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Currying favour: the Budget

By Saul Eslake - posted Thursday, 12 May 2005

The 2005-06 Budget, like its predecessor, represents a victory for what the Government sees as “good politics” over what economists (who don’t need to seek periodic re-election) would regard as “good economics”.

The Budget figures show the Government is literally rolling in cash. Over the past six months, projections of revenues (on a “no-policy-change basis”) for the five years from 2004-05 through 2008-09 have been revised upwards by some $49 billion, bringing the cumulative upward revision to forecast revenues since last year’s Budget to some $83 billion - or about 8 per cent. (These figures include ANZ guesstimates of upward revisions to the projections for 2008-09, which have not previously been published by the Government.)

Much of this comes from upward revisions to projections of company tax collections which, largely thanks to the boom in export commodity prices, are now expected to generate nearly $16 billion (or 9 per cent) more over the four years to 2007-08 than projected in last year’s Budget; and of personal income tax collections which (notwithstanding the tax cuts in this year’s Budget) are still expected to produce nearly $13 billion (or 3 per cent) more than envisaged this time last year. And these upward revisions could still be under-estimates, if commodity prices do not “revert to their long run average”, as Treasury assumes.


At this stage of the business cycle - where, after nearly 15 years of continuous economic growth, the Australian economy is beginning to run into capacity constraints, with demand increasingly spilling over into imports and anecdotal evidence of cost pressures becoming more widespread (albeit not yet to the point of showing up in broadly-based measures of costs and prices) - the “right” thing for government to do, from the standpoint of macro-economic management, would be to allow these revenue windfalls to be added to the budget surplus, to be drawn down when required to support economic growth during periods of weakness. (This approach to fiscal policy was first advocated by the Old Testament figure Joseph - see Genesis 41:33-36 - a passage with which one assumes the Treasurer is familiar.)

But this would have required the Government to defend “underlying” surpluses of around $20 billion per annum from 2005-06 onwards. This should not have been impossible. A surplus of $19.6 billion, which is what the Treasurer would have been projecting for 2005-06 had he “banked” the revenue windfalls which the Government has racked up since the mid-year review last December - would have represented 2.1 per cent of GDP, the same as the Government recorded in 1999-2000, and only marginally above those recorded by the Hawke Government in 1988-89 and 1989-90, when the Australian economy was at a similar point in the business cycle to where it is today.

But the Government clearly felt unable to do this. And so this Budget contains “give-aways” totalling $38 billion over the five years to 2008-09, coming on top of the $65 billion of net new spending or revenue reductions (over the five years to 2007-08) in the eleven months leading up to last year’s Federal election.

That brings the total of spending increases or revenue reductions over the past 18 months to $104 billion - equivalent to around 2 per cent of GDP.

It’s not as if the economy is in need of this sort of stimulus. As the Treasury notes in Statement 3, increases in export commodity prices will boost Australia’s national income by about 2 per cent in 2005-06. Since virtually all of this gain will accrue, in the first, instance, to mining corporations, the Government will rake off 30 per cent of it in company tax. But whereas mining companies will save or re-invest most of their windfall gains, the Government is effectively transferring the bulk of its share of the windfall to households, who will likely spend most, if not all of it.

Thus, fiscal policy is ensuring that more of the windfall gains from the surge in commodity prices (which the Treasury, correctly in our view, assumes is unsustainable), will be spent rather than saved than would otherwise have been the case.


This is essentially the same mistake that the Hawke Government made in the late 1980s when it gave what were then seen as large tax cuts at the peak of the last significant commodity price cycle, and when the labour market was last as tight as it is today.

If the Government really felt that it couldn’t hang on to such large surpluses, then we should be grateful that it has “given” most of them back in the form of tax cuts rather than increases in government spending. After all, 2004 saw Federal outlays - excluding defence, interest payments and payments to the States - rise by nearly 11 per cent in real terms, the fastest since the last time a Coalition government was trying to spend its way into a fourth term of office, in 1983.

But no-one should be fooled into thinking that these tax cuts, large as they are, represent the comprehensive tax reform that Australia has to have. The myriad of loopholes, concessions, deductions and exemptions with which Australia’s income tax system is almost uniquely burdened remains untouched - as does the plethora of anti-avoidance provisions intended to prevent their misuse, which is the main cause of the complexity of the system.

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About the Author

Saul Eslake is a Vice-Chancellor’s Fellow at the University of Tasmania.

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