How to eliminate the deficit now!

Are we living in La La Land? The polls seem to suggest so. Recent polls indicate we want to have our budget fixed but not at the expense of welfare cuts (see "Voters: cut spending but no pain to fix budget deficit"). Sort of having our cake and eating it too!

http://budget.gov.au/2016-17/content/glossies/overview/images/overview-29.png

At ~$160B Social Security & Welfare is the largest single cost in the budget representing some 36% of total expenditure, and of course it is growing at the fastest rate. With a ~$37B deficit if we were to leave Welfare untouched and bring the budget into balance the savings would have to be made from Education, Health, Defence, the Public Service, etc. I wonder how voters would react to cuts of over 10% in Health and Education. Or imagine how Unions would react to a reduction of 20,000 public servant (ie 13% of the estimated 150,000)!

If this option is not palatable why not just raise taxes? Of course that also received low approval in the poll, but I am sure the pollsters would have achieved a higher rating had the choice been to "tax the rich".  Alas, taxing the rich, won't cut it any more either (see Judith Sloan's article  "Stop the rich-bashing: they pay their share" The Australian 26 April 2017). Unfortunately there is not that much cake to go around.

That now only leaves increasing taxes on everyone, while leaving their welfare payments alone.

Yes! That could work and may even be acceptable. Don't tell anyone that you are taking their money then giving it back to them. They won't work that out. Hey they haven't so far.

Limit welfare to the needy!

But seriously, you could could try something really novel. Limit all welfare payments just to the needy. Who are the needy ? We can afford to be generous, so lets call the needy those households that earn less than the average household income.

While I don't have recent figures, the above table for the 2009-2010 year (Government Benefits, Taxes and Household Income, Australia, 2009-10), shows the various adjustments to household income resulting from social services and welfare. It shows that 11% of Social assistance benefits in cash were paid to households whose income was above the median ( I had to cheat a bit by taking the third quintile and halving it on the basis that half of those in this quintile would be above the median household income and half below.) Taking the total of Social assistance benefits in cash as the total Social security and welfare budget of $160B welfare budget in the above pie chart, the 11% savings is equivalent to some $18B. A significant sum!

If we also consider the Social transfers in kind, a further $36% of these transfers were paid to those above the median household income. Taking these Social transfer in kind as represented by Education and Health totaling ~$105B in the budget, the 36% savings equates to  ~$38B.

By these admittedly simple approximate calculations we can see that limiting all Social security and Welfare payments, and Health & Education transfers just to the 'needy' households, the Federal budget could be cut by ~$56B per annum. This is massive, and certainly enough to not only eliminate the deficit but leave some change to start repaying our debt!.

Spending or Revenue?

The recurrent argument about whether we have a spending or a revenue problem brings to mind my own experience back so many years ago. As a 10 year old I was given an allowance of but 2 shillings per week. Yes it was shillings and yes it was a long time ago.

 With such a well defined sum I was most scrupulous about my spending. My weekly 'treat' was the Saturday movie matinee at the local cinema, the Coronet in Bondi Junction. Armed with my 2 bob, I set off by tram, 3 pence each way, paid my 1 shilling admission and settled in for a full three hours of entertainment. In those days going to the movies was an outing to be relished, with cartoons, the odd serial, "The Lone Ranger" or "Rocket Man", and after intermission the featured movie. On my way home I indulged myself with 3 pence of chips, wrapped in newspaper, and a potato scallop. A full afternoon for two bob. I still remember this much loved ritual after all these years.

I knew exactly where my money was being spent and I made sure it was spent on what I wanted. I also know I had a serious revenue problem, as I did not have enough money for chocolate freckles or cobbers or indeed the cream-bun that I also desired. I explained this to my mum in a vain attempt to justify a raise. She disagreed suggesting I really had a spending problem. That I should make do with what I had and perhaps should miss out on the movies one week and indulge in the other vices I felt were entitlements. She even suggested I could walk instead of catching a tram.

Of course I coped without those extra 'necessities ' and learned to live within my means.

All in all a good early lesson on many levels.

Firstly living within a budget requires giving up some things, things you may really want.
Secondly there are some things you may really want but you can do without.
And, finally, people will have different perspectives on the same problem.

These very same lessons seem to apply to our government 'deficit' problem today.
Our politicians have a different perspective on this problem because they come at it from different sides.

The ALP see it as a Revenue problem. They have a long list of must have programs like Gonski, Healthcare, Disability Insurance and so on, that require increased expenditure and complain the government is not raising sufficient funds for these essential programs. By defining it as a revenue problem they are providing 'justification' for increasing taxes to raise revenue. 

The LNP however are motivated primarily by the need to ensure the budget is balanced. They do not want to raise taxes especially since government expenditure as a proportion of GDP is already at historical highs. So they look critically at the ALP wish list and identify what we may want but can do without. Hence the case against funding of Gonski among other things.

There are of course compelling arguments for all the ALP must-haves, and I don't pretend to have properly addressed these arguments. I too had compelling arguments for my wish list of must-haves with my Mum, but in the end a responsible adult took control.

We too sorely need a responsible adult to take control of our budget deficit.

Hypothetical Budget FY17

Despite the spaghetti of issues that face a treasurer and the PM there are a few simple steps that it can take that will win wide acclaim by their party and the electorate at large. That is not to say it will not receive wide criticism from the ALP, Greens and the cross bench, as well as all the vocal vested interests. Alas that is political life today. No policy good or bad will escape a cacophony of critique.

Nevertheless let me venture to suggest a hypothetical Budget for FY16-17.

Setting the narrative: principles and strategy

The government needs a straightforward narrative that applies not only for a single budget but for the long term. This narrative should include a statement of principles along the following lines.

The Narrative

Size of government
All money raised by government is revenue foregone by individuals and corporations. Therefore it is incumbent on the government to remain as small as possible but have sufficient revenue to effectively and efficiently deliver the services the electorate mandates.
Historically, average Australian government revenues have been below 25% of GDP. While in recent years this has blown out due to both additional spending and lower tax revenues, your LNP government will return the revenue to and then ensure it remains below this historical average.

Equity

It is incumbent on governments to ensure any spending is equitable across all sections of the electorate. Within any budget there will be individual measures which advantage some sections and disadvantage others, but taken as a whole the measures in any budget will fall equitably across all sections of the community.

Equity also applies to generational equity. It is immoral for the current generation to continue to spend more than it earns and leaving the debt to future generations. Therefore the government will always strive to reduce government debt and to bring the budget into balance.

Current Economic environment 

While we firmly believe in the above two principles, we find ourselves in a difficult situation.

• The large increases in expenditure initiated under the Rudd/Gillard/Rudd governments and the subsequent collapse of the mining boom have caused a wide and widening gap between Government income and expenditure creating a ongoing structural deficit.
• The current gap between Expenditure and Income is such that we are failing our own limits on the size of government. Last year government revenue rose to just under 26% of GDP and due to the on going deficit we are failing on generational equity as well.
• However our structural deficit cannot be redressed in a single cycle, as the consequences of introducing measures to redress it could be counter-productive putting further pressures on the economy and reducing government revenues.

Our strategy 

Given these constraints we see it prudent to take gradual but significant steps to redress our issues, with an emphasis on growing the economy while maintaining but not growing government.

This implies; -

• Addressing inequities in welfare and superannuation systems whereby lower income earners subsidize higher income earners.
• Limiting personal tax relief to the real savings achieved by the above measures.
• Ensuring full compliance with government policies, applies to corporate and personal tax collections, welfare payments etc.
• Increasing the productivity within government departments.
• Increasing productivity within business by eliminating red-tape and high-cost industrial relations practices.

Proposed policy changes

While I am at it I may as well put some 'flesh on these bones' and propose some specific budgetary changes. Needless to say these are just hypothetical and where figures are provided they are largely '"guesstimates".

Specific Measures and their Impact

Proposed Expenditure measures

Effective for the 2017 Financial year we will require all government departments to improve their productivity by 5%.

Given total government projected spending for 2016-2017 is $451 B (see MYEFO papers), of which ~$150 B is for Social Security and Welfare, the cost to run the government is ~$ 300B, a 5% cut amounts to ~$15B pa (see Table 1).

Table 1: Australian Government general government sector historical and projected fiscal balance (a)

	Receipts(b)		Payments(c)			Net Future Fund earnings	Underlying cash balance(d)
	$m	% GDP	$m		%GDP	$m	$m	% GDP
2013-14	360,322	22.7	406,430		25.6	2,348	-48,456	-3.1
2014-15	378,301	23.5	412,079		25.6	4,089	-37,867	-2.4
2015-16(e)	394,891	23.9	428,335		25.9	3,955	-37,399	-2.3
2016-17(e)	415,327	24.1	445,277		25.8	3,717	-33,667	-2.0
2017-18(p)	440,883	24.3	459,897		25.3	4,007	-23,021	-1.3
2018-19(p)	473,531	24.8	483,295		25.3	4,465	-14,229	-0.7

(a) Data have been revised in the 2015-16 MYEFO to improve accuracy and comparability through time.

(b) Receipts are equal to cash receipts from operating activities and sales of non financial assets.

(c) Payments are equal to cash payments for operating activities, purchases of non financial assets and net acquisition of assets under finance leases.

(d) Underlying cash balance is equal to receipts less payments, less net Future Fund earnings. For the purposes of consistent comparison with years prior to 2005 06, net Future Fund earnings should be added back to the underlying cash balance.

(e) Estimates.

(p) Projections.

Source http://www.budget.gov.au/2015-16/content/myefo/html/16_appendix_d.htm

As a result of this move the size of government will decrease from 26.1% of GDP (projected in the 2015 Budget papers ) to 25.2%, close to the government's target.

In support we note; -

• The lack of productivity in governments of all persuasions is legend. Moreover such directed cost cuts are a common approach in larger commercial organisations, which traditionally do not carry as much 'fat' as governments departments.
• Rather than single out specific sections of government for cuts, we will do it uniformly across all departments with the details of the cuts to be worked out by Department heads.
• No doubt this will create a lot of noise from Unions and other vested interests, but the savings can come from many areas not just staff numbers.
• Nor does it require redundancies since staff turnover is greater than 5%, any savings related to staff can be done through natural attrition.(Australian Human Resource insititute survey showed the average Staff Turnover Rate for in 2103 was 13%) 

Proposed Revenue measures

Superannuation
The objective of our superannuation system is Self Funded Retirement for the majority of Australian workers. 

To be fully self funded a retiree today must have an Accumulated Superannuation Balance of ~$1,000,000. With this balance even at a modest investment return rate of 5% they will have an annual income equivalent to the single pension cut-off rate of $50,000.

The government provides concessions on super contributions in order to maximise the contributions by workers during their working life in order for them to reach this Self-Funded Retirement Threshold (SFRT).

Effective July 1, tax concessions on super contributions will only apply while the Projected Superannuation Balance at retirement is less than this SFRT.

The SFRT (Self-Funded Retirement Threshold ) will be established each year together with a table of how to calculate the projected balances based on the workers years to retirement. These will take into account investment return rates and inflation.

The super contribution discounts however will stay as they are today in order to limit the cost to business of administrative changes.

This measure will ensure everyone is entitled to concessional contributions but only to the extent that they contribute to a self-funded retirement.

Lump Sum withdrawals from super will be limited. Retirees will only be allowed to withdraw a lump sum from their super if their balance remains above the SFRT. ie you cannot withdraw a lump sum then go back on to the pension.

This measure will raise ~$4 B pa.

Personal Income Taxes

Bracket creep is the insidious mechanism by which inflation pushes workers to increased Tax rates.
We will apply all the savings from the Superannuation measures ($4B) and part of the reductions in the Productivity Dividend ($6 B) from government departments to relieve the tax burden on all workers. The reduction will be applied across the tax brackets to ensure the saving as proportional for all workers.

This measure will re-dress most of the bracket creep projected in FY17. Further measures will be introduced when the government can afford them.

Corporate Income Tax

Red tape
The existing program to eliminate red-tape will continue to reduce business costs and streamline operations.

Corporate Tax compliance and Minimum Tax
While most corporations pay their due taxes, there are some, including that largest multinational corporations which through complex transfer pricing mechanisms limit the amount of tax they pay in Australia.

The government will continueit s programto close taxation loppholes and audit corporations to ensure all corporation comply with taxation rules.

Effective for FY17 all corporations with an annual Turnover in excess of $250 million will have to pay a Minimum Tax equivalent to 5% of their turnover. This is a temporary measure that will be terminated when global agreement on the taxation of Multi-national corporations come into effect.

These measure are anticipated to generate $5B per annum and will be applied to reduce Company tax for all companies to 27.5%.


No other changes
There will be no change in GST, Negative Gearing, or capital Gains tax. These raise limited revenues to the Federal Government and can have a range of unintended consequences.

Summary

The effect of these changes on the projected figures from the 2015 Budget papers are presented in Tables 2 and 3.

Table 2: Financial impact of new policies

Measure	$B
Revenue	$B
Superannuation	4
Corporate tax cut	-5
Corporate compliance and Min Tax	5
Personal Income Taxes	-10
Total	-6
Expenditure
Productivity Dividend	-15
Net impact	-9

Table 3 Impact on Estimates for FY17 after MYEFO (see MYEFO appendix)

Impact on FY16-17 after MYEFO	$B	$B	$B
Revenue	423	-6	417
% of GDP	24.5		24.2
Expenses	451	-15	436
% of GDP	26.1		25.2
Net Capital Investment	5	0	5
Fiscal Balance	-33		-24

In summary

The proposed measures will;

• provide personal income tax cuts reducing the effect of bracket creep
• provide modest but significant company tax cuts 
• address the inequities in Superannuation 
• partially address the problem of large companies not paying the fair share
• reduce the projected deficit for FY17 from $33B to $24B 
• reduce the size of government from 26.1% of GDP to 25.2% of GDP.

Now let's see what ScoMo and Mr T deliver.

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.