Date created: May 15, 1997

Last modified:18 December 2002

Maintained by: John Quiggin

Confusion in Budget policy

May 12 1997

As usual, the debate leading up to the 1997 Budget is dominated by concern over largely meaningless categories rather than by a serious assessment of the economic choices we face as a community. Once such issue is the distinction between revenue and outlays. Last year, the government tied itself in knots trying to pretend that its changes to superannuation policy were not really tax measures. This year looks likely to be much the same. The central issue in much commentary is the need to focus on expenditure cuts and particularly on 'middle class welfare'.

One problem with this claim is that there is almost no middle class welfare left on the outlays side of the budget. Every significant program in the social security budget, the only major area of expenditure growth in recent years, is means-tested. Higher education funding is subject to income-related cost recovery through the Higher Education Contributions Scheme (HECS). In fact, subsidies to the middle class in this area have almost been eliminated. With recent changes, the HECS charge for students in law, economics and commerce is about equal to the resources allocated by typical universities to teaching and administering their courses, so that the taxpayer subsidy is close to zero. Public funding for universities is now primarily allocated to support for research, assistance to low-income students and to subsidies for high-cost areas such as the trainign of scientists and engineers.

Health is a partial exception. The universal Medicare scheme has been frayed at the edges, but remains the primary approach to policy, primarily because all attempts to come up with a coherent alternative have failed. Partial steps in the direction of a market solution have done little more than point up the dangers of the expensive and ineffective residualism of the US system. Nevertheless, the abolition of the Commonwealth Dental programme, income testing of the Pharmaceutical Benefits Scheme and the tax penalty for high income earners who fail to take out private health insurance mean that, even here, it is hard to find a pure example of 'middle class welfare'. If there is a genuine example of middle class welfare in the outlays side of the Commonwealth Budget, it is the $1.8 billion paid to non-government schools, a sum projected to rise tp $2.3 billion by the year 2000.

The really important area of middle class welfare in the Budget, however, is that of tax expenditures, of which the most important are concessions for superannuation and unlimited dividend imputation, which enables some high-income earners to avoid paying tax altogether. Imputation has been justified on the basis that it results in tax neutrality, but this is true only on the assumption that the benefits of incorporation, including protection from creditors and favourable tax treatment, ought to be provided free of charge to all who demand them. This is universalism at a level rarely seen from the social welfare lobby. In practice, dividend imputation has proved hugely expensive, but has had no apparent effect on levels of private investment. Indeed, it is arguable that the disincentive to retained earnings has reduced aggregate investment. But because no entry appears on the outlays side of the ledger, the issue has scarcely been debated.

There is a more fundamental problem with the way in which the current debate is conducted.The means tests and targeting devices used to restrain outlays have much the same effects as taxes. First, they have a general disincentive effect on work effort. Second, if applied to a particular good or service they reduce consumption of that good or service. The lack of any clear distinction is reflected in the confusion over whether or not policies like last year's superannuation changes are tax or expenditure measures. It is surprising then, to find so many commentators who are enthusiasts for all forms of means-testing, but are implacably opposed to any increase in taxes, or even to reductions in tax expenditures. The mirror image of this problem is to be found among those members of the welfare lobby who reject any kind of means testing but endorse all proposals to raise taxation revenue.

The critical issue that is being missed in all of this is the allocation of national resources between services like health and education, for which total output is ultimately determined by government funding decisions, and market goods and services like consumer durables and restaurant meals. The pressure to cut measured government outlays has prevented any significant growth in the proportion of national income devoted to health and education, even though there is substantial unmet demand for these and other publicly provided services, and substantial scope for employment growth in meeting this demand.

The pressure for expenditure cuts does not reflect a considered judgement that we, as a community, prefer more TV sets and hamburgers, and less engineers and hip replacements. Rather, policy has been driven by an ideological desire to cut back the measured share of national income being spent by the public sector. The ideological confusion of current policy is reflected in the idea that 'national savings' can be promoted by cutting back expenditure on education, the most important single form of investment in a modern economy. Only when Budget policy is based on genuine economic analysis rather than attempts to force economic activity into arbitrary categories will there be any hope of escaping our current malaise.

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