Australia’s Treasury secretary John Fraser delivered a landmark speech last night.
He explained the fundamental change in the reality of the Australian government’s fiscal position, the government’s tax take, and its ability to fund the growing welfare demands of the community during an era in which the population is ageing and global economic uncertainty remains high.
In a clear sign that Fraser, and his political masters, are set on a path of budget repair and reform, Fraser asked: “Why should the living standards of future generations be compromised just because we were not willing to make sacrifices to address the unsustainable growth of government expenditure?”
While the focus is often on the current budget year, Fraser pointed out that it is the forward estimates which “now seem to be a little more important.”
That’s important because “beyond the immediate Budget year and the forward estimates, we must now be more mindful of the longer term pressures on government spending from population trends and, in particular, the ageing of the population and the associated rapidly growing pressures on health funding,” Fraser said.
As these pressures grow, getting the budget forecasts right becomes more important.
But Fraser said that forecasting is becoming more difficult because of continued uncertainty in the underlying forecasts and the fact that “we are now a far more integrated part of the global economy – and far more at the mercy of international financial and economic pressures”.
Fraser noted that each budget update since 2014 has seen a downgrading to the fiscal outlook.
But that is not to give his department, the Treasury, or the government a leave pass. Rather, what’s clear in Fraser’s speech is that this very uncertainty is driving the need for structural reform of the budget.
Fraser neatly explained the intersection of the commodity boom, cyclical revenue, and structural spending decisions (our emphasis):
We have a structural budget problem that arose before the global financial crisis. The recent weakness in revenue is only partly to blame. From the outset of the commodity price boom of the early 2000s, Government revenue grew faster than expected as the terms of trade persistently exceeded expectations.
But structural expenditure decisions offset much of the temporary revenue gain. In particular, a very substantial amount was spent on ongoing programs that increased transfer payments and benefits.
In simple terms, and as I said in my speech to CEDA in February last year, some of the proceeds of our once-in-a-generation commodity price boom were used to pay down debt and set against future liabilities through the creation of the Future Fund.
Changes to the personal income tax scales over this period also helped to relieve pressure on households and reward personal effort and initiative.
In addition, the work of fiscal repair during the late 1990s and early to mid 2000s provided an important buffer for when the global economy was hit by the GFC.
But a very substantial amount of the revenue windfall was used to lock-in long-term spending commitments.
That growth in spending has continued, however.
As a result, government spending as a percentage of GDP in the current financial year is at 25.9%. Close to a post-GFC peak. Spending will not get below 25% at any time in the next decade, Fraser said.
(Treasurer Scott Morrison has, in recent interviews, repeatedly stressed that that a level of government expenditure as a portion of GDP at 25% being a benchmark.)
Borrowing costs high and rising
Leaving aside increased spending on “critical programs like aged care, disability care and help for the unemployed and sick”. Fraser said a big part of the rise in government costs is that the cost of servicing the increased government debt has risen to $1 billion a month.
The slower rate of nominal growth in the economy which has materially impacted government receipts, and increased the burden of servicing debt. But Fraser highlighted that the interest costs are “projected to more than double within the decade, unless action is taken to improve our budgetary position”.
“The debt burden and servicing costs are growing with each budget deficit and will grow even faster when global bond yields inevitably normalise,” he said. “If the bond rate were to return to its long term average of about 7.25 per cent, the Government’s debt servicing costs would increase by over $29 billion over the forward estimates (2015-16 to 2018-19),” Fraser said.
Something has to give.
Australia needs to keep its Triple-A credit rating to ensure borrowing costs stay as low as possible. But it also means Australia’s hard-won “reputation for fiscal prudence” must be maintained, Fraser said.
Structural budget reform is a must
While the focus is often on this year’s budget and the current deficit, it’s the structural budget balance that matters, Fraser said.
This is about the budgetary position in the absence of cyclical – or temporary – factors.
“With the exception of unemployment benefits, government expenditure is assumed to be structural,” Fraser said.
That, again, highlights many of the commitments made during the mining boom have been structural in nature and as a result in the 2015-16 financial year “only around $9.9 billion of the $37.4 billion deficit is considered to be due to the weak cyclical state of the economy,” Fraser highlighted.
He’s got his eye on the budget and spending reform undertaken in the 1980s and late 1990s. Specifically, Fraser noted the measures taken then “were characterised by: limiting new spending and/or fully offsetting net new policy with savings from the same portfolios; better targeting of transfer payments; and changes to payments to the states.”
That’s not to say Fraser has a knife in each hand ready to cut swathes out of the budget. He is making it clear to those who want more from government that the current benefit structure is generous by global standards.
To make the point, he pointed out that when it comes to the poorest 20% of Australians, the nation redistributes more “than any other OECD country except Denmark.”
On pensions he countered the perception that Australia is behind OECD averages noting that even though the “OECD recently reported that Australia spent well below the OECD average on pensions… when other forms of assistance are included, such as non-cash benefits – for example, subsidised health care, and superannuation tax concessions – Australia compares more favourably.”
“Australia’s retirement income system also ranks favourably compared with other countries, taking into account the Age Pension, household savings and homeownership. The Melbourne Mercer Global Pension Index ranked Australia 3rd out of 25 countries overall and 1st for adequacy,” he added.
A line in the sand
Having highlighted that government spending has ballooned back near the post-GFC high at 25.9% of GDP this year Fraser said that, “seeking to keep spending below 25 per cent of GDP may be a useful marker.”
That means he said “simply increasing the overall tax burden to raise more revenue is not the answer.” That’s because such a plan “runs the risk of distorting economic incentives and lowering international competitiveness with negative impacts on investment, growth and job creation.”
That’s the cornerstone on which Australia’s economic future rests.
Frasers prescription is that Australia must lay out “a path of sensible and credible fiscal repair — along with a plan for structural reforms that address our long-term growth challenges — will provide the building blocks for long-term fiscal sustainability and strong and stable economic growth.”
Other nations, the US, UK, and Ireland, have achieved great results, Fraser says, highlighting that “expenditure restraint played a key role in all these countries in improving their fiscal situation.”
If Australia can do that, the long term challenges of the ageing population and the demographic and “broader medium term pressure” on government finances can be faced.
But it’s not an easy process and Fraser has laid out the other challenges besides spending that he believes Australians must face:
Structural reform is critical and this includes reforming competition policy and implementing the Harper Review recommendations.
Improving productivity is a far more sustainable way to boost economic growth than relying unduly on an exchange rate depreciation.
These growth-enhancing policies also very much include tax reform. Tax is not just about raising revenue, it is also about helping to shape the economy so that we attract and deploy resources in a manner to promote long-term growth. The arguments for a tax mix switch rest heavily on encouraging more jobs through a higher growth path. Tax reform is a complex issue and is very much the focus of the Government at the current time.
But none of this can be done without reforms to how government collects and spends taxpayers’ money.
And that is over to the politicians.
Scott Morrison, you’re up.