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Monday, 11 January 2016

It is simply a deficit problem.

Are you a 'big-endian' or a 'little endian"? Some may recognise this as a reference to the inclinations of the Lilliputians and Blefusci of Jonathan Swift's classic Gulliver's travels. The two 'countries' had an, err, endless conflict over which side of a soft-boiled egg you break. Swift certainly took an extreme example of the trivial to illustrate the stupidity of politics. No one would think real grown-ups would have passionate and interminable arguments about such trivia.

Not so it seems! The on-going passionate disagreement between the Coalition and the ALP whether our ever extending budgetary problem is a Revenue Problem or a Spending Problem seems to fall into this category.

The ALP argue that we have a revenue problem, the government's coffers have not grown as expected, or,  indeed more recently have fallen (eg see You do have a revenue problem, Mr Morrison )

While the Coalition has argued our budgetary problem is due to expenditure (eg see Spending problem, not revenue, says new Treasurer.)

Is there a problem?

This argument has persisted for much too long. Lets try to get some perspective.

Figure 1 below (from Budget explainer: what is a structural deficit and why does Australia have one?) puts some light onto the argument.

The budgetary problem is the deficit resulting when government expenditure is greater than government revenue, ie the red line is higher than the blue dashed line in the graph above. Clearly since 2008 when the lines crossed there has been a deficit, indicated by the large and generally widening gap between Revenue and Expenditure. Moreover, without significant and ongoing reform, projections indicate the deficit is set to continue for decades! (see Australia on track for a decade or more of deficits, without major policy change)

All deficits are funded by borrowing, generally from overseas benefactors. Over time on going deficits result in an ever increasing burden due to debt servicing, and indeed with increasing interest rates as the benefactors become more nervous.

"an on going structural deficits is a failure of government."
Debt inevitably has to be repaid by some future government(s). So in effect such long term debts are left to our children. It is no way to run an economy. An going structural deficits is a failure of government. 

Yes, we do have a problem and any government must take action to eliminate it over time!

But is it a Revenue problem or an Expenditure problem?

What difference does it make? The reason that our Big Endians and Little Endians focus on this is to justify their preferred actions to resolve it, and in the case of the ALP, to obfuscate, in order to deflect criticism since, at least on the spending side, they created the problem.

The graph itself shows there was a budget surplus and indeed there was no net debt when the Howard government left office. Soon after the ALP took over expenditure rose steeply and then leveled off at around 26% of GDP. ALP argues this was necessary due to the GFC to safeguard the economy from a deep recession. While the coalition accepts some increase in spending was justified at the time of the GFC, it argues that too much was spent and that high expenditure was 'locked in' in new on going programs that would not be supported even when revenues returned to 'normal'. 

The graph also shows that after a steep fall during the GFC Revenues  recovered to the level they sustained in the past, ie within the period from 2000-2007 around 24% of GDP. 

It is therefore hard to deny that unsustainable long term expenditure initiated by the ALP has been the major cause of the current structural deficit.

At the same time, since the collapse of the mining boom over the last year, there has been a fall in Revenues that are now at the lower end of the historical range.

Yes, we definitely have a Spending problem caused by the ALP's long term expenditure commitments during the GFC, and ,
Yes, we now also have a Revenue problem as tax collections have dropped with the collapse of the mining boom. 

Yet the argument still goes on. It is simply amazing how so many politicians can talk so much about the budgetary issue with such little clarity.

It is simply a deficit problem

The professional and social media and the commentariat are just as bad. They have shed little light  but have added a lot of heat to these arguments. Invariably siding strongly with one side or the other according to their own political leanings.

Our experts, the economists, have also let us down. Instead of simply and persistently pointing out that; -

  • it doesn't matter who caused the problem, 
  • it really doesn't matter whether it's due to a revenue shortfall or too high expenditure, 
  • just admit there is a problem
  • then act to correct it, over time.

No, they have preferred not to upset their benefactors and simply said it is 'both', emphasizing the component that their interviewer prefers. Sometimes, worse still, they introduce red-herrings by pointing to tax collection and expenditure patterns in the OECD. While all that may be interesting, it only gives oxygen to an argument that should have been settled quickly by the two observations; -
Yes, we definitely have a Spending problem caused by the ALP's long term expenditure commitments during the GFC, and ,
Yes, we now also have a Revenue problem as tax collections have dropped with the collapse of the mining boom.
This pandering by the media and the experts has allowed the pollies to continue with their nonsense.

But are all deficits bad?

Many in the ALP refuse to accept there is a problem. They argue that deficits are acceptable and give examples of countries that have sustained deficits over long periods. 

There is some truth in this assertion. There are two circumstances under which government deficits can be justified. If an unforseen event, such as the GFC or the collapse of the mining boom, causes a severe and sudden downturn in revenues, a government is justified in running a deficit for the short term. This provides for an orderly adjustment of the country to the new circumstances. However such deficits are only justified in the short term eg a year or two, and certainly cannot justify the introduction of new long term operational expenditures

The second circumstance is where the country goes into deficit only to finance expenditure which increases future government revenues. If the Revenue on which this deficit is predicated is realised  within the expected expenditure budget then the deficit can be justified. However this depends on getting all your sums right and can be very risky.

Australia's deficit is the result of excessive on-going operational expenditure. It is not due to investment into projects which will generate future government revenues. Given the recent mining collapse the goverment can justifiably move slowly to address the structural deficit, nevertheless the structural deficit remains as an on-going 'challenge' and it cannot be ignored by any responsible government. 

Even if some level of action is postponed, the problem needs to be faced directly and openly!

Government must address problems

Governments are elected to legislate in the long-term best interests of the country. Responsible governments must identify any future problems, devise strategies to address them and then inform and educate the electorate to bring them on side. Clearly our structural deficit is an issue crying out for a solution.

Alas reform has been sadly absent in recent governments and our politicians have been letting us down.

The Turnbull government cannot simply ignore the economic reality that is facing the country and focus on blame-shifting and kite-flying. It cannot continue to raise, then discard potential policies when they attract harsh scrutiny. The government must act to address the deficit.

But the opposition does not get off scot free, the ALP/Greens cannot simply reject all government proposals without submitting alternative proposals of its own. These should not be the current batch of half baked solutions that offer some minor savings but do not address the massive spending black hole. As to the accidental power brokers, the minority senators, they should not sabotage a coherent legislative agenda by cherry-picking popular policies.

It is time to show real responsibility, fess up that we have a serious deficit problem, and accept the harsh medicine that is required to address this harsh reality. The continued mindless debate by our politicians over whether we have a revenue problem or a spending problem only makes them look more and more like the dwarfs of Lilliput.

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