Australia’s future fiscal shock

Policy Local government Economics Australia

The government is facing the arduous task of securing sustainable expenditure, revenue and debt beyond the current four-year horizon of the budget estimates, argues this report.

Key findings:

  • Long-term prospects for Australia’s public finances are not receiving the attention they deserve. It is one thing for Commonwealth and state governments to balance their budgets in the short term, as they are attempting to do, but spending commitments are being made as though nothing beyond the four-year horizon of the forward estimates matters.
  • Under current policies, Australia is heading in the long term for a substantially larger share of government spending in the economy, which will bring pressures for higher taxation or borrowing or both. Spending by governments at all levels as a proportion of gross domestic product (GDP) (currently around 36%) could rise to well above 40% over the decades ahead, if not sooner.
  • The financial and economic crisis in the developed countries in the Northern Hemisphere can in part be attributed to the risks those countries took with their public finances over many years, and particularly the very high levels of government spending, which in some cases exceed 50% of GDP. Their experiences should serve as a warning to Australia.
  • The Commonwealth’s 2010 Intergenerational Report looks ahead to 2050 and projects that over the long term, an unsustainable fiscal gap of expenditure over revenue will open up under spending policies as they existed three years ago. It also shows that over the next several years, there is a window of opportunity to anticipate this problem and adjust policies to avoid it.
  • But governments are showing few signs of using this opportunity wisely. To the contrary, new spending commitments are accumulating at an alarming rate, and more are piling up at government’s doorstep. Commitments are being entered into with deferred start dates, which means the full fiscal consequences will only become apparent well into the future.
  • The 2010 IGR outlook, being based on 2009 policies, incorporates none of this new spending. A review of policy announcements and other budget pressures shows that new spending measures adopted in the three years since the 2010 IGR could easily add $28 billion a year to spending by 2020. How this is shared between the Commonwealth and the states is a secondary issue. The total public sector picture is more important.
  • So far in the current decade, spending appears to be following the pattern of the decade to 2010, when new initiatives accounted for more than half the very substantial real growth in Commonwealth spending. In those 10 years, growth was paid for by a revenue boom. Governments should not count on another revenue boom this decade. There are significant risks to revenue, both of a general kind and those specific to the mining resource rent tax and the carbon tax.
  • Governments and oppositions need to curb their enthusiasm for launching or promising new spending initiatives. This will require a change in behaviour not only from politicians but also the community, whose expectations of government need to be lowered. Governments should also step up the search for expenditure savings, and adhere to a rule that requires new spending to be offset by savings in existing programs. A compete audit of spending under existing programs would allow spending to be re-based to a lower level and create more fiscal headroom.
  • The alternative is to increase revenue through higher tax rates, broader bases, and cuts to concessions. This approach would entrench, rather than avoid, expanding the government sector. The increase would need to be very large, spread over the next several decades, and take the proportion of tax in GDP from around 30% to 40%. This would expand the deadweight economic costs of taxation by a large order of magnitude and is inferior to policies to contain government spending.
  • Governments are more likely to take a long-term view under the pressure of transparency. Four-year forward estimates have passed the limits of their usefulness and are now ‘gamed’ by governments. There should be more focus on intergenerational reports, which should in future be prepared for the whole public sector (Commonwealth and states combined). Major reviews every few years should be complemented by annual fiscal sustainability updates that capture the net impact on long-term fiscal gaps of all expenditure and tax policy decisions taken in the preceding year.
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