the pandemic-related measures were temporary. As soon as possible, they were ended.

But also: the rise in world fossil fuel prices caused by the war in Europe produced a huge surge tax collections from our mining companies. Last week’s budget announced the new government’s decision to use almost all of this windfall to reduce the deficit.

And last week we learnt the government had also decided to keep a very tight rein on government spending. It introduced all the new spending programs it promised at the election, but cut back the previous government’s programs to largely cover the cost of the new ones.

Its frugality had one objective: to help the Reserve Bank reduce inflation by first using higher interest rates to reduce people’s demand for goods and services.

Keeping the deficit low for another year has, Treasurer Jim Chalmers said this week, changed the “stance” of fiscal (budgetary) policy to “broadly neutral” - neither expansionary nor contractionary. Which, he’s sure to be hoping, will mean the Reserve has to raise interest rates by less than would have.

Another benefit of his decision not to spend the tax windfall, Chalmers said this week, is that by June next year, the government’s gross debt will be $50 billion lower than it would have been. And, according to Treasury’s calculations, this reduction means a saving of $47 billion on interest payments over the decade to 2033.

Great. Wonderful. Except for the strange bit: two years after this financial year, the budget deficit is expected to have gone back up to $51 billion, or 2 per cent of GDP.

What’s more, the budget’s “medium-term projections” foresee the deficit stuck at about 2 per cent each year – or $50 billion in today’s dollars – for the following eight years to 2032-33.

In the first budget for this year, just before the election, the deficit was projected to have fallen slowly to 0.7 per cent of GDP by 2033. Now, no progress is expected. Which means, of course, that the amount of public debt we end up with will be higher than expected during the election campaign.

The gross public debt is now not expected to reach a plateau, of about 47 per cent of GDP, until the first few years of the 2030s.

So, if the budget deficits last year and this are so much better than we were expecting just seven months ago, why on earth are the last eight years of the medium term now expected to be significantly worse?

Three main reasons. First, because a new actuarial assessment of the future cost of the National Disability Insurance Scheme (NDIS) shows the cost growing much faster than previously thought.

Second, because, with world interest rates having risen so much this year, the interest bill on the public debt is now projected to be much bigger over the coming decade.

Third, because the previous government based its projections on the assumption that the productivity of labour would improve at the quite unrealistic average rate of 1.5 per cent a year, but Chalmers has cut this to a more realistic 1.2 per cent. This change reduces government revenue by more than it reduces government spending.

What this exercise reveals is that the “persistent structural deficit” earlier projections told us to expect, will actually be worse than we were told. The deficit won’t go away but, on present policies, will stay too high every year for as far as the eye can see.

Fortunately, Chalmers freely admits that present policies will have to be changed. “While this budget has begun the critical task of budget repair, further work will be required in future budgets to rebuild fiscal buffers [ready for the next recession] and manage growing cost pressures”.

He repeated this week his view that, as a country, we need to “have a conversation about what we can afford and what we can’t” - his way of breaking it gently that, if the structural deficit is to be removed, taxes will have to rise.

Read more >>

Memo RBA board: Time to stop digging in deeper on interest rates

If, as seems likely, the combined might of the advanced economies’ central banks pushes the world into recession, the biggest risk isn’t that they’ll drag us down too, but that our Reserve Bank will raise our own interest rates too far.

That’s the message to us – and everyone else – from the International Monetary Fund’s repeated warnings about the unexpected consequences of “synchronised tighten” by the big economies – America, Europe and, in its own way, China, all jamming on the brakes at the same time.

Synchronised macro-policy shifts are a relatively new problem in our more globalised world economy. Until the global financial crisis of 2008, world recessions tended to roll from one country to the next. Since then, everyone tends to start contracting – or stimulating – at the same time.

When you were stimulating while your trading partners weren’t, much of your stimulus would “leak” to their economies, via your higher imports. But, as we learnt in the fight to counter the Great Recession, when everyone’s stimulating together, your leakage to them is offset by their leakage to you, thus making your stimulus stronger than you were expecting.

The fund’s warning is that we’re now about to learn that the same thing happens in reverse when everyone’s hitting the brakes – budgetary as well as monetary – together. Synchronisation will make your efforts to restrain demand (spending on goods and services) more potent than you were expecting.

So the fund’s message to us is: when you’re judging how high interest rates have to go to get inflation heading back down to the target, err on of side to doing too little.

But there are four other factors saying the Reserve should be wary of pushing rates higher. The first is Treasurer Jim Chalmers’ confirmation in last week’s budget that the “stance” of his fiscal policy has also switched from expansionary to restrictive, and so is now adding to the restraint coming from tighter monetary policy.

Chalmers has cut back the Coalition’s spending programs to make room for Labor’s new spending plans, while “banking” the temporary surge in tax revenue arising from the war-caused jump in world energy prices, and the success of the Coalition’s efforts to return us to full employment.

As a result, the budget deficit has fallen from a peak of $134 billion (equivalent to 6.5 per cent of gross domestic product) in 2020-21, to $32 billion (1.4 per cent) in the year to this June. The present financial year should see that progress largely retained, with the deficit rising only a little.

What’s more, the government’s already acting on its intention to force our greedy gas producers to raise their prices by a lot less than has been assumed in the budget’s inflation forecasts.

Second, the Reserve’s efforts to reduce aggregate (total) demand by using the higher cost of borrowing to reduce domestic demand, will be added to by the other central banks’ efforts to reduce our “net external demand” (exports minus imports).

What’s more, the expected further big fall in house prices will help reduce domestic demand by making home owners feel a lot less well-off than they were (the “wealth effect”).

Third – and this is a big point – the restrictive effect of the Reserve’s higher interest rates will be massively reinforced by the “cost-of-living squeeze” (aka the huge fall in real wages). Comparing the wage price index with the consumer price index, real wages fell by 2 per cent over the year to June 2021, and by an unbelievable 3.5 per cent to June this year.

Now the budget’s predicting a further fall of 2 per cent to June next year, with only the tiniest gain by June 2024.

This is an unprecedented blow to households’ income. It just about guarantees an imminent return to weak consumer spending. And it’s a much bigger blow than the big advanced economies have suffered, suggesting our central bank should be going easier on rate rises than theirs.

The final factor saying the Reserve should be wary of pushing rates higher is “lags”. As top international economist Olivier Blanchard reminded us in a recent Twitter thread, monetary policy affects the inflation rate with a variable delay of maybe six to 18 months.

This says you should stop tightening about a year before you see any hard evidence that inflation has peaked and started falling. Wait for that evidence, and you’re certain to have hit the economy too hard, causing the recession we didn’t have to have.

But to stop tightening before the money market know-alls think you should takes great courage.

Read more >>

Budget will reduce need for increases in interest rates

When the economy’s needs have switched from stimulus to restraint, it helps to get in new economic managers, who can reverse their predecessors’ direction with zeal rather than embarrassment.

The need for economic policy to change course became clear only during this year’s election campaign, when the Reserve Bank’s concern about rapidly rising inflation prompted it to make the first of many rises in the official interest rate.

So this week’s second go at a budget for the present financial year was needed not just to accommodate a new government with different policies and preferences, but to change the budget’s direction from push-forward, to pull-back.

In just those few months, we changed from “gee, aren’t we roaring along” to “gosh, we better slow down quick”. One moment we’re seeing how low we can get the rate of unemployment, the next we’re jacking up interest rates in a struggle to get inflation down.

A drawback of living in a market economy is that it moves through a “business cycle” of alternating boom and bust. The role of the economic managers is to “stabilise” – or smooth out - the demand for goods and services, cutting off the peaks and filling in the troughs.

The problem with booms is that as demand (spending) starts running ahead of supply (production), it pushes up prices and the inflation rate. The problem with troughs is that as demand falls behind supply, businesses start sacking workers and unemployment rises.

The macro managers use two “instruments” to smooth the cycle’s ups and downs: the budget (“fiscal policy”) and interest rates (“monetary policy”).

With the budget, they increase government spending and cut taxes to add to demand and so reduce unemployment. They cut government spending and increase taxes to reduce demand and so reduce the rate of inflation.

With interest rates, the Reserve Bank cuts them to encourage borrowing and spending by households, so as to reduce unemployment. It increases them to discourage borrowing and spending by households and so reduce inflation.

So, which of the two policy levers should you use?

A new conventional wisdom has emerged among top American academic economists that, because of the two levers’ contrasting strengths and weaknesses – and because interest rates are so much closer to zero than they used to be - you should use fiscal policy to boost demand, but monetary policy to hold it back.

This more discriminating approach has yet to become the accepted wisdom, however. The old wisdom is that monetary policy is the better tool to use for both stimulus and restriction.

The budget’s “automatic stabilisers” (mainly bracket creep and unemployment benefits) should be free to help monetary policy in its “counter-cyclical” role, but discretionary, politician-caused changes in government spending and taxes should be used only in emergencies, such as recessions.

So expansionary fiscal policy did much of the heavy lifting during the pandemic – hence the huge budget deficits and addition to government debt.

But now the Reserve and monetary policy have taken the lead in slowing demand within Australia, so it doesn’t add to the higher prices we’re importing from abroad, thanks to the pandemic-caused supply chain disruptions and the Russian-war-caused leap in fuel prices.

The conventional wisdom also says that, whatever you do, never have the two policy tools pulling in opposite directions rather than together.

If you’re mad enough to have the budget strengthening demand when the independent central bank wants it to weaken, all you do is prompt the bankers to lift interest rates that much higher. This is the “monetary policy reaction function”. One way of saying the central bankers always have the trump card.

Which brings us to this week’s budget redux. How did Treasurer Jim Chalmers play his cards? He did what he thought he could to get the budget deficit as low as possible and so back up monetary policy’s efforts to reduce demand. He’s no doubt hoping this will reduce the need for many more interest-rate increases.

First, Finance Minister Katy Gallagher hacked away at the Morrison government’s new spending programs, so that Labor’s promised new spending could take their place with little net addition to expected government spending over this financial year and the following three.

This wasn’t particularly hard because most of the Coalition’s plans were politically driven, and most hadn’t got going before government changed hands in May.

Second, the same attack on Ukraine that’s causing household electricity and gas bills to rocket has also caused the profits of Australian gas and coal exporters to rocket, along with their company tax bills.

As well, the Coalition’s success in getting employment up and unemployment down has caused a surge in income tax collections.

This huge boost to government revenue isn’t expected to last, so Chalmers has decided to “bank” almost all of it rather than spend it. That is, use it to reduce the budget deficit.

The budget in March expected a budget deficit for the year to this June of $80 billion. Thanks mainly to the tax windfall, it came in at $32 billion, a huge improvement, equivalent to more than 2 per cent of gross domestic product.

The deficit for this year was expected to be $78 billion, but now $37 billion is expected, an improvement of almost 2 per cent of GDP. Next financial year, 2023-24, has gone from $57 billion to $44 billion.

So, the budget deficit is expected to fall continuously from a peak of $134 billion (6.5 per cent of GDP) in 2020-21 to $37 billion (1.5 per cent) this financial year.

That’s enough to convince me the “stance” of fiscal policy is now restrictive. I reckon it’s also enough to convince Reserve Bank governor Dr Philip Lowe that fiscal policy is co-operating in the effort to restrain demand and control inflation.

One small problem. After this year, the deficit’s projected to start drifting back up, and stay at about 2 per cent of GDP until at least 2032-33.

Oh dear. Why? Tell you next week.

Read more >>

Join the dots: your taxes are heading up, not down

Treasurer Jim Chalmers’ “solid and sensible” budget is not so much good or bad as incomplete. It hints at “hard decisions” to be made but doesn’t make them. It tells us times are tough and getting tougher – which we already knew. What we don’t know is what the government plans to do about it. We were told some things, but one big gap remains.

Chalmers said the budget’s priority was to provide cost-of-living relief. No, not directly – its true focus is on reducing the budget deficit so that the Reserve Bank won’t have to raise interest rates as much to control inflation.

But the big fall in this year’s deficit – made possible by the greater tax revenue from higher export prices – isn’t expected to stop the deficit rising the following year.

And although the budget does include measures that will cut costs for some families – for childcare and prescriptions – these are election promises, not newly announced moves.

The budget’s biggest bad news is that the cost-of-living squeeze is now expected to continue for another two years, with price rises continuing to outpace wage rises. And even when the squeeze stops, real (inflation-adjusted) wages will be a lot lower than they were before the pandemic.

Strangely, the budget’s best news is that the economy’s rate of growth is forecast to slow to just 1.5 per cent in the year to June 2024.

What sounds bad is good when you remember the growing likelihood of a global recession. While most rich economies will go backwards, we should only slow down. Our rate of unemployment is predicted to rise just a bit from its near 50-year low.

World recessions mean we earn less from our exports. They don’t necessarily drag us into recession, as our earlier run of almost 30 years without a recession demonstrates.

Still, a forecast is only a forecast, not a guarantee. The main factor determining if we too end up with negative growth will be whether, in its efforts slow the rate of inflation, the Reserve Bank accidentally raises interest rates more than needed.

This is the BNPL budget – buy now, pay later. Labor bought an easy return to government by promising lots more spending on better government services, while also promising not to increase any taxes – apart from on wicked multinationals – and not to interfere with the already legislated stage three income tax cuts, due in July 2024.

This budget is Labor’s payment for the election it bought. But, as with BNPL schemes, payment comes in four instalments. This is just the first of the four budgets the government expects to deliver before the next election.

Chalmers says it’s “a beginning of the long task of budget repair, not the final destination”.

True. Another way to put it is that this is only the start of his Dance of the Four Veils. In the end, all will be revealed. But right now, we’ve been shown little.

Chalmers keeps saying he wants to “start a conversation” about what services we want government to provide, and how we should pay for them.

A few weeks ago, he got the conversation going by entertaining whether, in the light of all that’s transpired, the stage three tax cuts are still appropriate.

But his boss Anthony Albanese quickly closed the conversation down. No decision had been made to change the cuts, he said firmly.

Since the cuts aren’t due for 20 months, there’s no need for any decision to be announced in this budget, or in next May’s budget. Indeed, any decision could be held off until the third veil is removed in May 2024.

Albanese is waiting and manoeuvring until time and circumstance have convinced us it would be better for the promise to be broken. He’d like people marching the streets with banners demanding the tax cut be dropped.

Those hugely expensive and unfair tax cuts would be so counterproductive to all the problems Chalmers is grappling with, I don’t doubt that at a propitious time, a decision to reduce them will be unveiled.

This will set the stage for the final unveiling of the government’s plan to increase taxes after the next election.

Why am I so sure? Because everything the government is doing and saying points to the need for taxes to go up, not down.

Finance Minister Katy Gallagher has slashed away at the Morrison government’s spending on “rorts and waste”, to make room for Labor’s spending promises – not all of which escape a similar label.

But she has also exposed the way her predecessors were holding back spending on aged care, health, education and much else. Add the National Disability Insurance Scheme, defence, and the interest bill, and you see that strong spending growth in coming years will be unavoidable.

Except for the government’s reticence on tax issues, Chalmers is justified in his repeated claim that this is a “responsible” budget. His more debatable claim is that the budget’s first priority was to provide cost-of-living relief.

That claim came with a heavy qualification: that relief had to be “responsible, not reckless … without adding to inflation”. Yes, the adults are back in charge of the budget.

But the government reticence on tax issues is a big exception to its record on responsible budgeting. The huge increases in gas and electricity prices – mostly collateral damage from Russia’s war on Ukraine – that will do most to continue the cost-of-living squeeze on families this year and next are counterbalanced by the massively increased profits of our exporters of fossil fuel.

Labor’s irresponsible election promise to bind its hands on tax changes has stopped it giving hard-pressed households the consolation of seeing most of those windfall profits taxed, and so returned to other taxpayers for use on more deserving causes.

Read more >>

Labor's 'plan' to fix the economy has three big bits missing

If you think the jobs summit was stage-managed, you’re right. Anthony Albanese & Co got the tick for policy changes they’d always wanted to make. But the two top-drawer economists who addressed the summit – Professor Ross Garnaut and Danielle Wood, boss of the Grattan Institute – proposed three other vital matters for the government’s to-do list, which it had better get on with if it’s to manage the economy successfully.

Both wanted action on competition policy, immigration policy and fiscal (budget) policy. All of these could play an important role in making the economy less inflation-prone, achieving and retaining full employment, improving our productivity and ensuring workers get their fair share of the proceeds.

The major element in our inflation problem that no one dares to name – certainly not Reserve Bank governor Dr Philip Lowe who, in a long speech about the problem last week, didn’t find time to mention it – is the pricing power that our oligopolised economy gives our big businesses.

Much Treasury research has found that Australia’s businesses lack “dynamism”. To be blunt, they’re fat and lazy. Wood reminds us that lower levels of dynamism and innovation have been linked to a lack of competitive pressure in the economy.

“In competitive markets, excess profits should be dissipated over time as new and innovative competitors enter. But increasingly in Australia and elsewhere, we have seen the biggest and most profitable firms remain largely untroubled by new competitors,” she says.

“While being relaxed and comfortable may be profitable, it is not good for Australia’s long-term economic prospects.”

So, what should Labor do about it? “Making sure that Australia’s competition laws are fit for purpose is part of the response ... The former head of the Australian Competition and Consumer Commission, Rod Sims, has argued that the current merger laws are failing to adequately protect competition. His warnings should prompt serious thought,” Wood says.

Garnaut agrees. He says we have to think about the increasing role of “economic rents” – the ability to earn profits exceeding those needed to keep you in the business. “Productivity is reduced and the profit share of [national] income increased by monopoly and oligopoly,” he says.

The answer? “Rod Sims has drawn attention to the increasing role of oligopoly in the Australian economy, and the competition policy reforms that would reduce it.”

The point for the government to note is that, if it leaves big business’s pricing power unchecked, but restores the unions’ bargaining power, that will be a recipe for a more inflation-prone economy – and a Reserve Bank using high interest rates to keep the economy comatose.

Both Garnaut and Wood gave the highest priority to urging a lasting return to full employment and the many social and economic benefits it would bring, if the jobs market was always about as tight as it is now.

But, as Garnaut says, full employment is hard work for employers. “Many prefer unemployment, with easy recruitment at lower wages.”

Which helps explain why they’re so desperate to get the immigration flood gates reopened and flowing. They talk about shortages of skilled labour but, in truth, they’re just as keen to have less-skilled labour. High immigration is just one of the instruments from their toolbox they’ve been using to keep their labour costs low, including the cost of training workers.

But we can’t keep our gates shut forever, so what should the government do to open up without losing the benefits of full employment (including a strong incentive to train our own youngsters)?

Garnaut says immigration is much more likely to raise, rather than lower, average real wages if it is focused on permanent migration of people with genuinely scarce and valuable skills that are bottlenecks to valuable Australian production, and cannot be provided by training Australians.

Wood says we need to fix “out-dated” skilled migration rules. “Targeting higher-wage migrants directly for both temporary and permanent skilled migration would improve the productivity of the migration system and the Australian workforce,” she says.

Which brings us to the budget. Wood says that although our response to the pandemic may now seem to have stimulated demand more than is helpful, these pressures will dissipate, “especially if the federal government and the central bank work in tandem to address strong demand, and do what is possible to boost supply”.

That’s her nice way of saying that, if the government fails to get its budget deficit down, the Reserve Bank will take interest rates higher than it would have. And she’s right, it will.

The deficit needs to come down despite Labor’s expensive – but welcome – promise to greatly increase the wage rates of the mainly female workers in aged care and other parts of the care economy.

How can this circle be squared? To Garnaut, the answer’s obvious. If the government has to do more and pay more – including on defence – it will just have to tax more.

He reminds us that “in the face of these immense budget challenges, total and federal and state taxation revenue, as a share of gross domestic product, is 5.7 percentage points lower than the developed-country average.”

And when it comes to what more the government could tax, Garnaut has some ideas. Disruption from the Russian invasion of Ukraine has given our fossil fuel companies record profits from higher coal and gas prices, while substantially lowering living standards by greatly increasing electricity prices.

Garnaut says the government shouldn’t kid itself that leaving this disparity unchallenged wouldn’t leave deep wounds in the public’s faith in government.

Introducing a tax on these windfall profits would be one solution, but I suspect he wants something more substantive. He says a significant part of the increase in the profit share of national income in recent years has come from mining.

One response would be for mine workers to get much higher wages. But, he says, miners are already paid much more than workers in other industries. So, the appropriate public policy response is a mineral rent tax – that is, a tax on the mining companies’ excess profits – which would share the benefits with all of us.

Finally, Garnaut rebukes those economists who rely on fancy calculations to tell them how low the unemployment rate can get before we have a problem with inflation. He says this is not an output from an econometric model, it’s “an observed reality”. That is, you have to suck it and see.

“Economics is less amenable than physics to definitive mathematical analysis because it is about people, whose responses to similar phenomena change over time. We build models in our minds or computers that fit observed reality at one point in time, and reality changes. Then we have to think harder about what’s going on.”

Economics is about the behaviour of people! Who knew?

Read more >>

Look up, we're on the verge of employment greatness

“Visionary” and “inspirational” aren’t words normally used about economists, but they certainly apply to Professor Ross Garnaut, of the University of Melbourne, and to his Thursday dinner speech to the jobs and skills summit. His message to Anthony Albanese is that he’s taken the helm at the worst of times. But, if he can rise to the challenge, he can lead us to the best of times.

Garnaut’s message is in two parts. First, we must stop kidding ourselves about the state of the economy and the budget. Second, we can make the seemingly impossible changes needed to gain all the material and social advantages of economic success.

First, we are kidding ourselves about how well our economy has been performing. It’s true our economy bounced back more quickly from the COVID-19 pandemic recession than did most developed economies - because our stimulus from the budget was bigger and faster.

Since then, however, Garnaut says, “we have looked ordinary in a troubled developed world”.

“We can’t turn the economy back to before the pandemic,” he says. “Even if we could, pre-pandemic conditions aren’t good enough. That’s high unemployment and underemployment and stagnant living standards.”

Recently, our problems have been compounded by the invasion of Ukraine and its disruption of global energy markets. But, unlike the Europeans and most other rich countries, Australian energy companies benefit when gas and coal prices rise.

“We are kidding ourselves if we think no deep wounds will be left in our polity from high coal and gas – and therefore electricity - prices bringing record profits for companies, and substantially lower living standards to most Australians,” he warns.

And “we have to stop kidding ourselves about the budget”. We need unquestionably strong public finances to have low cost of capital, private and public, for our transformation from fossil-fuel loser to Superpower exporter of clean energy and minerals, and to shield us from a disturbed international economy and geo-polity.

We’ve emerged from the pandemic with eye-watering public debt and large budget deficits, when high commodity prices should be driving budget surpluses.

“We talk about [the need for] much higher defence expenditure, but not about higher taxes to pay for it.

“We say we are underproviding for care and underpaying nurses, and underproviding for education and failing to adequately reward our teachers.”

The latest Intergenerational Report tells us that the ratio of over-65s to people of working age will rise by half over the next four decades, bringing higher costs and fewer workers to carry them, he says.

But, “in the face of these immense budget challenges, total federal and state taxation revenue as a share of gross domestic product is 5.7 percentage points lower than the developed-country average”.

Get it? Yet another economics professor telling us taxes must go up – not down.

The budget update issued at the start of this year’s election campaign predicted real wages would decline by 3 per cent over the two years to next June. Treasurer Jim Chalmers’ update three months later increased the decline to 7 per cent.

So, says Garnaut, “the facts have changed, and we should be ready to change our minds”. When we stop kidding ourselves, we’ll recognise the need for policies we now think impossible. That’s Garnaut’s second, more inspiring point.

“Australians accepted change that had been impossible on two earlier occasions when we faced deep problems, and responded with policy reforms that set us up for long periods of prosperity, national confidence and achievement.”

The most recent was the reform era starting in 1983. The first was postwar reconstruction of the economy in the 1940s, which was followed by a quarter of a century of full employment and rising incomes.

Back then, the Curtin and Chifley governments were determined Australians would not return to the high unemployment and economic insecurity of the interwar years.

“The 1945 white paper on full employment was premised on the radical idea that governments should accept responsibility for stimulating spending on goods and services to the extent necessary to sustain full employment ...

“This would achieve the highest possible standards of living for ordinary Australians.”

The Menzies Liberal government’s political success – it stayed in power for 23 years – “was built on full employment, helped by Menzies insulating policy from the influence of political donations to an extent that is shocking today”.

Garnaut says he grew up in a Menzies world of full employment. (So did I, as it happens.)

The authors of the white paper wondered how low the rate of unemployment could fall before it caused high or accelerating inflation. They were surprised to find it fell to below 2 per cent, and stayed there for two decades without a problem.

It’s tempting to think that, with all the problems of controlling inflation and decarbonising the economy, this brush with our glorious past will soon disappear, and we’ll be back to the 5 to 6 per cent unemployment we’ve learnt to think is the best we can do.

But Garnaut’s inspiring vision is that, with the right, seemingly impossible policy changes, we can complete the return to a fully employed economy and stay there, reaping its many material and social benefits.

In the world he and I grew up in, “workers could leave jobs that didn’t suit them and quickly find others – often moving from lower- to higher-productivity firms. Employers put large efforts into training and retraining workers.

“Labour income was secure and could support a loan to buy a house. Businesses that could not afford rising wages closed and released their workers into more productive employment.”

Steadily rising real wages encouraged firms to economise in their use of labour, which lifted productivity.

Sounds worth striving for, to me.

Read more >>

Welcome to the job, Treasurer. Rather you than me

Very occasionally, some poor misguided letter-writer suggests to my boss that I’d make a better treasurer than the incumbent. I’m flattered, of course, but it’s never been a job I’ve lusted after. Nor do I delude myself I’d be much good at it. And that goes double for the present incumbent, Jim Chalmers.

I wouldn’t want to be in his shoes (especially not with people like that grumpy old bugger Gittins offering a critique of my every move).

When, within days of taking up the job, Chalmers declared the budget situation was “dire”, people thought he was just softening us up. But I suspect it had finally dawned on him (with a little help from his new treasury advisers) just what an unhygienic sandwich he’d promised to eat: the more so because he’d played his own part in making such a meal of it.

Chalmers’ problem comes in two parts. First, he inherited an almighty mess from Scott Morrison and Josh Frydenberg. They hadn’t exactly tidied the place up before leaving.

Justifiably, they’d racked up huge additional government debt to tide us through the worst of the pandemic, and now the economy was growing strongly. But they were still looking at a decade or more of budget deficits continuing to increase the debt.

It was a problem they’d think about when and if they were re-elected. Meanwhile, nothing mattered more that avoiding doing anything that could cost them votes.

All this we knew before the election. What was less obvious were the many stopgap measures they’d used to hold back the growth in government spending, building up a dam that would inevitably burst.

The stopgaps included making oldies wait many months for a homecare package, making people wait months for a visa, keeping the unemployed below the poverty line and thinking of excuses to suspend their payments.

And that’s before you get to the various, hugely expensive problems with the National Disability Insurance Scheme – problems that can’t be solved by telling the disabled to like it or lump it.

The Morrison government’s projections of continuing budget deficits assume those dams will never overflow. Much of the deficit is explained by the continuing cost of the Morrison government’s already legislated stage-three tax cut in July 2024, which the Parliamentary Budget Office now estimates will have added almost a quarter of a trillion dollars to our deficit and debt by 2032-33.

The second element of Chalmers’ budget problem is that, as part of its small-target strategy for finally winning an election, Labor promised never to do anything anyone anywhere would ever dislike.

When it came to the budget, while banging on about our trillion-dollar debt, they painted themselves into a corner by promising not to do what they’d need to do to stop adding to it. Not to rescind the stage-three tax cut, nor do anything else to increase taxes apart from a tax on multinational companies. (Talk about pie in the sky: make the wicked foreigners pay their fair whack and all our problems are solved without any pain.)

In theory, eliminating the budget deficit is easy. Just slash government spending to fit. All you’d have to do is, say, suspend indexation of the age pension, or cut grants to the states’ public hospitals and schools (while taking care not to touch private hospitals and schools).

In practice, making cuts sufficient to fill the gap is politically impossible. It’s true the government is busy reviewing all their predecessor’s spending, looking for waste and extravagance. But all that’s likely to achieve is to make room for their own new spending promises.

As several former top econocrats have told me, what’s needed to eliminate the deficit is to increase tax collections by about 4 per cent of gross domestic product – about $90 billion a year. See what I mean about Labor boxing itself in?

One thing that wasn’t clear before the election was the full extent of our problem with inflation, even though the Reserve Bank did increase interest rates a fraction during the campaign.

It’s made the need to reduce the budget deficit more pressing because the more the government reduces its own stimulus of the economy, the less the Reserve has to increase interest rates to get inflation down.

And the less rates rise, the less the risk that – as has happened so often in the past – the Reserve’s efforts to reduce inflation send us into recession. One of the side-effects of recession would be to increase deficit and debt greatly.

After his “dire” remark, I expected to see Chalmers edging quietly towards a door marked Sorry About That, and preparing a Keynes-like speech about how “when the facts change, I change my promises”.

But so far, he seems still to be painting himself into the corner. Apparently, keeping promises, no matter how ill-judged and overtaken by events, is more important to Labor than managing the economy well or even avoiding becoming a one-term government.

I’d never seen Chalmers and his boss as martyrs to the cause of Unbroken Promises.

Read more >>

What we weren't told before the election: taxes to rise, not fall

The rule for Treasury bosses is that, as public servants, any frank and fearless advice they have about the state of the federal budget must be given only to their political masters, and only in private.

But last week the present secretary to the Treasury, Dr Steven Kennedy, used a speech to economists to deliver a particularly frank assessment of the Labor government’s budgetary inheritance.

We can be sure his remarks came as no surprise to his boss, Dr Jim Chalmers, who would have been happy to have his help to disabuse us of any delusions lingering from an election campaign which, as always, was fought in a confected fantasy-land of increased spending on bigger and better government services and lower taxes.

Surprise, surprise, the post-election truth is very different. The budget released just before the campaign began foresaw a budget deficit of a huge $80 billion in the financial year just ending, with only a trivial decline in the coming year and continuing deficits for at least another decade.

Neither side admitted to any problem with this prospect during the campaign, but Kennedy’s first bit of frankness about such a leisurely approach was to observe that “a more prudent course” would be for the budget deficit to be eliminated and turned to a surplus. (By the standards of bureaucratic reticence, this was like saying, “You guys have got to be joking”.)

Eliminating the deficit would mean adding no more to our trillion-dollar debt. Running budget surpluses would actually reduce the debt, thus leaving us less exposed should there be a threatening turn in the economy’s fortunes.

The two obvious ways of improving the budget balance are to cut government spending or to increase taxes. Some people love making speeches about the need to absolutely slash government spending, but they usually mean spending that benefits other people, not themselves.

The sad truth is that “waste and extravagance” is in the eye of the beholder. There’s always some powerful interest group on the receiving end of government spending – medical specialists, say, or the nation’s chemists – and they don’t take kindly to any attempt to slash their incomes.

The last time a serious attempt was made to cut government spending – by Tony Abbott in his first budget, in 2014 – the public outcry was so great that the Coalition beat a hasty retreat, and never tried it again.

Instead, it limited its parsimony to quietly restraining money going to the politically weak – the jobless, the public service, overseas aid – but this didn’t make a huge difference to the more than $600 billion the government spends each year.

Kennedy’s next frank observation was that, even excluding the many billions in spending related to temporarily supporting the economy during the lockdowns, government spending as a proportion of the nation’s income is expected to average 26.4 per cent over the coming decade, compared with 24.8 per cent in the decades before the pandemic.

In other words, government spending is likely to grow much faster than the economy grows, to the tune of about $36 billion a year in today’s dollars.

The new government is undertaking a line-by-line audit of all the Coalition’s “rorts, waste and mismanagement”. But, to be realistic, it’s unlikely to find much more in savings than it needs to cover its own new spending promises.

Kennedy said that most of this additional spending is driven by money going to the National Disability Insurance Scheme (by far the biggest), aged care, defence, health and infrastructure. “Further pressures exist in all these areas,” he said.

To that you can add underfunding by the Coalition in tertiary education and healthcare, plus a massive capability gap over the next 20 years or more which can only be fixed by an immediate increase in spending on defence, diplomacy and foreign aid.

Which leaves us with taxes. Higher taxes. Scott Morrison’s promise to guarantee the delivery of essential services while reducing taxes was delusional – a delusion many of us were happy to swallow.

The simple, obvious truth is that if we want more services without loss of quality, we’ll have to pay higher taxes.

Kennedy warned that the expected (but, in his view, inadequate) improvement in the budget balance over the coming decade will rely largely on higher income tax collections. “Inflation and real wages growth will result in higher average personal tax rates.”

This is a Treasury secretary’s way of saying “the plan is to let bracket creep rip”. And unless other taxes are increased, there’s “little prospect” of giving wage earners any relief via tax cuts.

“This would see average personal tax rates increase towards record levels,” he said, meaning more of the total tax burden would fall on wage earners.

The election saw both sides promising not to introduce new taxes or increase the rates of existing taxes (apart from, in Labor’s case, promising to extract more tax from multinationals).

But neither side made any promise not to let inflation push people into higher tax brackets. One way or another, we’ll be paying higher taxes.

Read more >>

Treasury boss’s message: higher taxes the cure for debt and deficit

Anthony Albanese and his Treasurer, Dr Jim Chalmers, have inherited many problems that won’t be solved quickly or easily. Nor will they be solved without the new government being willing to persuade voters to accept the sort of tax changes no pollie wants to talk about in an election campaign.

That’s the conclusion I draw from Treasury secretary Dr Steven Kennedy’s belated annual speech to the Australian Business Economists this week.

Election campaigns are times when we hear about all the wonderful things the politicians want to do to improve the public services we get and reduce the taxes we pay. It’s after the election that pollies present the bill.

Especially when the election has changed the government. This wasn’t Chalmers bringing us the bill, it was the waiter reminding us we’d eaten quite a lot and the bill was getting pretty long.

The economic story had “shifted significantly”, Kennedy said. Inflation pressures had emerged faster and more strongly than most people expected. These were likely to persist into next year “at the very least”.

This, of course, is why the Reserve Bank has been raising the official interest rate – to eventually bring inflation back to acceptable levels.

“Interest rates are at near-record low levels and therefore highly accommodative and should normalise”, Kennedy said. In other words, they need to be increased until they’re back to more-normal levels. If so, they have a lot further to go.

But, Kennedy says that “just as fiscal [budgetary] and monetary [interest-rate] policy worked together to respond to the pandemic, they will need to work together in managing the risks to inflation and the economy more broadly”.

Ah yes, the dreaded duo, Debt and Deficit. Not a subject to be dwelt on during election campaigns, but one to return to afterwards. Presenting the bill, remember?

Chalmers is, understandably, anxious to remind us that our trillion-dollar public debt is inherited from his predecessors. What Kennedy does is implicitly confirm that the previous government’s “medium-term fiscal strategy” - to “focus on growing the economy in order to stabilise and reduce debt” - is still the go.

With an important, after-the-election qualification: “a more prudent course would be for the budget to assist more over time”.

How? We’ll get to that. But first, he gave the best explanation I’ve seen of how a government can get on top of a big debt simply by ensuring the economy grows at a faster annual rate than the rate of interest on the debt.

To “get” the explanation you have to accept one proposition that many otherwise sensible people and media commentators can’t get their head around: that the government of a nation is in a radically different position to an individual household.

Households have to repay any money they borrow sooner or later, but governments don’t. That’s because every family gets old and dies, whereas nations are a collection of many millions of households that, though the faces change, goes on forever.

For a nation, what matters is not its ability to repay the debt, but just its ability to afford the interest payments on it. As long as the nation continues to exist, it can re-borrow by issuing a new government bond to replace an old government bond as it falls due for repayment.

Kennedy explained that strong economic growth and interest rates that are low compared with what’s been normal for the past 50 years are likely to ease the burden of the debt. This is by reducing its size not in dollar terms, but relative to the size of the economy, measured by the dollar value of all the goods and services the economy produces annually (nominal gross domestic product) in coming years.

Interest payments add to the amount of debt the nation owes, but growth in the economy (nominal GDP) increases the economy’s capacity to “service” (pay the interest on) that debt. “When the economy grows quicker than the interest payments add to the debt, the debt burden will decrease,” he said.

That’s the basic mechanism all governments in all the rich countries have relied on since World War II to get on top of their debt. It’s what the Morrison government was relying on, and it will be what the Albanese government continues relying on.

But – with Treasury there has to be a but – there was a weakness in the previous government’s strategy: their projections showed the budget remaining in deficit for the next decade and, indeed, the next 40 years.

That means it wasn’t just the interest bill that was adding to the debt each year, it was also the continuing deficits.

“The current projected reduction in the debt [relative] to GDP is unusual in that it is relying solely on favourable growth and interest-rate dynamics [that the average rate of interest on the debt will rise more slowly than the rising rate of interest on the new borrowing because the average government bond takes about seven years to fall due] to reduce the ratio [of debt to GDP],” Kennedy said.

So here’s the post-election But (which, since it’s the same Treasury, would probably have happened even without a change of government): “A more prudent course would be for the budget to assist more, over time,” Kennedy said.

How? By getting the budget deficit down a lot faster than the Liberals were planning to. Maybe even by running budget surpluses for a while – which would involve repaying a bit of the debt.

Sure, but how do you get the deficit down? The government will be reviewing all the spending programs left by the Coalition, looking for savings. But what savings it finds will mainly be used to pay for Labor’s promised new spending.

So the main way to improve the budget balance will be by “raising additional tax revenues”. Kennedy implied that this would be done by reducing businesses’ and households’ tax concessions.

The next three years will be interesting.

Read more >>