Opinion & Commentary
Hey, big spender, stop simulating
The 2009 budget forecasts the biggest expansion in federal government spending since Gough Whitlam. While the budget deficit is being sold as a necessary response to the worst global economic downturn since the Great Depression, government spending will hinder economic growth long after Australia’s recession is over.
The government has made much of the reduction in revenue flowing from the global economic downturn and the resulting domestic recession. But this is only one side of the budget deficit equation. The unprecedented deterioration in the budget balance is also driven by the biggest increase in government spending in a generation.
The federal government spending share of GDP will increase by 2.6 percentage points this financial year, with a further increase of 2 percentage points forecast next financial year, the biggest increases since the early 1970s. Government spending will reach 28.6% of GDP in 2009–10, a figure unprecedented in peace-time.
It is appropriate that the government should allow the automatic stabilisers to work in response to an economic downturn. However, the deterioration in the budget balance has been made worse by discretionary fiscal stimulus packages of doubtful effectiveness.
There is little reason to believe that these discretionary policy decisions have been effective in supporting economic growth. Even Treasury concedes that ‘it is not possible to measure precisely the actual impact of the Economic Security Strategy.’
It should be recalled that Australia has also seen an unprecedented easing in monetary policy, which has made a much more timely and significant contribution to supporting economic growth than the stimulus packages.
Monetary policy can be tightened again when recovery begins, but the legacy of the government’s fiscal stimulus packages will be with us for much longer.
While the government talks-up the short-term stimulus effects of government spending, it neglects to mention the crowding-out of private investment by government borrowing that will occur long after the recession is over.
In the United States, the Congressional Budget Office has recognised that these crowding-out effects will see fiscal stimulus measures subtract from economic growth in the long-run.
Most of the impact of the government’s infrastructure spending will not be seen until the recovery is well underway. Even then, the economic benefits of some of these projects may turn out to be less than the opportunity cost of the resources they consume, leaving Australians worse-off.
The danger is that the government’s fiscal stimulus measures simply divert resources from one sector of the economy to another, rather than bringing unemployed labour and capital back into employment.
The government says it will keep real growth in government spending capped at 2% per annum in future years, but no government in recent history has shown this degree of expenditure restraint. Real growth in government spending averaged 4% between 1971–72 and 2007–08, which excludes the government’s recent stimulus packages.
Government spending has increased 13.5% this financial year, an increase unprecedented since the Whitlam era, and will increase by a further 3.9% in 2009–10.
There is a large body of literature demonstrating that the size of government matters for long-run economic growth. Economist Gerald Scully estimated the optimal tax share of GDP for all levels of government in the United States at 23%.
Above that level, the size of government begins to subtract from, rather than contribute to, economic growth. The welfare costs of big government are enormous. Scully estimated that the US has lost $4 of national income for every $1 in tax beyond the optimal level of taxation.
The Australian economy is structurally similar to the US, so it would seem unlikely that our optimal tax share is significantly larger than in the United States. The tax share of GDP for all levels of government in Australia is already 30.8% of GDP.
The government is forecasting a return to surplus over the medium-term, but these forecasts are well and truly overshadowed by the elephant in the room – the massive long-term fiscal deficits projected in the previous government’s 2007 Intergenerational Report (IGR).
That Report projected net debt to rise to 30% of GDP by 2046–47, with further increases expected beyond the Treasury’s 40 year projection period. Treasury indicated that the expected path for net debt was unsustainable in the absence of major policy changes
The government spending share of GDP was expected to rise by 4.75% over the same period.
The next IGR prepared by the Rudd government will proceed from a worse starting point. Although this will be offset to some extent by saving measures announced in the budget, it is likely the IGR will once gain show that the federal government’s finances are not on a sustainable long-term footing in the absence of major policy changes.
The projected fiscal gap and the associated growth in government spending points to unsustainable growth in Commonwealth debt. This situation can only be resolved through some combination of higher taxes or reduced spending.
Most Australians would not want to go down the higher tax route. Yet neither side of politics has shown much appetite for the required expenditure reforms. The unsettling conclusion is that Australia is on the path to a permanent expansion in the size of government that will lower living standards for future generations.
Dr Stephen Kirchner is a Research Fellow at The Centre for Independent Studies.
