Not when but if China slows down

THE International Monetary Fund projects that within five years, China will overtake the United States to become the world's biggest economy. Yet investors are nervous that long before then the world's most astonishing growth engine might run off the rails.

In consecutive falls since the middle of last week the Shanghai Composite Index shrank by 4.75 per cent in six days, amid fears that the People's Bank of China might overreach in its campaign to rein in inflation.

The index is now more than 10 per cent below its peak, mainly because China's inflation rate climbed to 5.4 per cent in March (BHP and Rio, take a bow) and in just seven months, the central bank has tightened quantitative controls eight times and raised interest rates four times.

So it should be no surprise that recent figures have shown growth in manufacturing output slowing, or that analysts such as Goldman Sachs are edging down their forecasts of China's 2011 growth (in Goldman's case, just from 10 per cent to 9.4 per cent), or that Standard & Poor's should highlight the possibility that in a worst case scenario, 10 per cent of loans by Chinese banks could be non-performing within three years.

Does that mean China's extraordinary run is ending? And what are the risks for us if our main customer should stumble? Like most of us, I'm no China expert. But over the years, we've all seen warning after warning that China's record growth is about to end. So far it hasn't, and the institutional wisdom is that it won't.

This year the IMF estimates China's GDP will be 20 times what it was in 1980. That's right: twenty times. Australians think we've done pretty well, yet our GDP is only 2.7 times the size it was then.

On the IMF's figures, China has gone in just 30 years from being one of the world's poorest countries to being its biggest middle-income country. For 30 years it has averaged growth of 10 per cent a year. Not even Japan or South Korea have matched that.

Nonetheless, China has got there with an economic model that owes far more to its Asian neighbours than to standard Western economics. In Western economics, the consumer is king, and the goal of economic policy is to maximise consumer welfare. In Chinese economics, the producer is king, and the goal of economic policy is to make Chinese producers the most competitive in the world.

Its policy mix is quite different from that used by Japan and Korea in their rise. They relied essentially on protecting their domestic market by shutting out foreign investment and imports alike, and developing a highly effective culture of innovation by imitation and kaizen (continuous improvement) to develop world-class industries behind their protective walls. The walls came down only when they were already globally competitive.

By contrast, in the 1990s, the West forced China to lower its protection dramatically as its entry fee for joining the World Trade Organisation. That forced China to rely on weapons the WTO could not control: a heavily undervalued currency that makes its exports more competitive, and imports into China less competitive; a host of behind-the-border controls; and a culture of ruthless piracy of Western innovations.

Many argue that this cannot last. To keep its exchange rate low despite its explosive growth, for instance, China acquired more than $1 trillion of US Treasury bonds exposing itself to the risk of huge losses if its de facto currency peg collapses. But as the US dollar has slid since 2009, the People's Bank has managed to juggle its conflicting goals: at first going down with the US, then allowing the yuan to creep up by 5 per cent against the $US, but continuing to slide against other currencies.

It is gradually moving out of US Treasuries, instead using its huge current account surpluses to buy up companies and resources in direct investments around the globe. Federal Reserve data suggests China bought just $51 billion of Treasury bonds in 2010, and has been a net seller this year.

The fears of investors are not shared by the international financial authorities. The IMF's latest Outlook last month projected that China's growth would slow only marginally, from an average of 10 per cent a year since 1980 to 9.5 per cent over the coming decade. Here in Australia, Treasury's forecasts are broadly similar.

If it is wrong, the consequences for Australia could be dramatic although more for individual companies than for the economy overall. Australia's currency has soared largely because of the high commodity prices created by China's booming demand for iron ore and coal. If China stumbles, the first casualties here would be high commodity prices and the high dollar.

The effects of that could be complex. Mining companies gain from high prices, but lose from the high dollar. The new mines opening up are cost efficient and a lower dollar could see them offset lost sales in China by gaining new markets elsewhere. But the dislocation would be severe.

Mining investment would slow sharply. But other globally exposed industries such as manufacturing, tourism and agriculture would benefit if the high dollar disappeared.

The Reserve Bank too would face conflicting pressures. The high dollar has helped it by lowering import prices and slowing the rest of the economy: the transition to a low dollar would imply higher import prices, pushing up inflation. But the Reserve's prime fear is that the resources boom could lead to a wage-price spiral. If China stumbled, that boom would deflate, and the fear with it.

But will China stumble? Before you join the bears, remember: China is a country that lives well within its means. The IMF estimates its savings rate at an astonishing 54.3 per cent of GDP. And its current account is running a surplus of 5.7 per cent of GDP. Just as Australia is bound by its low savings rate and current account deficit, China's high savings rate and surplus gives it the freedom to flick the switch to consuming whenever it needs to.

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Miners talk big but don't deliver

MINING companies are planning an investment boom to make all other booms look flat. But can they deliver?

If they can, then the hawks have a case for lifting interest rates now, despite almost all the arguments against it. If they can't, then let's preserve our options as the future grows murkier.

Yesterday's Bureau of Statistics survey of business investment reveals a widening gulf between what mining companies say they will invest and what they actually invest. Three months ago, they said they had invested $22 billion in the six months to December 2010. But they told the ABS they would invest $35 billion in the six months to June.

Uh-huh. Well, three months later, we find they invested only $10 billion in the March quarter.

Sure, there was a cyclone and floods, and yesterday's figures are only preliminary. But 2010-11 will be the fifth consecutive year in which mining investment will stop well short of the forecast.

It matters because the miners forecast $83 billion of investment in 2011-12 twice what they're investing now. If they achieve that, it would be by sucking resources from other parts of the economy to clear shortages that limit investment now.

The main story of 2010-11 was that Australia sank back into below-trend growth as interest rate rises forced consumers to tighten their belts. Fitch Ratings reported yesterday that mortgage delinquencies soared in March to 1.8 per cent. Take care.

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Let consumers carry the can on carbon

Labor is losing the carbon tax debate. It is pressing on, hoping that once the tax is in place, the fearmongering will die away, and Australians will accept it reluctantly, as they accepted the GST.

They might. But it is equally likely that the Coalition will keep riding the issue, win the 2013 election, dismantle the tax, and we will end up much worse off than we started.

Is there a better solution? Yes. What matters most - for anyone who wants to see Australia and the world take effective action to stop climate change - is not to press on regardless, but to stop right now and ask if there is a politically more acceptable way to achieve that goal.

And there is an alternative: not perfect, but politically more acceptable, in Australia and in other countries - such as the United States and China - that have been cowed by the same problems and refused to put a price on their carbon.

Labor plans to tax carbon emissions produced in Australia, following the model set by Europe. But its task would be easier if it were to tax carbon emissions on products consumed in Australia, wherever they were produced.

This would make its carbon tax easier to sell here. But more: it would make it easier for any country to put a price on carbon - because this gives them a model that does not disadvantage local producers.

It is global action, not Australian action, that will decide if carbon emissions stop heating the world. Globally, taxing production of carbon emissions has proved too hard for key countries. But if we tax consumption of them instead, it could unlock the door to global action.

Why? Look at what is happening in the debate here.

Labor is losing the debate for many reasons. But a key one is that it has to fight on too many fronts. Most Australians want action on climate change, but don't want it to make them worse off. Their wishes could be met, but only if the money raised by a carbon tax is returned to households by cutting taxes and raising welfare payments - as happened with the GST.

But companies exposed to global competition are also fighting a plan that would tax them but spare their overseas rivals. A carbon tax would threaten key industries that Australia will need once global supply of minerals expands, and prices go back to normal.

The government plans to compensate industries it sees as ''internationally exposed''. But it can't compensate industry and fully compensate households. And last time, its list of industries was arbitrary, leaving out many that would lose from a tax on domestic producers only.

Bluescope Steel, rated in the top third of global steel makers for carbon efficiency, estimates that in year one it faces a tax of up to $39 million, while its Asian competitors go tax-free. A study by PricewaterhouseCoopers for the Federal Chamber of Automotive Industries concludes that the Australian car industry could pay between $30 million and $84 million a year, up to $412 per vehicle.

That shouldn't worry us if all car makers faced the same tax - but they won't. In Labor's model, only Australian car makers would pay the tax. Tell me, what is the benefit of that?

Geoff Carmody sees no sense in it. A respected economist who left Treasury in 1990 to co-found Access Economics, he argues that, rather than follow Europe in taxing producers of carbon emissions, we should set the world an alternative model by taxing consumption of them.

How does that make a difference? Carmody put it very simply in a recent interview on ABC radio's Late Night Live: ''A production tax hits all our exports, and none of our imports. A consumption tax hits all our imports, and none of our exports.''

In practical terms, that means there is no need for any compensation of industry: none at all. All of them would be facing the same taxes as their overseas competitors. The whole issue of unfair burdens on business would disappear, and all the revenue from carbon tax could be divided between compensating households and investing in renewable energy.

There are two problems with the Carmody model. First, any estimate of the carbon content of an imported product will inevitably be arbitrary, approximate and bureaucratic.

How much carbon is there in a frying pan from China, a ream of paper from Indonesia, a car from Korea, or a machine tool from Germany? Australia would be the first mover on this form of carbon tax, so we would have to work it all out, for every product. That would take time and money, to deliver rough justice.

Second, it gives no advantage to more carbon-efficient producers. There's no incentive for producers to reduce carbon use, because for simplicity, all frying pans and paper reams would be taxed the same. In the long term, when the whole world uses carbon pricing, the Carmody model should give way to emissions trading or a global carbon tax.

But it makes a global carbon deal more likely. The governments of the US, China, Russia, Japan and the rest have put off carbon pricing because they fear it would disadvantage local producers. If Australia, one of the largest emitters of greenhouse gases, adopts a model that is politically acceptable, it would open an easier path for them.

Three years ago, I thought the flaws in the Carmody model outweighed its strengths. Now, with key countries hanging back from carbon action, no global deal likely, and the high dollar forcing Australian industries to the wall, it seems to me the best option.

It could give us a carbon tax that works - and the world, a way to break the impasse.

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National tax pain set to be Victoria's gain

WHO wins, who loses from the West Australian government's decision to end a $2 billion loophole in its iron-ore royalties? WA wins in the short term probably. Victoria and other states stand to win big in the medium term. The miners will get off scot-free, thanks to Canberra's pledge to pay their royalties.

And that means the Commonwealth will be the loser but an angry loser, with many ways to get even.

The WA royalties won't kill off Wayne Swan's budget surplus. On Treasury estimates, there would still be surpluses of $3 billion to $5 billion each year from 2012-13 to $2014-15. And Labor will find ways to get back its losses.

The key result will be to heighten WA's bitter complaints over the split up of Commonwealth grants by pushing the system to breaking point.

WA Treasurer Christian Porter says that under current rules, the Commonwealth Grants Commission eventually will take the new revenue off WA so that by 2014-15 it would receive just 33 cents in every $1 that WA taxpayers pay in GST.

For decades, Victoria and NSW have subsidised other states (including WA), but never on that scale.

We now face a new reality. One state can raise far more revenue than the rest. WA estimates its iron-ore royalties will grow from $305 million in 2003-04 to $4.75 billion in 2013-14. It's a colossal windfall. It would be like Victoria seeing an extra $10 billion fall from the sky.

But WA has one problem: the Grants Commission. Its job is to distribute GST money to even out the differences in state revenue capacities. That means, over time, it takes all that extra money off WA to give to other states including Victoria.

It's happening now. Before the resources boom, WA was always subsidised by NSW and Victoria. But next year the Commission will give $1.5 billion of WA's GST revenue to poorer states and territories. WA projects that by 2014-15, it stands to lose $4 billion almost all the money it raises in iron-ore royalties.

There is not space to explain the technicalities. But Swan is right: over time, WA stands to lose all its new royalties, and more. It could even lose them next year, although it is likely to keep them for a few years before the commission's formulas claw them back.

Resources Minister Martin Ferguson says the Commonwealth will honour its pledge to pay the miners' royalties when it brings in its own mining tax. It will continue existing infrastructure projects in WA. But WA could lose the rest of the $2 billion of infrastructure projects promised with the mining tax.

So why did WA do it? I suspect it's a deliberate strategy to change the Grants Commission formulas, by raising the stakes so high that they become politically unworkable.

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NZ opts to cut family benefits

NEW Zealand's centre-right government will follow Australia in cutting family benefits, amid a range of spending cuts to pay for rebuilding Christchurch and returning the budget to surplus.

In a budget remarkably similar to that presented last week by the Gillard government, NZ Finance Minister Bill English pledged yesterday to spend $NZ5.5 billion ($A4.1 billion) to rebuild Christchurch from the devastation of its two earthquakes.

Yet he also brought forward his pledge to end the budget deficit to 2014-15, two years later than Australia plans to get there.

Mr English said NZ's deficit in 2010-11 would blow out to $NZ16.7 billion or 8.4 per cent of its GDP, partly due to the earthquakes, but halve in 2011-12, and the budget would be in surplus by 2015.

But that goal rests on optimistic forecasts of three years of strong growth, and big spending cuts in five areas:

Better-off families will lose family benefits or have them cut, while families with older teenagers will get higher benefits reforms almost identical to those planned by Labor here.

The huge subsidy to NZ's superannuation scheme, KiwiSaver, will be halved, with employers and workers each required to lift their contributions from 2 per cent of wages to 3 per cent.

New Zealanders living overseas will have to start repaying their HECS-style student loans after a year away (instead of three years).

Minority stakes will be sold off in electricity generators Mighty River Power, Genesis Energy, Meridian Energy and Solid Energy, as well as Air New Zealand.

As in Australia (and Victoria), the government has chosen invisible spending cuts by giving departments less money to do their jobs and leaving them to decide what to cut.

And as in Australia, Mr English said NZ would use most of the money for new spending in health, education and rolling out broadband and transport infrastructure.

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Live and let live - as long as it's elsewhere

The NIMBY syndrome (Not In My Back Yard) has won Melbourne. A new survey finds 52 per cent of the city's residents oppose having more people in their suburb, and only 11 per cent favour it.

In a survey with bleak implications for governments, planners and developers trying to create a new Melbourne by building up rather than out, a Nielsen survey for the Productivity Commission has found a clear majority oppose residential redevelopment in their suburb.

The survey, of more 3000 Melbourne residents, found 53 per cent oppose redevelopments that replace single dwellings with units or apartments.

Such redevelopments have generated half of Melbourne's building approvals in the last year. The Brumby government had planned for them to house half the city's growth to 2030.

The ever-widening gap between housing prices in inner, middle and outer suburbs suggests that the big unmet demand for housing in Melbourne is from people wanting to live in inner and middle suburbs. But resident opposition has blocked many redevelopment plans to house them.

The survey, conducted for a commission report that benchmarks the states in planning, zoning and development assessments, suggests the resident activists reflect the views of their neighbours - not only in Melbourne, but almost everywhere.

People in Sydney were even more hostile to redevelopment, while Geelong was the most hostile of all. The only place where supporters outnumbered opponents was Mount Gambier.

Of Melbourne residents against having more people in their suburb, 86 per cent fear it would lead to increased traffic congestion, 56 per cent to increased noise, 48 per cent fear loss of street appeal, 37 per cent more crowded public transport, 35 per cent shadows from tall buildings, and 27 per cent fear it would lower their property's value.

Those who want more people around them say this would create more vibrant suburbs, attract more services, retailers and public transport, and lift property prices.

Some oppose not just redevelopment, but any development. The survey found 29 per cent oppose residential development in new areas - underlining how hostile Melbourne has become to population growth. It comes as the Bureau of Statistics reports that lending to rental investors in Victoria fell by 4 per cent in March from a year earlier.

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Budget's not tough enough? Get real

THE Age/Nielsen poll tells us 44 per cent of Australians are satisfied with the federal budget, and 44 per cent are dissatisfied. I'm with both groups.

We are right to be satisfied. This was a workmanlike budget that responded to Australia's economic needs. It invested in skills training, trimmed spending on middle-class welfare, kept the budget on track to surplus by 2012-13, and kept investing in infrastructure.

And we are right to be dissatisfied. Australia needs more than a workmanlike budget. We need to train many more skilled workers, to invest far more in infrastructure, and to pay for it by reforms to shut tax loopholes and use our resources more efficiently. That didn't happen.

But the critics hit the budget for the wrong reasons. The Australian slammed it on Wednesday for being too soft - ''That's not a knife, Treasurer'', its headline ran - then reversed course on Thursday to claim Labor had declared ''War on middle-class welfare'' (without a knife to fight with?)

It was wrong both times. Treasury estimates that the last two budgets will deliver the sharpest fiscal tightening seen since records began. In the three years from mid-2010 to mid-2013, Treasury predicts, the budget will go from a deficit of 4.3 per cent of GDP to a surplus of 0.2 per cent.

That would withdraw 4.5 per cent of GDP in three years. By contrast, the Howard government lifted the budget balance by 4.1 per cent in four years. The Hawke/Keating/Walsh team in the '80s raised it by 4.8 per cent over five years (but largely by cutting grants to the states).

Think of this: the government over these three years will suck a cumulative $126 billion out of the economy. It has taken out $12.5 billion in the year just ending, and will take $43.5 billion out by 2011-12, and $70 billion out by 2012-13. That is like shutting Australia's communications and IT industry for three years.

Not tough enough? When half the economy is going sideways or backwards? Get real.

I suspect that is why Tony Abbott virtually ignored the budget in his budget reply. This is a well-crafted, workmanlike budget that is tough without belting anyone really hard. The right demanded cuts to middle-class welfare. It is humbug for it to whinge when its calls are acted on.

Some on the left criticise the budget for using sticks as well as carrots to try to get the unemployed from welfare to work. These measures might not be perfect, but the direction is right. They recognise that the long-term jobless are jobless mostly because, in some way, their lives are messed up, and they lack the mix of education, skills, health, and self-discipline we need to be effective workers.

Getting people from welfare to work costs money in the short to medium term. It delivers rewards in the long term. The failure of the Howard government to understand that cost us dearly; by 2007, 10 per cent of Australian men aged 15 to 54 were outside the workforce. Labor has understood that, and plans to invest in people who need help to return to the workforce. Too modestly, perhaps, but enough to deserve applause.

But this budget won't stop the Reserve Bank raising interest rates, some moan. No, sadly, nothing will stop the Reserve Bank raising interest rates. It is certain that Australia is heading into a mega-boom. It forecasts that non-farm GDP will jump 6 per cent in the nine months to December, which will send inflation soaring unless it raises rates.

Mere lack of evidence has not dissuaded the Reserve from this view, nor that it got it wrong last year (when it forecast non-farm growth of 3.25 per cent, but we got 2.1 per cent). Would cutting the budget deficit even harder change its mind? No. Governor Glenn Stevens says it will lift interest rates when it thinks they're too low, even if the budget too is cutting demand.

Some people I respect criticise the budget for making policy decisions that give a net stimulus of $2.4 billion in 2011-12, when the Reserve wants to slam on the brakes. But look closely: all of that ''stimulus'' and more comes from just three items.

They are: $1.4 billion to bring forward tax breaks for low-income earners; $1.2 billion to keep our soldiers in Afghanistan, East Timor and the Solomon Islands; and $700 million to allow small business to defer part of its tax bill until next year.

Which would you scrap? These tax breaks will help those not sharing in the resources boom to cope with its strains.

The real flaw in this budget is not what it does, but what it doesn't do. Issues Abbott won't talk about are mostly ignored: and they are big ones for our future.

We need to build the infrastructure for our cities to cope with a future Australia of 40 million people. We need to make housing affordable again for younger Australian families without rich parents. And we need to fix the tax system.

This means the government must return to the neglected Henry review. We need a proper mining tax to replace the weak one Julia Gillard gave us. We need to cut (and preferably end) the rort of negative gearing, in a broad reform of savings incentives. We need to cut effective marginal tax rates, and across the board, end tax rorts so we can cut tax rates.

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Tax benefit anger wasted on those earning $150,000

IF YOU'RE earning $150,000 a year, are you living on Struggle Street? Should we be outraged for you if some government decides you don't need family benefits?

No. Taxation statistics imply that only 3 to 4 per cent of Australians earn $150,000 a year. Compared with other Australians, they're not struggling.

Far more Australians have household incomes over $150,000. Updating the latest household income data from the Bureau of Statistics, 17 per cent of households, or one in six, have pre-tax incomes of more than $150,000.

But that's almost irrelevant to the budget cuts. The only benefit that depends on household income being under $150,000 is the baby bonus. And freezing its threshold until 2014 will deny benefits to only about 2000 families.

Coalition and media claims that households on $150,000 would lose the much bigger Family Tax Benefit B are wrong. They would lose Family Tax Benefit B, or the dependent spouse rebate or paid parental leave, only if the income of the primary earner rises over $150,000.

Anyone on that salary is not on Struggle Street. In 2008-09, only 3 per cent of Australians reported taxable incomes of $150,000 or more. Since then, household incomes per head have grown by 5 per cent. If evenly distributed, that would put 3.5 per cent of Australians above $150,000.

Families Minister Jenny Macklin said yesterday that only about 20,000 people stand to lose Family Tax Benefit B under the changes. "And let's remember: if they get a pay rise, families will still have more money in their pocket overall," she said.

However, it is a different story for the biggest benefit of all: Family Tax Benefit A, which goes to 1.9 million families, and will cost taxpayers $13.7 billion next year. It has no single threshold, but a number of them, depending on how many children you have, and their age. They range from $101,191 upwards, with most between $110,000 and $150,000.

Bureau of Statistics data for 2007-08, updated for growth in household incomes since, implies that a third of Australian households now earn more than the lowest threshold and by 2014, almost one in two could be above the threshold at which about the basic benefit starts to reduce.

Ms Macklin said yesterday about 76,000 families, about 4 per cent of beneficiaries, are likely to lose Family Tax Benefit A because of the freeze on thresholds. Another 210,000 families, or 11 per cent, will face a reduction in benefits.

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Mystery of dependent spouse

ONE of the biggest budget savings would be made by stopping taxpayers claiming the dependent spouse tax offset if the dependent spouse is under 40. The budget estimates that this will save other taxpayers $220 million in 2012-13, the saving rising.

That's a lot when the maximum offset you can claim is $2100, and the average in 2007-08 was $1614. That implies that at least 120,000 taxpayers will be losing the benefit or 30 per cent of all those now on it.

And yet there has been virtually no public reaction, no outcry. Tony Abbott said he was "instinctively" against it, but then Tony is instinctively against everything Labor does. Compared to the outcry over means tests on family benefits, it has barely registered.

Yet if you could fill the MCG with people who will lose $2000 from it, why aren't we hearing about it? Is it because for under 40s, the idea of being a dependent spouse at home without children seems archaic?

Labor hopes so. It sees the benefit, introduced in 1936, as a relic from another age. The Henry review argued that it reduces the incentive for the spouse to seek a job, and should be limited to carers, the disabled and the elderly.

What's the plan?

From July 1, you would get the tax offset only if your spouse was born before July 1, 1971. Labor was more timid than the Henry panel, which implied a cut off more like 1946. Treasurer Wayne Swan says setting 40 as the cut-off age "recognises that dependent spouses who may have been out of the workforce for many decades would find it more difficult to find jobs." But the 1971 date would be fixed, so the threshold age for the tax offset would rise to 45, then 50, and so on.

The new rule will not apply to dependent spouses who are carers, invalids, permanently unable to work, in a remote zone, or accompanying a partner on overseas service.

Will mothers at home still get it?

No, they don't get it now. If you're a dependent spouse with young children, you will be on the more lucrative Family Tax Benefit B and under the rules, you can't get both.

Then who gets it?

That's the mystery. In 2007-08, 401,625 taxpayers claimed the benefit. Apart from those earning less than $25,000 a year, they made up 4 to 5 per cent of every income group above that. The battlers and the rich claimed the same benefits in the same numbers. But is it true that one in three of their spouses are under 40?

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Benefits to be denied to 70,000

HUNDREDS of thousands of Australians will have their family benefits reduced, and about 70,000 families will be cut off benefits altogether, under Labor's reforms to get the federal budget back in the black.

As debate over the government's cuts to middle-class welfare dominated reactions to Tuesday night's budget, it emerged yesterday that the wealthiest three per cent of families now receiving benefits are likely to lose them altogether.

Opposition Leader Tony Abbott accused Labor of launching "class war" and asked Prime Minister Julia Gillard: "Why is the government tougher on families than on border protection?"

Mr Abbott and shadow treasurer Joe Hockey accused Labor of dodging tough spending cuts, but at the same time opposed key spending cuts Labor did make above all, to family payments.

The government hit back, arguing that cuts had to be made, and its moves trimmed only a small part of the $100 billion-plus that it will pay families over the next four years.

Under the plan, the mainstream Family Tax Benefit A will still be indexed for inflation, and the largest benefit, now $6161 a year, will be paid to parents of all teenagers still at school, rather than just those aged under 16. But the budget will:

Freeze the upper thresholds for benefits at the top end for two years, so that as incomes rise, parents on higher incomes will lose benefits faster, and ultimately lose them altogether.

Freeze the threshold for Family Tax Benefit B at $150,000, so that families will lose the benefit designed by John Howard for stay-at-home mothers, then extended to those working part-time as the income of the principal breadwinner tops $150,000.

Freeze the end-of-year supplements paid to all recipients of both benefits, which began life as the $600 "cash splash" offered by Mr Howard to families at the 2004 election.

The government estimates that 31,000 families will lose Family Tax Benefit A in the first year of freeze, which implies that up to 70,000 families could lose their benefits by the end of year two.

Hundreds of thousands more would have their future benefits reduced as their incomes topped the thresholds, mostly around $100,000, but varying with the number of children and their age.

The freeze on benefits for the supplement would hit all the 1.9 million families on benefit A and 1.6 million on benefit B. But their losses would be relatively minor, at most $20 per child in year one, rising to $69 per child in year three.

Ms Gillard said yesterday the government had to take tough decisions. "Family payments will still increase under this budget", she said. "All fortnightly rates will still increase under family Tax Benefit A and B", she said.

Mr Abbott said: "This is a government which thinks that a policeman married to a nurse is part of a super rich family. This is a government that thinks that two school teachers living as a family in Sydney are super rich.

"Why is this government always targeting people who want to get ahead? This is a government which is not tough on waste but is tough on families".

Treasurer Wayne Swan defended the government's commitment to families. "We've increased the Child Care Cash Rebate from 30 per cent to 50 per cent", he said. "We've added schools uniform to the Educations Tax Rebate. So there's a lot we are doing for families under financial pressure."

Mr Swan said there would be a "really healthy debate" over family payments and how to simplify the tax and transfer system in the lead-up to the October tax summit.

He told a post-budget lunch that the intersection of taxes and welfare clawbacks created high effective marginal tax rates. While the government's reforms had taken pressure off some of the worst effective marginal tax rates, he said there was "more work to be done in that area".

Roughly 40 per cent of the money saved by freezing the thresholds would be recycled to pay far more generous benefits to parents of 16-to-19 year-olds, provided the children are still at school.

Families Minister Jenny Macklin said the measure, which was recommended by the Henry tax review, "will help families with the cost of raising teenagers, and encourage teenagers to stay in school".

"The families of around 650,000 teenagers turning 16 over the next five years could benefit from these substantial increases, if the young person stays in school," she said.

Equipping young Australians with the skills needed to find a job, and using carrots and sticks to get people from welfare to work, were the twin themes of the budget, along with getting the bottom line back in surplus.

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Labor is too weak to cut spending? Sorry.

HOW do we explain it? Unemployment is less than 5 per cent. Banks and mining companies are reporting record profits, even if High Street is hurting. The global financial crisis ended here long ago. Soaring export prices have made Australia richer than ever.

Yet our federal budget is sick. This year's deficit will be almost as big as last year's. And then, even with a formidable $22 billion of spending cuts and revenue rises announced yesterday, and on optimistic forecasts of economic growth, Treasury estimates that it will still be in deficit next financial year, although less so, and will deliver only small surpluses in the following three years.

The Liberals want us to think it's because Labor is too weak to cut spending. Sorry, guys, but this budget cuts spending quite a lot. We will see that in coming days because the Liberals and Nationals will be screaming blue murder against the very cuts they say there should have been more of.

It can't have been an easy political decision for Labor's leadership to take $2 billion off middle-class families by freezing family benefit payments and thresholds at the upper levels. It can't have been easy to choose to lose votes by cutting younger Australians' access to a dependent spouse rebate, or to halve the discount for making HECS payments as you go.

This budget has hundreds of savings measures, mostly transparent, and some of them deliberately opaque. That includes an extra $1 billion saved by increasing the so-called "efficiency dividend" by which the starting point for every allocation is cut by 1.5 per cent. It's a tactic that forces bureaucrats to cut programs without the politicians having their fingerprints on it.

But wait, there's more. On top of that, the budget makes dozens of cuts mostly small, one very big for additional "efficiency savings" in specific departments and agencies, and many other silent cuts by requiring departments to fund new programs from existing resources. The Defence Department alone has been ordered to make $1.2 billion of additional savings over four years. The Department of Education, Employment and Workplace Relations will have to fund $128 million of new programs from existing resources.

This is not a hair-shirt budget, and most of its savings will be used to fund new spending: on workforce training, mental health, hospitals, flood relief, and more support for families with teenagers. At first sight, most of that seems well-targeted, even overdue. The budget estimates the net savings over five years at just $3 billion, which is not much help towards Labor's goal of ensuring that the budget is back in surplus by 2012-13.

The economic forecasts by which Treasury predicts the surplus will be reached on target are not reassuring. Treasury now concedes that despite all the rebuilding, business investment has grown just 4.5 per cent in 2010-11, not the 8 per cent it forecast six months ago, and that private spending overall grew just 3 per cent, a far cry from its 4.75 per cent forecast.

Some of us would interpret that as evidence that the headwinds facing the economy are much stronger than Treasury and even more, the Reserve Bank will admit. We would trim our forecasts. They, however, are bumping theirs even higher. Treasury now forecasts that business investment, already at record levels, will soar by a third over the next two years: 16 per cent next year, and a further 14.5 per cent in 2012-13, lifting GDP growth to 4 per cent. If it's wrong, the surplus could be in trouble.

But how could the budget be in any trouble, with record numbers of us in jobs, earning record amounts, producing more than we have ever produced before, and with two of our biggest sectors recording sky-high profits?

Some will tell you it's too much spending, but it isn't. Between 2000 and 2008, the Howard government on average spent 24.1 per cent of Australia's GDP. Next year, Treasury estimates, Labor will spend 24.5 per cent, and then an average of 23.7 per cent over the next three years of skinny surpluses. Spending was certainly part of the problem in the past three years, but not in the period we're moving into.

No, the enduring problem is revenue. In the years of plenty from 2000 to 2008, Howard and Costello took 25.3 per cent of Australia's GDP in taxes and other revenue. This year that slumped to just 21.9 per cent, a shortfall of $47 billion. That's almost the entire budget deficit.

What about the new financial year? Revenue is forecast to rise to 23.2 per cent of GDP, still a shortfall of $31 billion. Over the next three years after that, it is forecast to average 24.2 per cent, a cut of $17 billion a year from the Howard/Costello average. If we had normal revenues, we would be in surplus in 2011-12, with cushy surpluses thereafter.

Then why is revenue so sick? There is no one reason, there are five of them. The global financial crisis and generous tax laws have left companies with almost $300 billion of tax losses, which they will use up slowly to hold down their taxes for years ahead. The weak stockmarket has slashed collections from capital gains tax, companies other than banks and mining are doing it tough and, let's face it, we never could afford the income tax cuts both sides offered us in 2007.

The worst blow is that the record mining profits are not lifting us into surplus, as they did in the past. Generous tax breaks allow miners to quickly write off against their tax bills the cost of developing new mines. They're investing so much that they're not paying much tax either. One day they will, but that day is still years away.

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State's prayer: 'Get us out of debt, but not yet'

IT WAS the young St Augustine who prayed: "Lord, make me chaste but not yet." Last week he was joined in the pews by the young Baillieu government.

After denouncing the Brumby government for taking on new debt to build infrastructure, Team Ted's first budget did just the same. It increased spending, cut taxes, and paid for it by almost trebling the state's debt from $8 billion in mid-2010 to a projected $23 billion in mid-2015.

At the same time, like its predecessor, it pledged to stabilise the debt in a few years' time but now at $23 billion, rather than the $16 billion Labor promised last year.

Both sides are united in the same prayer: "Lord, make me stop living off debt but not yet."

Last Tuesday's budget focused justifiably on keeping Ted Baillieu's campaign promises. Most were humane, targeted programs to benefit pensioners, low-income earners and first-home buyers, and to boost services such as public transport and mental health.

Treasurer Kim Wells argued that the government could not tackle the debt while implementing these promises.

That it chose to keep its promises tells us something about Baillieu. But that it put off tackling the debt indeed, allowed it to treble also tells us that his rhetoric about the "ruinous" fiscal position left by Labor is just rhetoric.

The Brumby government had serious flaws, but its handling of state finances was responsible, as the state's AAA credit rating testifies.

But now the focus switches to what comes next. And that could be very different.

The day after the budget, Wells foreshadowed that next year's budget will be tough. By then, the government will have received the final report of the Vertigan review of state finances that will examine how and where spending can be cut.

The panel's first report last month claimed the state's finances were already in underlying deficit, and on an "unsustainable" course. It urged spending cuts of $2 billion a year to put things back on track and finance future investment in infrastructure.

Rather than using debt to help finance infrastructure spending, as governments have done for centuries, the Vertigan panel called on the government to:

Pay off all infrastructure spending within 10 years claiming the main benefits of new infrastructure projects are to the generation that builds them, not future generations.

Pay off its existing debt as soon as possible.

Ensure that net infrastructure investment, as defined by the Bureau of Statistics, is around 0.5 per cent of gross state product each year. By contrast, Tuesday's budget envisaged it will be just 0.02 per cent of GSP in 2013-14, and 0.12 per cent in 2014-15.

These are very challenging goals particularly for a government that has begun its term by increasing spending and debt. The government has yet to respond, and Wells declined to do so last week. But he agreed in principle that infrastructure spending should be financed by taxes, not debt.

"Over the long term, we want to be able to generate enough cash in the operating surplus to be able to fund our infrastructure works," he said. "I find it difficult to believe we are going to fund infrastructure projects with debt in the long term."

But to finance them with cash, you need either more cash (a.k.a. higher taxes) or big cuts in spending. And if Baillieu is to meet voters' expectations of better infrastructure, he will have to spend even more on it. His government, like Brumby's, could promise to stabilise the debt only because it plans to turn down the flow of infrastructure spending to a level that, on the Vertigan panel's definition, would barely keep assets at current levels.

The issues the panel raised are real, so it's a pity its report was so flawed. It began by falsely claiming the government's April statement on state finances "suggested the current level of debt may be significantly larger than previously reported". It didn't, and they weren't.

Its claim that government spending has jumped sharply to an unsustainable trend ignores the reason why: the federal stimulus that staved off the global financial crisis was paid through the states and that spending is deflating already. The state's share of Victoria's spending including infrastructure was 12 per cent at the end of the Kennett government, and rose to 12.5 per cent in the three years to 2008. That was needed, and it was sustainable.

The panel's argument that infrastructure investment should be paid for by the current generation because its main benefits flow to them is just nonsense. The railway network built in Melbourne in the late 19th century benefited the millions of people who have lived in Melbourne since far more than it benefited the relative few living in Melbourne at the time. The same is true of roads, schools, hospitals, parks, dams even desal plants.

Baillieu has an alternative: to rely on future growth and sustained fiscal discipline, with some spending cuts, to allow him to build more infrastructure without increasing debt faster than the state's output.

After all, he needs a solution that is compatible with winning re-election.

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Reserve's deja vu forecasts

A YEAR ago, the Reserve Bank forecast that non-farm GDP would grow by a buoyant 3.25 per cent in 2010. In fact, it grew 2.1 per cent. The RBA predicted underlying inflation, its key target, would grow 2.75 per cent. In fact, it grew 2.2 per cent.

Those erroneous forecasts drove the Reserve's decision to raise interest rates four times in 2010, while the private banks exploited the lack of competition to boost their profits with what amounted to a fifth rate rise.

Now, we seem to be in deja vu. The Reserve's new forecasts yesterday assume that the growth in output and prices that didn't happen in 2010 will show up in 2011. And its concluding comments clearly flag an interest rate rise ahead.

It estimates that the floods in January will send GDP backwards in the March quarter. That implies non-farm GDP growth for the year to March of just 1 to 1.5 per cent. Yet despite that, the RBA predicts growth for 2011 at 4.2 per cent, and non-farm growth of 4.5 per cent, with underlying inflation rising to 3 per cent.

Well, that implies an annualised GDP growth rate of 6 per cent over the three quarters to December, including this one. And that's with the dollar dragging down trade-exposed industries; consumers saving, not spending; housing in a slump; job growth slowing; business confidence flat; and the risks to global growth still significant.

But wait, there's more. The final section of yesterday's Statement on Monetary Policy warns that the biggest risk to that forecast is that the economy will grow even faster, and put even more pressure on prices. Its central forecast is for a 2011 boom, with a big risk that the boom will get out of hand.

Well, it's possible. The Reserve has picked some long shots before. And yes, mining is booming, but the economy is not.

A year ago, the Reserve forecast GDP growth in 2010 and 2011 combined at 7.1 per cent, with inflation at 6.1 per cent. Despite all that has happened since, yesterday its two-year forecasts were exactly the same. It simply shifted into its 2011 forecasts the growth it wrongly predicted for 2010. With the data pointing elsewhere, this suggests a touch of hubris, that might be insulating it from the reality on Main Street. The data we see presents no credible case for a rate rise. Last year the Reserve jumped the gun, delivering too much restraint, too soon. The risk now is that it might repeat that mistake.

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Victoria Budget: Tougher next time, Wells

TREASURER Kim Wells has flagged a tough budget next year, with the state government set to take hard decisions on spending cuts so it can stop relying on debt to finance Victoria's new roads, railways and other infrastructure.

In the wake of Tuesday's unexpectedly mild budget, Mr Wells told a post-budget lunch the Baillieu government's ultimate goal is to pay for its infrastructure spending out of current revenue, not borrowing.

If it is to keep building at current levels, that would require big tax rises or spending cuts. Next year, the government plans to invest $6.1 billion, and pay for it with almost $5 billion of new debt.

By 2013-14, the budget forecasts, net borrowing would shrink to $1.2 billion a year, but largely because infrastructure spending would shrink to about $4 billion far below the level urged by the task force on state finances, headed by the Kennett government's Treasury secretary Mike Vertigan.

Mr Wells told the Committee for Economic Development of Australia the Vertigan taskforce will now investigate government services to suggest where and how spending can be cut.

Mr Wells said this year's budget was the wrong time to tackle Victoria's reliance on debt financing.

"We had a choice to make," he said. "Do we fix the debt issue this year, or do we deliver our election commitments? The people expect us to deliver our election commitments, so we have done that."

The first report of the Vertigan task force last month said spending cuts of at least $2 billion a year are needed to allow the government to finance an adequate level of infrastructure spending from operating revenue. It proposed net infrastructure investment of 0.5 per cent of gross state product (GSP) as the benchmark.

But Tuesday's budget foreshadowed net investment of just 0.02 per cent of GSP in 2013-14, and 0.12 per cent in 2014-15, a tiny fraction of the current level of 0.78 per cent. .

Mr Wells yesterday declined to respond to the Vertigan team's proposals, other than to endorse the principle of paying for infrastructure spending from taxes rather than long-term debt.

Shadow treasurer Tim Holding said he had no qualms about the sustainability of the budget debt levels, but accused the government of breaking a promise by failing to outline a strategy to reduce debt.

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Victoria Budget: Team Ted sings precisely to the election tune

THIS budget is very Ted. For months his government has been thumping out an alarming drumbeat about the "ruinous" state of the budget Labor left behind. It seemed we were being psyched up to accept a budget that cut spending and hiked taxes to put it all back in order.

But no. Yesterday's first Baillieu government budget is so moderate that no one could sensibly object to it other than for lack of daring. Team Ted has done what he promised to do in the election campaign, and hardly a thing more. Despite the tough talk, the bottom line is that this budget increases spending, cuts taxes and pays for it by taking on more debt.

Remember when Jeff Kennett and Alan Stockdale did when they took power? Within three weeks, they had announced massive job cuts, electricity price hikes, cuts to transport and other services. Union chief John Halfpenny led 100,000 people to demonstrate against them on the steps of Parliament House. It was revolution.

Remember when John Howard and Peter Costello took power and declared they had inherited a "Beazley black hole"? They then used their first budget to cut spending by $6 billion in one hit, dumped half their campaign pledges as "non-core promises", and slashed export and job training programs so deep it still hurt 10 years on.

The Baillieu government is not going to be like that. It came in with a program, and it is going to deliver that program. Yes, it's been shouting out from the rooftops that Brumby left the budget in ruin, and that the Gillard government has made it even worse. Its handpicked fiscal task force headed by former Treasury secretary Mike Vertigan claims the budget is on an "unsustainable" track, and requires spending cuts of $2 billion a year.

But is that going to change Ted's plans? Not one sausage.

Treasurer Kim Wells took pride yesterday in telling us that the budget enshrines all the Coalition's campaign promises, except for putting protective service officers into hospitals, which is still being worked out. For all the rhetoric, his budget is business as usual.

Those promises include spending cuts estimated to save $1.6 billion over five years, by forcing departments to trim their purchases, consultants, advertising and head office staff. That's just housekeeping: this government will be spending more than $250 billion in that time.

Yesterday added another $638 million over four years of small-scale spending cuts, most deliberately left vague. The pointiest of them is to limit the $300 School Start bonus to low-income families. If you've got to cut spending, that's a pretty fair way to do it.

The budget papers reveal another $932 million over four years from anonymous "reprioritisation and other adjustments" to spending plans: we'll find out what they are when they don't happen. Ted also plans to collect $481 million in extra revenue over four years, mostly by hiring 50 more tax inspectors. That's as revolutionary as this gets.

The bottom line, even after all those savings, is that the Government's decisions collectively will increase ordinary spending by $2.9 billion over the next three years, and cut taxes by $174 million. It plans to spend $2.35 billion more on new infrastructure than the Brumby government had budgeted for.

And to finance all that and to pay for the hits from the Grants Commission and cost overruns on projects such as regional rail and myki Ted and his team plan to borrow $10 billion over the next three years, more than twice as much as Brumby last budgeted for. Over five years, the Baillieu government would almost treble the budget's net debt, from $8 billion in mid-2010 to $23 billion in mid-2015. That wasn't one of their campaign promises, but it's their solution to the pickle they found themselves in trapped between campaign promises, shrinking Commonwealth grants, and rising project costs.

Let's make two points clear. First, that level of debt in itself is nothing to worry about. If these figures are right which is a big if the debt would peak at about 6 per cent of Victoria's annual output, at a time when Washington would owe 83 per cent of its GDP, and Japan 156 per cent.

But second, no one can increase debt forever. Wells envisages that Victoria's debt will settle by 2015, but in part because infrastructure investment would shrink to replacement levels. That's not a long-term solution, so he also implied that next year's budget will be the tough one, after the Vertigan audit team has picked through spending in detail.

That would be challenging. Baillieu has shown us he is a careful decision-maker. He could prove a hard man to convince of the need for big spending cuts, when fiscal discipline and years of growth could do the job without that pain.

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