Federal Budget Woes

With the leadership speculation swirling around in Canberra, the treasurer's performance has been called into question along with his prime minister. The 2014-15 budget was widely condemned as a shambles, and has become something of a lightning rod for criticism of the government. This kind of criticism overstates the importance of the budget, and confuses its purpose. As we've argued previously, the federal budget is really (or should be) just a bit of an accounting exercise. But, instead, over time, it has become the instrument through which successive governments have made major policy announcements and set out their vision for the years to come. The 2014-15 budget was no exception. As such, the budget itself should not be the target of the criticisms, the target should be the flawed, incoherent, jumble of policy directions that the current government sprung on Australia after the election, around the time of the 2014-15 budget.

Part of the government's problem is that it went into the 2013 federal election without a coherent policy platform. Its election pitch was a succinct statement about scrapping the carbon tax, stopping the boats and pay down debt. On top of that there were a few discrete proposals, like the paid parental leave scheme. On forming government, the Coalition has failed to deliver a narrative that explains the range of seemingly mean and unfair policy shifts that it has since taken. It failed to use its Commission of Audit to press home the importance of fiscal consolidation. And, on top of that, it failed to fiscally consolidate anyway, in spite of its pretensions to austerity.

In opposition, Mr Abbott and Mr Hockey spent so long talking abut Labor waste and debt and deficit, one can't help but wonder if they actually began to believe the entirely political nonsense they were spouting. In fact, the numbers show that the former Labor government was fiscally conservative, given the prevailing global economic conditions (and, as we've noted previously, Australia's revenue and expenditure are low by world standards). The budget issues, the debt and deficits that Mr Abbott and Mr Hockey were so fond of talking about, were due, largely, to declining government revenues. These are now the same problems that Mr Hockey is facing as treasurer.

Since taking the office, Mr Hockey has seen a massive write-down in government revenue, partly due to economic factors out of his control and partly due to policy decisions taken by the government. The 2014-15 budget, despite being sold and bought as a "tough" budget, actually saw a deteriorating fiscal position. The mid-year economic and fiscal outlook statement published this year showed further deterioration. (Note: see our previous post on the government's budget problems for more information about this chart).

Australian Government underlying cash balance

Despite some very optimistic estimates ad projections published in the 2014-15 budget and subesquent MYEFO (shown below), the Australian Government is, in fact, facing a massive problem with dwindling income. A low exchange rate, a declining terms of trade, collapsing commodity prices, weak domestic demand, rising unemployment - these and other factors are all playing their part. This year's budget could well show a fiscal position that is tens of billions of dollars worse than currently is assumed.

Australian Government revenue and expenditure

Australian Government revenue and expenditure as proportion of gross domestic product

Apart from problems on the revenue side, the treasurer has bigger problems on the expenditure side. While he is busy trying to find savings anywhere he can in the budget, his prime minister is talking like an old fashioned Keynesian, suggesting that the government should be looking to prop up demand in the economy rather than withdraw on spending. This is a reasonable suggestion to make, and his treasurer would be wise to listen, given the unemployment rate has now hit a 12 year high. Even at the height of the global financial crisis, unemployment did not reach that high in Australia.

Australian unemployment rate (%)

Rising unemployment, along with other indicators of a stagnating economy (everywhere but housing, it seems) have even caused the incredibly reluctant RBA to finally drop interest rates, for the first time since August 2013. In its rationale, and in subsequent remarks from governor Glenn Stevens, the RBA has made it very clear that there is only so much lifting that monetary policy can achieve at this point. The subtle message seems to be: some expansionary fiscal policy is needed. We made this point previously, showing the relationship between the unemployment rate and official interest rate, with some notes on government fiscal stimulus (chart here).

There are plenty of ways that the government could spend up big to boost the domestic economy. As many commentators have noted recently, three and ten year bond rates are currently so low that the government could borrow up big for infrastructure projects without incurring much interest at all. This would create jobs and provide vital infrastructure for future economic growth. It's a win-win. All it would take is some political humble pie from a government that has spent years talking about budget emergencies.

Meanwhile, on the revenue side of the budget, we've previously commented on ways that the government might improve its take. It could be achieved quite simply by looking at ineffective or unfair policies like negative gearing, superannuation tax concessions, the absence of a greenhouse gas emissions trading scheme, ineffective mining royalties. There is also a need to debate the possibility of expanding and increasing the GST. All these measures, if taken together, could returns tens of billions of dollars to the budget every year. And most of them wuold have a negligible negative impact on the economy. Taxing superannuation at an appropriate rate will not take money out of people's pockets. Abolishing negative gearing would see investment go into more productive sectors of the economy. Charging companies to pollute has not only the benefit of reducing greenhouse gas emissions, but places little burden on households.

In the wake of the recent near leadership spill, Mr Abbott's reflection on his and the government's problems is that it has tried to achieve too much reform in too little time. This is not the problem. The problem is that this government has pursued the wrong kinds of reform. It is time that Mr Abbott and Mr Hockey considered some meaningful budget reform, but, more importantly, faced up to the economic realities facing the nation and took appropriate action.