If the government wants a budget surplus, why is it increasing spending?

January 27, 2015

by Stephen Koukoulas

With the budget just over three months away, Australia’s economic policy is in trouble.

If the fiscal policy actions of the Abbott government are anything to go by, the budget will be framed with conflicting messages and will have no specific objectives. It will continue to talk of the need to reduce government debt and the budget deficit, yet it will include an extremely high level of government spending, one rarely, if ever, seen outside times of recession.

So what is the strategy?

The government clearly does not want to take the tough decisions needed to reduce the budget deficit and lower government debt. It has certainly made some cuts, and if it had left things there, its message would be clearer and its economic credibility greater.

Instead, the government has used the money raised from spending cuts and increased taxes for its pet projects. The budget deficit is now large and growing. The government has budgeted for huge increases in spending on payments to the Reserve Bank of Australia, paid parental leave, defence, national security, roads and infrastructure, to name a few.

One of the problems of the Gillard government was its insistence on giving away the proceeds from the revenue and other savings it made in vital policy reforms. Two good examples of extra revenue raised were the carbon price and the mining tax which, in isolation, would have made a decent contribution to the budget bottom line.

Alas, the Gillard government decided to effectively give away the revenue from these policy changes rather than using it to improve the budget bottom line. In addition, revenue from the carbon price and mining tax fell short of Treasury estimates, in large part due to falling commodity prices and a stubbornly high Australian dollar.

The Abbott government is making the same mistake, but in even greater order. The budget deficits outlined in the mid-year economics and fiscal outlook are more than double those it inherited from the previous government. Their budget surplus is more than five years and two elections away. The error of the government’s fiscal strategy is evident from the proposal to impose a Medicare GP co-payment, the revenue from which was designed to go to a $20bn medical research fund rather than to reduce the budget deficit. That clouded any merits the co-payment might have had. Was the government acting to reduce the budget deficit or not? It was another example of the government shuffling money rather than making decisions to improve the bottom line of the budget.

Given how poorly the electorate engaged with these policies from governments of both sides – especially the carbon price, mining tax and GP co-payment – it would have been better for each government to frame them as stand-alone issues: the price on carbon aimed at tackling global warming; the mining tax aimed at securing broader benefits from the steady exhaustion of finite resources; and the co-payment aimed at dealing with long-term healthcare costs.

They would have been easier to explain, their purpose more obvious, and it is highly probable they would have had greater support.

As the 2015-16 budget approaches, the bad news for the government is that commodity prices are very weak and still falling. Australian growth will be constrained as the global economy lurches towards deflation. Domestically, business and consumer confidence remains weak. No forecaster is expecting real GDP growth to exceed 3% this year and the unemployment rate is likely to be nearer 6.5% than 6%.

The budget looks set to remain in deficit for some time, and the quest for a surplus will be made all the harder if the government continues down the path of spending the revenue from savings and tax measures elsewhere in the economy.