John Hewson
Budget reality bites

I have been analysing and forecasting economies since joining the International Monetary Fund in the late 1960s, and I can say it is much more difficult now than at any time since then to predict how the world and our economy will evolve. Multiple global liquidity injections, stretching back to the Alan Greenspan era of the early 2000s through to the responses to the 2008 global financial crisis, and most recently to the pandemic, have finally released the inflation genie. As a result, major central banks are reversing their easy monetary policy settings and rapidly raising interest rates.

However, this inflation resurgence is not just demand driven – a cause that higher interest rates could readily address. Supply disruptions and shortages related to the pandemic and Russia’s invasion of Ukraine have collectively blown out the costs of transport, energy and some key commodities. These pressures are unlikely to respond significantly to increased interest rates, which means the inflation challenge will continue, with the peak yet to come.

The policy challenge for the Albanese government is compounded by pressures left deliberately by the Morrison government, or attributable to its incompetence and neglect – in aggregate, record debt with budget deficits stretching as far as the eye can see. Important and urgent structural challenges are needed in the health system, and aged and disability care in particular, along with energy, housing, defence and climate policy. Financial strain is showing in weaker confidence among households and businesses, which are understandably suspicious of our governments’ capacity to respond effectively.

While they have been left in a precarious position by the previous government, the Albanese government clearly accepts that it can’t keep pointing the blame, as it will be – and should be – marked on how it responds.

Treasurer Jim Chalmers has made a strong start in this regard with his recent economic statement to parliament, offering revised forecasts based on an honest and balanced assessment of where we sit economically and of the challenges and opportunities ahead, though he is yet to provide the detail.

With a majority of people struggling to meet the runaway costs of living, the government is under pressure to deliver sustained cuts in key excises such as petrol and beer and thus ignore the bigger picture of responsible long-term budget management. The government must be prepared to show leadership on this, to admit that essential, effective budget repair will probably require an increase in the overall tax burden, even with further expenditure cuts.

There is plenty of scope for cutting expenditure. The easy cuts are the rorts of the Morrison government – funds for sports, car parks and other allocations for perceived electoral advantage – and the National Party slush funds. These included a variety of so-called regional and community grants and a host of infrastructure projects that were not recommended by Infrastructure Australia or the department. Each should be reassessed transparently, on a strict cost/benefit feasibility basis. The auditor-general has identified many of these potential savings. Subsidies in support of and to defend the fossil fuel industries should also be targeted.

Beyond this, the Albanese government needs to declare its priorities and be prepared to defend the trade-offs involved, as well as any new spending it feels is required. The most obvious areas for increased support, given Anthony Albanese’s election commitments, are childcare and aged care, TAFE, vocational training and universities.

One aspect of budget management that has long been conspicuously missing is regular reviews of all major projects and programs to see that they are achieving their objectives as effectively as they should be. This is particularly important in the big expenditure areas of education, health, training, defence – especially defence procurement – and some welfare programs. Addressing the blowout in the bureaucracy and spending of the National Disability Insurance Scheme will be a difficult but essential call.

Perhaps the biggest budget challenge is to start the debate about raising taxes. There were authoritative studies pre-pandemic that concluded the overall tax burden would need to increase during this decade just to meet the expenditure programs already under way in education, health, defence and infrastructure. The pandemic and the election expanded the challenge. But it will be tough to launch the debate given the surreal framework for such discussions built over many decades on the expectation that taxes can and should be lower, despite the volume of inquiries that have suggested alternative frameworks. This tax discussion has always proceeded without being matched to expenditure aspirations.

The Albanese government has committed to tax multinationals that presently pay little or no tax in Australia thanks to a series of arrangements that legally allow them to move profits offshore. This is a major inequity in our tax system that is relatively easy to address. These companies earn billions in revenue in Australia. Many are global fossil fuel giants that have been significant players in the development of our gas and coal industries and in petroleum refining, which has also earned them direct financial support. The politics here is relatively easy, given media reports that some of the largest corporations actually paid more in political donations than in tax.

A more difficult political manoeuvre, but one that could easily generate revenue, would be for the Albanese government to reconsider its support for the Stage 3 tax cuts.

Other inequities, such as franking credits, capital gains tax concessions and negative-gearing concessions, are more difficult to address, as Bill Shorten found when he made them a major part of his 2019 election manifesto. Any genuine attempt at tax reform should include these, but they have been ruled out by the Albanese government.

An obvious revenue-raising avenue is the GST, by expanding its base and/or increasing the rate. This option would be difficult given the perceived inflationary consequences – although the increase in inflation on the introduction of the GST was demonstrated to be a manageable one-off effect – and those who would be particularly disadvantaged could be fully compensated. As it is possible to raise a very large amount relatively efficiently by such adjustment, many see the GST as the key enabler to genuine broad-based reform of the tax system. The major political hurdle is that under the existing legislated processes any change requires agreement between the states and territories and federal parliamentary approval.

It will be critical for the Albanese government to spell out the interdependence of our economic outlook, budget repair and its vision for our national transition to a low-carbon society, which could make us a clean-energy superpower over the next several decades. This detail should also demonstrate how and when gas and electricity prices will fall.

Time lines will be important here. While the longer-term focus of sustainable growth will be the thrust of the October budget, it may already be too late, without action, to avoid a recession before then. The concept of “living with the virus”, with governmental sloppiness over mask mandates and ignorance of other medical advice, could have real economic consequences that compound rising interest rates and tip us into recession in the next few months.

A recent study by Quentin Grafton, Tom Kompas and Hoang Long Chu, which was cited in an Australian national university policy forum, noted the persistent myth that “what is good for public health is frequently bad for business”, even though the success of Australia’s initial tough response to the pandemic ranked us among the better economic performers. They tested the claim that mandating masks imposes too great a cost on the economy by calculating the “avoided losses of labour hours from reduced Covid-19 cases because of additional public health measures such as mandated mask wearing”, compared with the “business-as-usual outcome” that assumed current public health settings were left unchanged. The authors concluded that the estimated percentage decline in economic output, under business-as-usual, from lost labour hours due to Covid-19 in 2022 is between 2.2 per cent and 3.4 per cent. They concluded that “when combined with rising interest rates, this reduction in labour output from Covid-19 is big enough to push Australia into recession in coming months”.

To be clear, this study probably underestimates the value of public health interventions, as the definition used does not include the economic costs of Covid-related fatalities.

The Albanese government has clearly appreciated some of this, as government members have been wearing masks in question time, while Peter Dutton’s opposition have not, smirks on full display.

Good policy can only become smart politics if the government accepts the unequivocal medical evidence on the benefits of widespread mask wearing to substantially reduce the rate of infection. In this sense, economic policy is intertwined with public health policy.

This article was first published in the print edition of The Saturday Paper on August 6, 2022 as "Talking about money".

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