Don’t-worry budget plan is built on bracket creep

I hope events prove me wrong, but I have a feeling that, whatever its other virtues, the Turnbull government won't be the one to get the budget back to surplus.

And that does matter. One of the reasons we escaped the Great Recession was that, unlike other countries, we went into it with little public debt. This allowed us to stimulate private sector activity and restore confidence with vigour and without hesitation.

It's looking likely we won't be so well placed next time. We used to have exemplary fiscal discipline – an example to the world – but now that distinction is slipping from our grasp.

It's become a twice yearly ritual for the treasurer to produce 10-year budget projections invariably showing the budget balance heading steadily back to ever-rising surplus.

The first such exercise, produced by Wayne Swan in his last budget in 2013, showed us returning to surplus by this financial year, 2015-16. Just a few months later, Labor's last statement pushed it back to 2016-17.

Joe Hockey's first budget pushed the date back to 2018-19 and his second to 2019-20. Now Scott Morrison's mid-year update has shifted the return to surplus back to 2020-21.

This ought to be enough to convince you these ever-confident predictions are not to be trusted. They're mere projections, based on assumptions that soon prove overly optimistic.

Any treasurer who endlessly repeats the ideologically blinkered but patently absurd line that the budget doesn't have a revenue problem, it has a spending problem, can have no credibility as a budget repairer.

The 2014 budget was the ultimate demonstration that, while repairing the budget almost solely on the spending side may be theoretically possible, it's not practically possible. Such plans can't be made to stick because they're too unpopular and too aimed at requiring the least able to bear the heaviest burden.

It seems Morrison's stopped repeating this mantra, but his replacement rhetoric is no better: "Our plan is straightforward – responsibly restrain expenditure while supporting economic growth to lift revenues."

Translation: we're prepared to do no more than match our inevitable new spending programs with offsetting savings – as we did last week – while we wait for the economy to return to trend growth and so allow the budget to fix itself.

This tells you Malcolm Turnbull isn't willing to increase taxes overtly but, by the same token, isn't willing to make major cuts in government spending that might cost him votes when he gets his ascension endorsed by the electorate next year.

If Turnbull goes to the election without mentioning a plan for slashing spending in his next term, what are the chances he'll do it anyway? Not great.

It's possible Morrison has stopped claiming the budget doesn't have a revenue problem because the plan is to cut back superannuation tax concessions as part of the tax reform package.

It's also possible the tax package will involve net savings to the budget, if not immediately then a few years down the track as the revenue saving measures grow faster than the cost of the tax cuts.

It's possible, but I won't be holding my breath. It's more likely the political frictions in the tax package will require it to be "budget negative", so that – whatever the happy claims about it encouraging people to "work, save and invest" – it sets back the budget's return to surplus.

Last week's mid-year update reveals Morrison to be presiding over a structural budget deficit equivalent to about 2 per cent of gross domestic product, even while he peddles the line that economic growth will get us back to surplus.

Don't believe it. By definition, the structural deficit is the deficit you still have after the economy has returned to trend growth. Only if the economy were to be in an inflationary boom might the cyclical surplus be big enough to hide the underlying structural deficit.

No, only explicit decisions to cut spending or increase taxes will reduce the structural deficit – with one key exception: bracket creep. Not deciding to index the income tax scales for inflation does help reduce the structural deficit.

Buried deep in the update's fine print (bottom of page 19) you find a sentence which, after you've reread it a few times, tells you that to help achieve the appearance of an ever-improving budget balance, the government has quietly pushed the assumed tax-to-GDP cap of 23.9 per cent out by another year to 2021-22.

Translation: Morrison latest "don't worry, we'll get back to surplus eventually" projection is built on the assumption of another six years of bracket creep. But would this government ever increase taxes? Never.

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Banning new coal mines would leave us better off

With the success of the Paris agreement on climate change, it's clear Australia will have to lift its game if we're not to be seen as global bludgers. But with an early return to carbon pricing an embarrassment for the Coalition, what other approaches should we consider?

Take the campaign for a global moratorium on the construction of new coal mines. Is it just a misguided idea dreamt up by idealistic greenies who don't understand economics?

Jon Stanford, of Insight Economics, thinks so. He's a former senior econocrat and an avowed supporter of action to reduce carbon emissions. But in a long post on John Menadue's blog, Pearls and Irritations, he argues strongly against a moratorium.

He readily acknowledges that substantial "social costs" or "negative externalities" – such as the emission of climate-changing greenhouse gases – are imposed on the community by the use of coal.

"There is little doubt that the combustion of coal to produce electricity has made the greatest contribution to increasing carbon concentrations in the atmosphere," he says.

But the most economically efficient way to deal with climate change is to tax all carbon emissions by means of a carbon tax or an equivalent emissions trading scheme.

"Banning new coal mines would reflect an arbitrary approach to reducing emissions. On what basis should various fuels be permitted or banned? Why is coal to be singled out but other fuel with significant emissions such as oil and gas are not?"

So his first objection to a moratorium is that it seeks to reduce climate change in a way that doesn't minimise the resulting loss of efficiency in the allocation of resources.

His second objection is more practical: it wouldn't work, anyway. He says that, according to the International Energy Agency's latest World Energy Outlook, global demand for electricity will increase by 70 per cent between 2013 and 2040.

The agency's middle projection, based on the commitments to counter climate change that countries took to the Paris conference, sees coal's share of global power generation still at 30 per cent in 2040 (compared with 41 per cent in 2013), meaning growth of nearly 25 per cent in absolute terms.

Stanford says that "while the Australian coal industry is a very efficient producer it does not dominate the global market and could not be said to possess any significant market power".

Australia's coal reserves amount to less than 9 per cent of global reserves. As a producer of steaming (thermal) coal, we rank a distant sixth behind China, the US, India, Indonesia and South Africa, not far ahead of Russia and Kazakhstan.

These other countries are unlikely to agree to a global moratorium on new mines so, were Australia to impose a moratorium on itself, the investment in new mines displaced from Australia would merely take place in other countries. Malcolm Turnbull has used the same argument.

Sorry, but I'm not convinced. It's true that a global carbon price would be a more economically efficient solution than an arbitrary moratorium on new coal mines.

But with the problem worsening as each year passes, we don't have the luxury of waiting until a "first-best" solution can be agreed upon. In an emergency, second-best solutions are better than inaction.

As for the practicalities of a unilateral Australian moratorium, the facts are more complex than Stanford implies. The International Energy Agency's figure of a 70 per cent increase in global demand for electricity is an assumption, not an estimate.

All 25-year projections are just projections, and likely to be wrong, often because they're overtaken by events. The agency's projections don't take sufficient account of the fall in China's coal consumption over the past 18 months.

Projections that don't allow for further technological advances and price falls in renewables and energy storage, nor for countries to step up their efforts to reduce warming, over the next 25 years, are particularly unreliable.

Stanford's figures for global coal reserves and even global coal production aren't relevant. That's because not all coal is the same. Some is high quality – in terms of its ability to generate more electricity – some is low. Some can be extracted quite cheaply, some would be very expensive.

Coal is a low value commodity that's expensive to transport over long distances. This means a high proportion of coal deposits and domestic coal production is irrelevant in assessing Australia's market power and the likely effects of a unilateral moratorium.

What determines the world price is seaborne exports of thermal coal. A Reserve Bank analysis shows Indonesia's low-quality coal has 41 per cent of world exports, while we come second with 18 per cent.

Australia is a high quality, low-cost producer, which makes us a more powerful market player than the raw figures suggest.

World prices of steaming coal have fallen a long way since their peak in 2011, in response to a huge increase in supply (mainly by Indonesia and Australia) and flat world demand.

If our 52 proposals to build new coal mines or expand existing ones went ahead, this would eventually double our exports. Do you really think that would have no effect on the world price?

If it caused the world price to be lower than otherwise, this would hurt our existing coal mines, their lenders and their employees. It would also hurt existing and prospective renewable energy projects.

And it would cause the price to be even less reflective of the high social costs caused by carbon emissions, the adverse effect on miners' health and air pollution around coal-fired power stations (the latter a big part of China's reasons for turning against coal).

With the world coal price relatively low, it's not at all clear other, higher-cost producers would happily step in to take our place. If they could, why aren't they doing it already?

The future for coal is a lot more uncertain and less rosy than Stanford implies.

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