Opinion & Commentary
The Budget needs discipline and fiscal sustainability to put ensure the economy recovers
As the Commonwealth budget plunges into deficit, it would be reassuring to know that those in charge have a medium-term plan in mind to restore fiscal balance and are not just throwing caution to the wind while hoping for the best. This comes down to having policies consistent with sustainable fiscal outcomes and the credibility to convince people that those policies will be adhered to. Both sustainability and credibility are critical to private sector confidence and are an essential part of the foundations for an eventual recovery.
While budget deficits around the world are still ballooning, there is increasing chatter about the limits to this process and the need for fiscal responsibility. Some of this is lip service, but there is also more concrete action such as the proposed constitutional amendment in Germany that would impose much tighter constraints on deficit spending than those contained in the euro area’s growth and stability pact. In time the IMF, the OECD and their member countries will be arguing, as they did in the 1990s, that fiscal consolidation (slashing deficits) can actually be expansionary.
In Australia there is at least a plan. In announcing the February stimulus package the government restated its commitment to a budget surplus, on average, over the business cycle. It also proposed to ‘bank’ all of the cyclical recovery in revenue, whenever that occurs, and to cap the annual real growth in spending at 2 percent. In the meantime, the discretionary stimulus spending is to be temporary.
It remains to be seen whether events turn out that way, but if the government’s policies are taken at face value there is at least the prospect of a return to budget balance before serious damage is done to Australia’s fiscal sustainability. The credibility of these policies is, however, being undermined by talk of another stimulus package and new policy intentions such as a huge increase in the age pension and the introduction of largely taxpayer-funded paid maternity leave that will represent a structural boost to the level of government spending. The government has a penchant for appointing commissions and inquiries that come up with these big new spending plans.
The Howard government’s fiscal strategy for many years centred on balancing the budget, on average, over the business cycle. Later on, this was changed to a surplus, on average, over the cycle and the Rudd government has adopted the same formulation. The practical difficulty with these rules was that for so long there was no business cycle to speak of and therefore no cyclical average budget outcome to observe. Up to 2007–08 the economy had been enjoying an exceptionally long expansion. That, of course, has now changed and there is some basis for assessing fiscal outcomes over the cycle.
With 2007-08 almost certainly marking the end of the expansion, eighteen years had passed since the same point in the last cycle. Over that period of deficits and surpluses, the cumulative underlying cash balance was a deficit of 5.5 percent of GDP, or an annual average of 0.3 percent. In other words, the underlying budget was not balanced on average over the cycle. The surpluses in the long run of good years were not sufficient to offset the deficits in the preceding downturn, although net debt was eliminated by the surpluses and privatization proceeds in combination.
The cyclical average can also be estimated from the low point of the last downturn to the low point of the present one. The latter, of course, is unknown, but if 2009–10 is assumed to be the peak deficit year and the deficit is assumed (generously) to be that estimated in the February stimulus announcement, then the underlying cash balance will be in deficit for a total of 3 percent of GDP over seventeen years, or an annual average of 0.2 percent of GDP. Again, on the stated assumptions, there will not quite be a balance on average over the cycle, let alone a surplus.
The purpose of this figuring is not to test political accountability, for both the current and the previous government can rightly say that their commitments to cycle-average outcomes were prospective. But the figuring does provide an historical benchmark for measuring the degree of fiscal discipline that will be needed in the future. The clear implication is that fiscal policy will need to be more disciplined, particularly if the long term funding gaps exposed by the previous government’s intergenerational reports are to be closed.
It will be a long time before the Rudd government’s fiscal policies can be assessed through the rear view mirror, but its current enthusiasm for fiscal stimulus packages and expensive new social policies do not make a good start.
Robert Carling is a senior fellow at The Centre for Independent Studies.
