The federal government’s taxing and spending powers have far-reaching consequences for our economic prosperity.

While the constitution and the Charter of Budget Honesty impose some requirements on the government in the exercise of these powers much is left to the discretion of politicians.

Unfortunately, this discretion has not always been used wisely. There is widespread dissatisfaction with the way both sides of politics have used fiscal policy for narrow political purposes, at the expense of the general welfare.

These problems have come into stark relief in the wake of the global financial crisis, with a cyclical deterioration in the budget balance being exacerbated by discretionary fiscal stimulus measures of questionable effectiveness that will harm Australia’s economic performance in the longer term.

Australia needs new legislation to force politicians to be fiscally responsible. The Howard government’s 1998 Charter of Budget Honesty has proven inadequate to the task. The Rudd government highlighted the need for legislative reform with its proposed overhaul of budget transparency, Operation Sunlight. As Senator Andrew Murray noted in his review of Operation Sunlight, ‘budget transparency and financial accountability reforms need to be entrenched through permanent change, and new statute where necessary’. The Rudd government has undertaken to strengthen the CBH, but it has made only minor progress in enhancing the transparency of the federal budget process. In the run-up to the 2009 federal budget, the government made a conditional commitment to hold real growth in commonwealth spending at no more than 2percent per year, but there are no mechanisms to enforce this discretionary undertaking.

At the same time, Opposition Leader Malcolm Turnbull proposed the establishment of a parliamentary budget office, modelled on the US Congressional Budget Office, and a commission for sustainable futures ‘to determine what levels of expenditure are sustainable and consistent with the need to address intergenerational equity’.

There is thus bipartisan consensus on the need to reform Australia’s fiscal framework. What we propose is a new fiscal responsibility act to replace the Howard government’s flawed CBH. The aim would be to provide a de-politicised framework for fiscal policy. Budget balance, the level of commonwealth net debt and the revenue and expenditure shares of GDP would be subject to legislated and enforceable rules to ensure the long-term fiscal sustainability and to restrain growth in the size of government. Governments would then be free to make tax and spending decisions within this overall rules-based framework.

Fiscal policy rules would give greater credibility to fiscal policy, thus lowering the cost of government borrowing in capital markets and freeing up resources that might otherwise be consumed by higher risk premiums in interest rates.

Fiscal policy rules would also reinforce the credibility of the Reserve Bank’s monetary policy and inflation target.

A new body, the fiscal commission, would enhance the independence, transparency and accountability of the federal budget process. It would enforce compliance with the fiscal policy rules and have the power to impose pecuniary penalties on members of federal parliament for non-compliance. It would prepare the parameters for regular fiscal policy statements according to a fixed timetable. Government decisions would need to comply with the fiscal policy rules.

The commission would cost government initiatives. This would act as an important discipline on the government, ensuring that proposals received independent scrutiny.

The commission would give the public and financial markets greater confidence in the key assumptions on which the annual budget and other fiscal policy statements are based.

It would also minimise pointless partisan conflict over budget parameters such as the economic forecasts, so that debate could focus on the substance of the government’s decisions.

Demographic trends render current policy settings unsustainable. This must be resolved through some combination of higher taxes and reduced government spending, but only the latter option is consistent with maximising long-run growth prospects.

A new fiscal policy framework will help politicians meet this challenge. Only by adopting a binding legislative framework for fiscal responsibility can Australia be sure of a prosperous future.

Robert Carling is a Senior Fellow at CIS. Dr Stephen Kirchner is a Research Fellow at CIS. Their paper Fiscal Rules for Limited Government: Reforming Australia’s Fiscal Responsibility Legislation was released by CIS in July.