Ignore the intergenerational report scaremongering – the news is good

April 2, 2015

Stephen Koukoulas

19 March 2015

One of the least reported but most striking features of the government’s intergenerational report was the revelation that the position of the budget is extremely favourable for the next decade.

While a lot of the focus of the IGR was how the budget balance would deteriorate over the long run out to 2054-55, most of the increase in the budget deficit occurs from around 2025, when some of the assumptions used by the Treasury on ageing and workforce participation kick in.

According to the IGR, over the next decade to the period around 2024-25 the budget deficit will average less than 1% of GDP. To sober analysts, this is small beer. In addition to that, the current budget deficit and failure of both side of politics to return to surplus by now owes much to the fact that over the past few years the economy has been dogged by below-trend economic growth, a steady rise in the unemployment rate and a jolt to national income from the freefall in Australia’s terms of trade. It should be acknowledged that once these budget drivers stabilise and the economy eventually grows at a more robust pace, which will happen, a large part of the budget deficit will simply go away as the stronger economy delivers higher revenue and lower spending for the government.

This is in no way to say that a policy agenda that takes a few extra steps at getting to a structural budget surplus sooner is not needed. It is. But there is no urgency for budget settings to change dramatically in the near term – that risks undermining economic growth at a time when economic activity is already subdued.

Looked at another way, if policy decisions in the next year or two can trim spending or raise revenue to the tune of about 0.25% of GDP over each of the next couple of years, then once the economy grows at a more robust pace, budget surpluses will be locked in.

It is important to note that a 0.25% of GDP tightening in fiscal policy is not severe, nor should it be all that difficult to find. In dollar terms it is less than $5bn a year, which could easily come from policies related to the tax treatment of superannuation, negative gearing and industry assistance, to name a few. Phasing in such policy changes progressively over a few years would do little if anything to hinder the pace of growth. The path to smaller budget deficits will also be helped in the near term as the Reserve Bank of Australia returns money to the government in the form of dividends from its war chest of funds that were bloated by the Abbott government’s unnecessary $8.8bn payment last year and the sharply lower Australian dollar.

The other reassuring aspect of the outlook portrayed in the IGR is the persistently low level of net government debt over the next 10 to 15 years. Net debt remains below 20% of GDP right through to the mid 2030s, a tiny amount of leverage for the government sector to have in almost any circumstances. If there is any moderate fiscal tightening or if the economy experiences a year or two of economic growth faster than assumed in the IGR, debt levels will be significantly lower than this already low level and, within a decade, net government debt could even be eliminated.

The main points from all of this is that many of the issues in the IGR are skewed to scaremongering in 20, 30 and even 40 years’ time, when the assumptions underpinning the budget forecasts are very rubbery. If the focus was on looking at the next decade and acknowledging how solid the fiscal position now is, even without a policy change, it would be even more obvious that just a few tweaks to tax and revenue would bring the budget back to structural surplus and debt levels would remain at minuscule levels.

If Joe Hockey were smart, he would realise this and change his messaging accordingly. It would no doubt make his task of bringing the population on board for the tax and spending changes needed all the more politically palatable.