Nobody likes spending cuts and tax hikes, but in our estimation the government will soon need more if they are to make a dent in the looming $70 billion a year budget deficits.
A new report from the Grattan Institute, Back in black? A menu of measures to restore the budget argues that the current combination of low unemployment and high inflation makes this a good time to put things in order.
The sooner we do that, the sooner we will be in a good position to respond to future economic shocks and avoid passing the costs on to future generations.
We were right to spend big when COVID hit
The massive government support unleashed during the 2020 and 2021 lockdowns was essential in supporting households and businesses and helped keep unemployment low and Australia’s 2020 recession mild.
It left us with a national debt that, on 23% of GDP, which is expected to rise to nearly 32% by the end of the decade, is high by historical standards but low by international standards.
Our real problem is a structural one where expenses are growing faster than revenues. And it was building long before COVID.
Demands on the government will increase
Costs are rising inexorably for three reasons.
The first is that our expectations grow as we age and become wealthier, increasing spending on health care, disability care, and elder care.
The second is that many of these services are the most difficult to mechanise, meaning there’s little we can do to keep them from getting more expensive over time.
The third reason is geopolitical and climate developments. The massive AUKUS deal is just the latest expression of pressure to ramp up defense spending. Increasing frequency and severity of natural disasters means we have no choice but to spend more on emergencies in the past.
Combined with higher interest rates driving up the cost of servicing debt, these three forces will create a persistent gap between government revenues and expenditures of about 2% of GDP, according to Treasury Department calculations. That’s $50 billion a year in today’s dollars every year.
Source: Treasury, Budget October 2022, graph 3.20
But even that grim forecast looks optimistic.
Estimates from the Grattan Institute suggest that the true structural gap is more than $70 billion a year when additional, largely unavoidable spending is taken into account – including for AUKUS, overdue pay raises for healthcare workers, more realistic hospital spending growth and long-anticipated increases of unemployment benefits.
See Figure 1.2 in Grattan Report for a full explanation and sources.
And that’s just the next decade. In the longer term, the budget will come under additional pressure from slower productivity growth, the aging of Australia’s population and climate change.
Higher economic growth and productivity growth would reduce the magnitude of the challenge, the Grattan Institute argues ideas about how you can support it sooner.
But hoping that we can grow out of chronic budget deficits is not a prudent approach. While we should try to stimulate growth, it is unlikely that it alone will get the country’s finances on a sustainable trajectory.
13 billion ideas
The magnitude of the problem and the political difficulty of restoring the budget means that both expenditure and revenue measures must be on the table.
Austerity has been the focus of budget recovery for most of the past decade, so much of the low-hanging fruit has already been picked. But there are still savings to be made.
The biggest would come from more discipline in decisions about what to spend on infrastructure and defense. Better advance decisions based on economic – rather than political – considerations can save several billion each year.
Buying smaller, more regularly and “ready-to-go” would reduce the risks and costs associated with mega projects with a history of massive cost overruns.
Read more: How can Australia afford $368 billion for new submarines? Some of the money will be created out of thin air
Our report identifies a further $15 billion a year in savings measures, including reversing Western Australia’s special GST financing agreement, including more of the family home in the old-age pension test, and improving hospital efficiency and procurement in health.
But even with substantial cuts, tackling Australia’s budget challenge without jeopardizing core services will require more revenue.
The biggest opportunity comes from plugging “leaks” in the income tax system. Tax benefits and minimization options are increasing. Curbing retirement tax breaks, cutting the capital gains tax credit, limiting negative gearing, and imposing a minimum tax on trust benefits could collectively bring in more than $20 billion a year.
Read more: Inheritance taxes, resource taxes and an attack on negative gearing: How top economists would raise $20 billion a year
Reworking the statutory Stage 3 tax cuts so they’re less generous at the top would save another $8 billion a year.
Raising the age at which people can access their super from 60 to 65 and freezing mandatory super contributions at their current level (10.5% of salary) would save at least another $8 billion.
Other options include raising the rate of the goods and services tax (with a compensation package, and the Commonwealth and states share the net revenue), rolling back fuel tax credits, and raising the rental tax on petroleum resources.
Ordering the entire menu at once would be a recipe for indigestion. But if Treasurer Jim Chalmers picks just a few items on the menu, we’ll be well on our way to tackling Australia’s budgetary problem.
Read more: Australia needs an honest talk about taxes and budgets – and Jim Chalmers is ready to talk
Kate Griffiths’ employer, the Grattan Institute, was supported in her work by the government, corporations and philanthropic giving. A full list of supporting organizations is published at www.grattan.edu.au.
Danielle Wood and Iris Chan do not work for, consult with, own shares in, or receive funding from any company or organization that could benefit from this article, and have not disclosed relevant ties outside of their academic tenure.
