Opinion & Commentary
Australia’s long-term fiscal future
Everyone knows that we had budget surpluses and little or no public debt before the crisis. This made the economy more resilient against global shocks. Less well understood is the advantage of having a smaller government sector than most other developed countries. At around 36 per cent of gross domestic product (GDP), the general government sector (including all levels of government) can hardly be described as “small” in any absolute sense, but we have managed to avoid expanding it to the magnitudes of 45 per cent or 50 per cent associated with euro-sclerosis and now the euro-crisis.
Those who want more government spending see Australia’s ranking in international comparisons not as a strength but as an opportunity to load up the public sector with costly new programs. If our governments follow this route, there will be much higher levels of public debt and/or much higher taxation somewhere in our future. The recent flurry of new spending initiatives by the federal government should be seen in this light.
The Intergenerational Reports (long-term fiscal outlook statements), which were first commissioned by the Howard government, have repeatedly revealed that Australia has a long-term fiscal problem stemming from population ageing and other societal trends. The last Commonwealth IGR (in 2010) projected an increase in the share of Commonwealth spending in GDP by 4.7 percentage points over 40 years and quantified the excess of spending over revenue in 2050 at 2.8 per cent of GDP, excluding interest expense.
The Commonwealth projections alone would be enough to lift Australia’s government sector to 40 per cent of GDP. In addition, the NSW government has made similar projections for the state budget and quantified its long-term fiscal gap at 1.8 per cent of gross state product.
The task presented to governments by these IGRs was to chip away at the long-term fiscal gaps through structural reforms to lower the future growth path of government spending. The phased increase in the eligibility age for the age pension to 67 is one example of what needs to be done. There is still time for governments to take more measures of that kind because the effects of ageing don’t start to bite until some way into the next decade. There is a window of opportunity to chip away at the problem.
Instead, government decisions are adding to the long-term fiscal gap. The IGR was prepared on the basis of then-existing policies. Policy changes since the IGR baseline was set in early 2010 (such as the national disability scheme and education funding), together with other pressures that the government may yet cave in to (such as a big increase in the Newstart allowance) could easily add almost $30 billion a year to the government expenditure baseline by 2020. There have been some offsetting measures, but most of them have been in the form of revenue increases or expenditure deferrals, not permanent cuts to spending programs. And notwithstanding the revenue increases, there are also long-term risks to revenue. The IGR assumes that Commonwealth tax revenue will be 23.5 per cent of GDP, but it is currently around 22 per cent.
The solutions may be politically difficult, but they are not rocket science. If large discretionary tax increases are to be avoided, governments will need to refrain from making so many new spending commitments that then are locked in to the spending base. The community also needs to refrain from demanding them. Alternatively, governments have to become much better at finding offsetting savings in the existing spending base. And at the same time, they have to keep chipping away at the long-term fiscal gap.
A failure to rise to these challenges would have profound implications for Australia’s economic future and put the economy at risk of euro-sclerosis in the long term.
Robert Carling is a Senior Fellow at The Centre for Independent Studies and author of Future Fiscal Shock.
