To understand the budget task facing Australia, look first at our history. The gap between what the government takes in each year and what it spends is our annual budget deficit. And over the 50 years to the start of 2020, we dropped deep into deficit on four separate occasions. Each time, the deficit ended up a bit deeper, and recovered a bit more slowly.In the fourth recovery, the deficit never quite disappeared. Instead, the pandemic that hit in March 2020 triggered a wave of government spending the likes of which Australia had never seen before. The 2020-21 federal budget deficit reached 6.6 per cent of gross domestic product (GDP).
That year, total debt – the accumulated annual deficits of past years – was unprecedented: around $729 billion. That number will keep growing for years, as the deficits mount up. For the first time in our history, we seem likely to spend an entire decade with debt above 40 per cent of GDP.
$729 BILLION AND RISING
And because the deficits mount up, they will become much more difficult to pay off. So organisations like the Parliamentary Budget Office see a future where that debt load persists even into the latter half of the 21st century.
All of that is very different from our previous debt and deficit experiences. Instead of being something that peaks and then falls, debt will now be something that hangs around.
On top of everything else it has done, it seems, COVID has reshaped our ideas of what makes a national budget problem. The economists who spoke to Public Accountant mostly say the same thing: it is not going to get us in trouble this year. It may never cause us real problems.
“Australia’s budgetary position isn’t one that requires urgent, immediate corrective action,” says well-known consulting economist Saul Eslake. “It isn’t as weak as that of countries like the US and the UK and a lot of other European countries … And although interest rates are rising quite sharply, they are still low by historical standards.”
But persistent debt does bring a new problem.
WE LIVE CLOSER TO THE EDGE
What economists are discussing is this: owing so much more debt, for so many more years, leaves us living closer to the edge economically speaking. As a nation, we now have less room to move if something goes unexpectedly wrong with the economy.
And most think something will go wrong again. As Treasury secretary Steven Kennedy observed in a June speech, economic downturns have tended to hit Australia roughly every 10 years. And the past 15 years have brought us the two worst economic emergencies since World War II. When a nation holds this much debt, it makes sense to think about how much insurance we need against the next bad patch.
DEBT “SHOULD BE USED RIGHT”
Economists are less certain than they used to be about government spending, taxing and deficits – collectively known as fiscal policy. Government borrowing and debt was seen to help nations recover from the global financial crisis. Real (after-inflation) interest rates fell, apparently permanently.
In the past few years, economists such as former International Monetary Fund chief economist Olivier Blanchard have suggested that with lower rates, government debt carries a lower economic price than many economists previously assumed. But that doesn’t make it an all-purpose fix. “Public debt is bad,” Mr Blanchard wrote soon after releasing his 2019 paper. “It is not catastrophic. It can be used but it should be used right.” Even that quote suggests Blanchard has very mixed feelings about continued high government debt.
WE NEED A SAFETY BUFFER
Many of Blanchard’s former colleagues at the IMF are putting more emphasis on risks from debt in an unpredictable world. IMF senior economists Marcos Chamon and Jonathan Ostry, for instance, argue that governments should stay well clear of debt’s outer limits “in a world where interest rates and growth are uncertain”.
Mr Eslake, who helped investigate Victorian government debt in the 1990s, cites another reason to push debt down. “If we want to be in a position to respond to it as forcefully as we did to the global financial crisis, or to COVID,” he says, “then the budget needs to be brought into better shape.”
Other Australian economists also argue for a buffer against certainty. Professor John Freebairn, holder of the University of Melbourne’s Ritchie Chair of Economics, has been a voice in Australia’s fiscal debates for decades. “There are more and more people saying that we’ve got to wind back the debt,” he says. Economist Jerome Fahrer, director of policy consultancy ACIL Allen, worries that “we are piling up the commitments, one on top of the other”.
WE’RE RELYING ON BRACKET CREEP
Treasury’s Steven Kennedy makes the same point in his June speech. In fact, he argues, federal government payments seem to have taken a permanent step up in the pandemic. In the half-century to 2020, they averaged under 25 per cent. In the years ahead, they now seem destined to average more than 26 per cent. And this new spending has not brought with it new ways to raise government revenue.
So, as Grattan Institute CEO Danielle Wood notes, in Canberra “there’s been no steps towards active budget repair as yet”. Most of the means that governments use to cut deficits have yet to appear. Mr Kennedy says that so far, budget repair relies on economic growth and low interest rates plus one other, rarely acknowledged source: bracket creep.
Bracket creep happens when inflation pushes people into higher tax brackets even though the purchasing power of their pay is unchanged. It’s particularly important in Australia, where personal income tax is more than half of all the national government’s tax receipts. It particularly hits low- and middle-income earners. And right now, bracket creep is where all of our future debt reduction will come from.
A better alternative to bracket creep, Mr Kennedy suggests, would be for the budget to explicitly adjust federal spending and taxing. He and other economists point to several places where Canberra can start fixing things.
KEY COSTS ARE RISING FAST
The National Disability Insurance Scheme (NDIS)
The rising costs of Australia’s disability funding scheme have surprised most observers. The NDIS was announced more than a decade ago with the approval of both major political parties. Now its costs are about to overtake first Medicare and then defence, and it is growing at 12 per cent a year. So far we have little evidence it’s fulfilling its founders’ hopes of putting many more disabled people in work.
Mr Freebairn says we have “grossly underestimated the number of people who appear deserving of NDIS support, and … the cost per person who is supported”. He suggests we can work at reducing the latter number, in particular.
Ageing and health
We’ve known for years that the population is ageing as Baby Boomers march into retirement, and that this will push up aged care spending and age pension outlays over several decades. The federal government’s Intergenerational Report projects that by 2060-61, 23 per cent of the population will be over 65, up from 16 per cent in 2020-21, and aged care spending will nearly double as a share of GDP, from 1.2% to 2.1%. And while we have a relatively low-cost aged care system by global standards right now, the pandemic prompted questions about whether we need to spend more.
Ageing is also pushing up the national health care bill. But that might be rising anyway: as nations get richer, their people tend to spend more on keeping themselves alive and healthy. And 70 per cent of health spending comes from governments, according to the Australian Institute of Health and Welfare, with 60 per cent of that spending coming from the federal government.
The one piece of good news: more old people are healthy and even working. Most of the increased costs of old age continue to come in the last three years of life.
Defence
In another surprise, we’ve seen a sharp rise in Australia’s defence spending supported by both our main political parties. Defence spending now tops 2 per cent of GDP, due in part to Chinese assertiveness and Russia’s war in Ukraine. And as John Freebairn notes, policymakers doubt the US will continue underwriting defence for the rest of the world. “The rest of us are going to have to pull our weight a bit more than we’ve done over the last 30 or 40 years,” he says.
Climate change
The federal government’s incentives for emissions reduction centre on a small Emissions Reduction Fund, now under review. Incentives are likely to need more funding in the years ahead. Economists say carbon pricing would provide far better value and raise money to boot (see below), but the nation ditched its last carbon pricing scheme in 2014. Expenses like flood recovery are already rising and extreme weather events are expected to impose higher costs as the decades roll on.
In coming decades, Australia and other rich nations may also need to help the poorer nations of the Indian subcontinent, Africa and south-east Asia move to less pollution-intensive techniques.
WE COULD RAISE NEW FUNDS
Road user charges
Economists point out that road user charges could raise money while giving people a new incentive to do something we all want other people to do – use the roads more frugally, particularly at peak periods. As Mr Freebairn notes, such charges were an important recommendation of the Henry Review of Australia’s Tax System back in 2010. But like most of that review’s options, it lacked voter appeal and so has been ignored.
Carbon taxes
Nicki Hutley, NSW president of the Economics Society of Australia, notes that the vast majority of leading economists, when polled, say a carbon tax or emissions trading system would provide the most efficient signals about energy use right through the economy. It would also provide much-needed funds. And like road user charges, carbon taxes encourage behaviour most of us want – in this case, lower carbon emissions.
Australian voters seemed to reject a carbon tax at the 2013 election. But some recent polls do show majorities in favour of some sort of carbon price.
Higher GST
Economists continue to name a higher goods and services tax as one of the most efficient ways to pay for extra government spending. We could also “broaden its base” by applying it to products like food, which it currently does not cover. As Ms Hutley points out, this is considered so politically dangerous that the Henry Review was not even allowed to look at it. But Saul Eslake, for one, argues it could still form part of a “grand bargain” which also introduces a range of measures that GST opponents would welcome. “If we’re looking to raise revenue, it should be on the table,” he says.
Death duties
“Most Australians don’t realise that we’re one of only eight OECD countries that don’t have them,” Mr Eslake says of death duties. And three of those eight “tax your wealth while you’re alive”, he adds. The US and the UK, for instance, both have them.
GOVERNMENTS WILL BE TEMPTED TO DELAY
Australian governments have kept adding to the debt problem even as the pandemic has died down. Says Grattan’s Danielle Wood: “In the most recent budget there was no decision that would have reduced spending. There were no decisions that would have increased taxes.”
Solving the problems of government debt, taxing and spending is not just about economic theory. As Ms Wood reminds us, it is also about the behaviour of very human political decision-makers. Regardless of party, politicians have a powerful incentive to spend now and be less concerned with the long-term results: voters tend to reward that sort of behaviour.
Most of the economists mentioned think a change in politicians’ behaviour may have to wait for later in the decade. The most likely catalyst is some new crisis that we can’t yet even imagine. Only then will a national leader make it clear to Australians just what sort of debt hole we’re in, and how we might get out.
- it creates “bracket creep”, by pushing down the real level of income that you (and your clients) get before you move into a higher tax bracket.
- if the inflation is unexpected, it pushes down the real value of debt, making repayment easier.
Government spending falls, perhaps because we decide to do less welfare spending (such as pensions or disability payments), defence spending (such as new submarine projects) or long-term investments (such as infrastructure or education).
