Opinion & Commentary
Trimming to fit budget's reduced revenue
The government has once again flagged the need for a tough federal budget. But the stated rationale for expenditure restraint has little to do with a thorough evaluation of the government's spending priorities. Instead, we are told restraint is needed because of a forecast reduction in revenues and a budget surplus timetable that is driven more by politics than economics.
The expenditure review process leading up to the annual budget is rarely about making cuts to existing spending programs. It has more to do with trimming ministers' wish lists to fit the revenue forecast and window-dressing the underlying cash balance for presentation on budget night.
Governments have increasingly announced big tax and expenditure policy decisions outside the annual budget so they can fit in with the political demands of the election cycle.
The May budget has become not much more than a housekeeping document tacked on to the appropriation bills. The political process then wastes enormous energy debating the economic and other assumptions underpinning the forecast budget bottom line at the expense of the substance of the tax and expenditure programs that go into it.
The economic and fiscal forecasts in the budget are good only until the next big policy announcement or change in economic parameters. They are at best a snapshot of the government's fiscal position and should be discounted as such.
The macroeconomic significance of the budget can be measured by the expected change in the budget balance as a share of the economy. With the exception of the massive fiscal stimulus measures put in place in 2008 and 2009, the change in the budget bottom line is typically too small to have significant macroeconomic implications.
Moreover, the actual change in the budget balance is often very different from the forecast change. While the Howard government was criticised for some big spending budgets, actual budget outcomes were often significantly tighter than forecast outcomes.
The actual budget outcome, when it is finally released, is usually little reported. If the forecast for the budget balance is so important, surely the budget outcome warrants just as much attention?
A good indicator of the macroeconomic importance of the budget is the reaction of financial markets on budget night. More often than not, the market reaction is minimal, highlighting the irrelevance of the change in the budget balance to economic growth and macro variables such as interest rates.
The real economic significance of the budget is its microeconomic implications: how tax and expenditure policies influence incentives to work, save and invest. Tax and spending policies should be evaluated based on the incentives they create, for better or worse.
The implications for the budget bottom line are a secondary consideration. Overall spending and revenue must satisfy the constraint of balancing the budget over time, but governments are typically not very good at estimating the fiscal effect of their policy measures. These estimates often rest on necessarily arbitrary assumptions and fail to take account of likely behavioural responses because they are too hard to model.
Tax reforms are usually held hostage to a revenue-neutrality requirement. The result is worthwhile tax reforms are deemed too expensive to implement, but the assumed cost to the budget often underestimates the likely dynamic benefits to the economy and thus overall revenue. Governments rarely give consideration to financing tax reform out of expenditure reductions, which is the only way the overall tax burden can be reduced.
The political debate over policy costings invariably focuses on allegations of budget black holes at the expense of the substance of the policy.
For example, the government expended considerable political capital on its flood levy, even though it makes little economic difference whether flood reconstruction is funded out of present or future taxes.
The more important issue was whether the government was making sound spending decisions on flood reconstruction and how overall government spending should be re-prioritised given the fiscal implications of the disaster.
The government also chose to cut a number of spending programs to help improve the budget bottom line, yet it is remarkable that it took a natural disaster and a threatened deterioration in the budget balance to get the government to review programs such as cash for clunkers that should never have been implemented on microeconomic grounds.
The budget is driven by a top-down process of fitting spending to available revenue and politically determined budget targets rather than a proper evaluation of individual program costs and benefits.
Stephen Kirchner is a research fellow at the Centre for Independent Studies and senior lecturer in economics at the University of Technology, Sydney, Business School.
