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John Quiggin

Budget manages to hold the line

John Quiggin Australian Financial Review

15 May 2006

Some Budgets are drawn up under pressure, from political crises, economic shocks, or simply a mismatch between commitments and the resources to meet them. By these criteria, few governments have been less pressured than the Howard-Costello government in 2006. It’s a mid-term budget, so there’s no need to worry about electoral reaction. The Opposition is divided and adrift, the economy is riding a resources boom, and the government is flush with cash.

Given the freedom for manoeuvre created by these circumstances, the government had an unparalleled opportunity to set the direction of Australian policy on tax and public expenditure. The central question, inevitably, is whether the share of national income collected in tax revenue and returned as public expenditure is too low, or too high.

The government’s answer, set out in detail in the Budget papers, is “Just right”. The revenue and expenditure shares of GDP are projected to hold rock steady at 23 per cent and 22 per cent respectively, leaving a 1 per cent surplus as a buffer.

We have yet to hear Opposition’s reply, but it seems unlikely that Kim Beazley is going to call either for cuts in expenditure or for a bigger tax take. It seems as if the long dispute over the appropriate size of the state has been fought to a standstill.

Comparisons over the longer term are complicated by shifts in the role of Federal and state governments, and particularly the tiresome dispute over whether the GST is really a state tax. These disputes can be avoided if we look at the consolidated general government sector, which includes all levels of government. The Budget papers show that the public expenditure share of GDP has been just about constant for the past twenty years or so; ever since the famous Trilogy commitment made by Bob Hawke back in 1984, to fix or reduce expenditure, revenue and the deficit relative to GDP.

Hawke’s commitment ended nearly a century of steady expansion in the size of the state relative to the economy, and reflected a fundamental shift in public debate, away from the social democrats and socialists who had dominated it until the 1970s, and towards the advocates of resurgent free markets.

Many predicted and hoped that the expansion of the state would not only be halted but would be reversed. There were proposals to cut the public sector back to 25 per cent of GDP or even less. Such proposals are rarely heard nowadays. The idea of a minimal state seems as utopian as that of comprehensive socialisation of the means of production, distribution and exchange.

As John Howard observed before the 2004 election, ‘There is a desire on the part of the community for an investment in infrastructure and human resources and I think there has been a shift in attitude in the community on this, even among the most ardent economic rationalists.’ The latest Budget had a reasonable amount of money for physical infrastructure but hardly anything for human capital (health, education and training); perhaps this is being saved up for the election year.

Looking ahead, the intergenerational analyses prepared by the Treasury suggest that the demands for public expenditure are only going to grow. This is partly because of the aging of the population, but more because of the inevitable (and desirable) growth of health care expenditure, as new and better treatments are discovered.

Although Treasury would like to hold down expenditure, the main concern implicit in the intergenerational framework is to avoid large increases in tax rates, which are seen as inconsistent with intergeneration equity. But, with growing demands, the only way to avoid future tax increases is to pay more now, and invest it in income-generating assets. This strategy is embodied in the Future Fund. It’s also reflected in the long-term shift from deficits to surpluses, which means that, while the public expenditure share of GDP has been almost unchanged, the tax revenue share has risen.

It’s possible that the stability we observe is an illusion, and that some economic shock or political eruption is just around the corner. For the moment, though, it’s steady as she goes.

John Quiggin is an ARC Federation Fellow in Economics and Political Science at the University of Queensland.

John Quiggin is an Australian Research Council Federation Fellow in Economics and Political Science at the University of Queensland.

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