Debate about how big government should be is the next political battlefield

October 6, 2015

30 September 2015

By Stephen Koukoulas

The ideologically driven “size of government” issue is emerging as a critical political and policy battlefield. This is caused by demographic changes and the electorate’s insistence the government provide decent services that are underpinning what appears to be a structural lift in government spending. If this is the case and the budget is ever to get to surplus, policies that raise revenue to pay for these services will be needed.

The treasurer, Scott Morrison, claimed last week the budget “problem” (to the extent there is one) was one of excess spending not inadequate revenue. Morrison offered little intellectual evidence for this other than citing obsolete data that spending to gross domestic product (GDP) was above average at 26%.

Amid the political upheaval of the last few weeks, the release of the final budget outcome for 2014-15 has received scant attention – even, it seems, from Morrison.

What coverage there was centred on the fact the budget deficit in 2014-15 was $37.9bn. This was $3bn below the budget estimate in May but $14bn above the level estimated in the pre election fiscal outlook prepared prior to the 2013 election and based on the policy settings of the previous Labor government.

The final budget outcome documents also revealed that government spending, at 25.6% of GDP in 2014-15, was a touch below the 25.7% of GDP in 2013-14, but for the first time since the mid-1990s, there had been two consecutive years where spending to GDP had been above 25.5%.

Government revenue is growing steadily, in line with the ongoing growth in the economy. It has lifted from 21.5% of GDP in 2010-11 to 23.5% in 2014-15.

One critical issue on the debate on tax and spending as the 2016 election looms large, is whether revenue growth is being sustained into 2015-16 and then into the budget forward estimates beyond that. The answer to this will not be confirmed until Morrison reveals the forecasts (out to 2018-19) in the mid-year economic and fiscal outlook (Myefo) in November or December.

With the economy still growing, the unemployment rate no higher than Treasury was forecasting in the May budget and commodity prices in Australian dollar terms higher than assumed, the path towards a smaller deficit and eventual surplus is likely to be confirmed in the Myefo, via higher revenue.

Revenue is likely to be around the long-term average at 24.5% of GDP within three years. That the budget is likely to be in deficit in the out-years is because government spending will be above average and perhaps reflecting a structural rise.

These facts raise some vitally important policy issues, that in recent years, were lost in the blather and economic trash-talk of the former prime minister, Tony Abbott, and his treasurer, Joe Hockey.

The sensible question is whether the size of government is increasing and needs to increase further due to structural and demographic trends. Is government spending and revenue around 25% of GDP simply too low? Australians are living longer, getting access to higher quality health care and there is a vital need to enhance the education system to maintain Australia’s global skills ranking.

These items have a high concentration of government funding and participation – pensions, Medicare and education. This government involvement is because of the policy thrust of progressive governments over several decades towards fairness, equity, decency and opportunity for all. The bulk of the population wants to see these quality of life issues supported and enhanced by government. To be sure, they are expensive which in itself suggests there could be an increase in the size of government if the electorate is to get its way.

There is, of course, nothing sacrosanct about government spending and revenue, each being anchored around 25% of GDP as they have been for the past few decades. Indeed, in the 1960s, government spending and revenue were well under 20% of GDP. With the structural social policy reforms in the 1970s – focused on education, healthcare and pensions – the size of government rose to the current norm around 25% of GDP and it has been held around that level by both sides of politics over that time.

It is possible, if not likely, the electorate will demand the government fund a significant proportion of the cost of health, ageing and education. If so, Morrison is wrong and government spending will remain higher than the historical average and the issue of returning the budget to surplus will all be about revenue – tax in other words. Any discussion of tax cuts – income or company taxes – would be erroneous and ideologically driven. Using ongoing economic growth to cover the cost of the structural increase in spending and then move to surplus as revenue flows to the Treasury coffers is appropriate and desirable, as would consideration of other measures to underpin a lift in revenue.

It would be a mistake for the government to contemplate reducing the tax take until it can be sure that the revenue will not be needed to fund the demographic and structural changes in the economy. Either that or the government will need to make sure people pay more for their healthcare, education and retirement from their own pockets and in this way, the size of government will be smaller.

It is an interesting ideological debate that is only just hotting up.