Tuesday, October 5, 2010

Finance razor gangs out to cut spending

The pressure is on for Canberra to put the brakes on its outlays.

Caution is an underrated virtue. When people gripped by some overwhelming idea want to sweep all before it, it's a good thing to stand in the way and ask why.

We needed people to do that in 1989 when the Reserve Bank was raising interest rates to 18 per cent - and planting the last big recession. We need people to do it now.

Think of last week's news that Irish taxpayers will have to pay almost $50 billion to bail out a single bank, raising Ireland's deficit to 32 per cent of GDP. Our bankers may be greedy, but when their Irish counterparts were swept away by the lure of high-return, high-risk lending, our guys were sensible and cautious. They asked the right questions, didn't get the right answers, so they said no.

I don't pretend that the risks we face now are of the same scale as in 1989 or Ireland in the '00s. But there are risks, from three sides. The Reserve Bank believes it has to raise interest rates now to guard us against the risk of inflation, maybe in 2012. The higher dollar is making some imports cheaper to buy, but will cost us jobs and incomes as it puts our firms out of business. And Treasury and the Finance Department want the Gillard government to stop spending so much on us, and make us pay our own way.

Let's first applaud the two departments for putting their briefing papers to the government on the internet (at www.treasury.gov.au and www.finance.gov.au). It's a great initiative, and even with too much blacked out by self-censorship, they are insightful, substantial contributions to our economic debate.

But before we get swept away by their case for further spending cuts, let's try caution. Let's ask:

Why should we cut government spending any faster? Is it because the budget is in crisis, as it is in the US, Japan, Britain, Italy and Ireland?

Clearly not. Net government debt at June 30 was 3 per cent of GDP, as against 66 per cent in the US or 121 per cent in Japan. Yes, the deficit was 4.2 per cent of GDP in 2009-10, but almost half was from temporary stimulus measures. As the International Monetary Fund puts it, Australia's public debt is ''very low'', and the deficit will soon return to surplus.

Is it that spending has grown out of control, as the opposition says, crowding out the private sector?

From a glance in the rear-vision mirror, you might think so. In 2009-10, federal government spending was 25.9 per cent of GDP, the highest since the 1980s. But exclude the temporary stimulus measures, and underlying spending was 24 per cent of GDP, the same as under the Howard government.

Treasury and Finance estimate that total spending will fall to that level next year, then keep falling. Unless their estimates are very wrong, that's no problem either.

On Treasury's figures, the reason a surplus in 2012-13 will be touch and go is that revenues will be below average - even with a mining tax, applied in a mining boom. Both sides cut income tax too much, too fast, leaving us a revenue base too small to sustain spending. The solution is tax reform.

Is it because the economy will be growing too fast over 2011 and 2012? Should the government slam the brakes on harder to take pressure off interest rates?

If you trust the Reserve Bank's forecasts, yes. It predicts growth of 3.75 per cent over 2011 and 4 per cent over 2012, with underlying inflation rising to the outer edge of its 2 to 3 per cent target band.

But the data shows most of the economy is weak, inflation is still falling, global growth uncertain, and six interest rate rises in a year are already hurting. The jury is still out on this.

Is it because spending will rise further in the long term, so that we will need spending cuts and/or tax rises to keep providing the services and entitlements we have now?

Now we're getting warm. This is what the Finance Department argues, and it's got a strong case. The Howard government opened up welfare benefits and tax breaks to the well off, especially self-funded retirees. As the baby boomers age, this will cost us.

The Finance briefing paper sets out the structural pressures forcing spending to rise inexorably. Not only are the baby boomers getting older, costing us more and contributing less, but governments are subsidising the middle class in areas that are rising fast.

The key lesson from that, to me, is that we need to go after the big, politically difficult cuts, such as tax breaks for negative gearing ($5 billion a year), private health insurance ($1.1 billion), and, yes, owner-occupied homes ($14 billion). Finance also has its eyes on reducing eligibility for family tax benefits, pharmaceutical benefits, and the seniors health card - now received, as it points out, by many who are far better off than the taxpayers paying for it.

Is it because Labor has pledged a surplus in 2012-13 so often that it now has to deliver it?

Now you're very, very warm! The Finance paper points out that a lot of things could go wrong, some spending items are excluded from the forward estimates, and on current settings, a surplus in 2012-13 is not the certainty Labor has suggested it is.

So there are two strong reasons why we'll get spending cuts. Be prepared.