The debt-and-deficit scare is back, wearing Labor’s colours. It’s still a dangerous lie.
Despite what we’re told, government debt is actually benign. ‘Budget repair’ is not.
|Why is Labor repeating Tony Abbott's debt-scare fantasy?|
“A trillion dollars of Liberal Party debt and nothing to show for it.”
It’s a nice, simple, saleable line that the electorate is likely to swallow, as they have many times before. It’s also a dangerous lie.
It’s a lie because the government actually owes – when you take everything into account – a fraction of that amount. And it’s dangerous because debt-and-deficit scares are used by politicians on both sides to justify their failure to spend on essential social projects – hospitals, Medicare, schools, universities, the dole.
That failure to spend has consequences. Inadequate benefits condemn unemployed people to live in poverty. That’s almost a million people – plus their children.
Over 600,000 people avoid going to a GP every year because they can’t afford it. Those people pay the price with their health and, sometimes, their lives.
Public hospitals around the country are unable to cope with demand. That costs more suffering, more premature deaths.
Schools, universities and early childhood education are all in their own particular states of dysfunction. The future human and economic cost of that is staggering.
What, then, is the real state of the Australian government’s debt? Is it what the Treasurer and the Prime Minister are saying?
And – most important of all – does it justify delaying or abandoning important social projects that the country so badly needs?
GOVERNMENT DEBT: REAL VERSUS IMAGINED
Politicians are good at cherry-picking facts. On one measure, the government’s right: gross debt is expected to reach a trillion dollars in the next financial year. But that’s not an accurate statement of the government’s financial position.
When you look at net debt – what the government owes other people, minus what other people owe it – a third of the trillion disappears.
A more significant gauge is the ratio of debt to annual gross domestic product. GDP measures the value of everything produced in an economy, so debt-to-GDP tells us what the country can afford. In 2023-24, net government debt will be at 25.8%. In the scheme of things, that’s not particularly high.
The situation becomes even less scary when you realise that around half of that net government debt is held by the Reserve Bank. It’s money the government owes to itself. Essentially, it’s a book entry.
During the pandemic crisis, the RBA created money (it can do that) to buy huge numbers of government bonds from banks and other financial institutions. It now owns $289 billion of the federal government’s $927 billion gross debt (that’s 31.2%) or its $575 billion net debt (that’s 50.2%.)
Factoring in the money the government owes itself, and the money other people owe the government, brings the real debt position for 2023-24 down from almost a trillion dollars to $291 billion; and from 37% of GDP to 14%. If we assume those holdings remain at current levels (in fact they’ll decline marginally) this will be the result:
The government has also ramped up its rhetoric on the increase in borrowing costs, quoting percentage increases that look, on the face of it, alarming.
Just before the October budget, and clearly following a government briefing, AAP reported it this way:
“The cost of paying back interest on government debt is tipped to blow out as soaring borrowing costs hit the budget bottom line.
“Debt repayments have been flagged as one of five key areas of spending ahead of the October 25 budget, alongside aged care, disability care, hospitals and defence.”
It’s clearly and deliberately misleading.
This financial year, interest repayments on gross debt are expected to be $18.9 billion. That compares with $221 billion for social security and welfare, $110 billion for health, $46 billion for education and $38 billion for defence.
But that’s gross debt. Net debt repayments are rather less alarming. This financial year, interest on net debt will be around $13.6 billion.
In 2020-21, the Reserve Bank earned interest on its Commonwealth government bonds of $4.3 billion. That means 30% of the federal government’s interest bill on net debt was paid to itself. It was a book entry from the Treasury to the RBA.
Figures from the OECD show that our debt position is far better than in most other advanced economies. The data in this chart is for all levels of government, not just the Commonwealth. Some states, particularly Victoria, have run up very significant debt. Even so, the comparison with the world’s richest nations is revealing.
BUT WE DO NEED TO PAY MORE TAX
Late in its term in office, the Howard-Costello government, about to fight an election they looked like losing, gave away many of the proceeds of a temporary mining boom in the form of permanent tax cuts. It fitted well with neoliberal ideology – ‘starve the beast’ – but left the nation with a structural budget deficit ever since. No government since has moved decisively or effectively enough to heal that wound. And the former Treasury secretary, Ken Henry, says we now need to increase taxes by around $50 billion a year.
Though our debt position is currently very far from perilous, the imbalance between revenue and expenditure has to be addressed for two reasons:
- Left as it is, debt-to-GDP will eventually become too great for the nation to afford; and
- An over-tight budgetary position deters governments from spending on important programs, just as the neoliberals wanted.
Despite the incessant calls for tax cuts, Australia is one of the lowest-taxing of all developed nations. Again, we look at the world’s richest nations (measured by GDP per capita).
But before we get carried away by the rush for budget-repair-at-all-costs, we need to understand that our basic budgetary position is not too bad, at least by international standards.
One way of calculating that deficit is to look at average long-term budget deficits. This reveals the extent to which governments are spending more than they earn. I’ve begun this series in 2007, which was about when the Howard-Costello tax cuts came into play.
As the chart shows, the Australian government’s ’s average deficit over that 14-year period has amounted to 3.5% of GDP, more than the average of our peer-group nations but not dramatically so. Only four of the 20 – Sweden, Denmark, Korea and Luxembourg – have managed on average to run a surplus over that period, and even then not by much.
There have been many contributions to the debate on which taxes can be increased. Most are political poison, unacceptable to the electorate and therefore irrelevant.
On this pile we can put increasing the rate of the GST and broadening its base to include fresh food, health and education. Forget about it.
Then there’s the clever idea of taxing capital gains on the family home. Apart from being administratively impossible – a house in Sydney costs a lot more than its equivalent in Hobart – the merest whiff of that idea cost Bill Hayden and Labor the election in 1980 and it has become no more palatable since. Again, forget about it.
The Grattan Institute suggests “trimming spending on hospitals, pathology and pharmaceuticals”. Try selling that one.
But a few major ideas could make a more profound difference:
The Stage 3 tax cuts have to go. If they go ahead, they will benefit the relatively rich: the people least in need of a tax cut. In their first year, 2024-25, they will remove $17.7 billion, or 0.71% of GDP, from the budget. Over the first five years, that drain will add up to $112.2 billion. That is already being factored into the budget forward estimates and contributes mightily to the feeling that we have some sort of budget crisis.
Superannuation has become, for too many, a rort. Very wealthy people have been using the low-tax environment of super not to pay for retirement but to minimise tax they could and should pay. The government has moved cautiously, announcing that the earnings on the super for people with more than $3 million in their super accounts should be taxed at 30% rather than 15%. It’s still a concessional amount, but the measure will save around $2 billion a year. The change starts in 2025-26.
It needs to go much further and, eventually, it probably will. All up, tax breaks on super cost the budget almost $50 billion a year. According to the Grattan Institute, two-thirds of that – about $33 million – goes to the top 20% of income earners. These people do not need this public subsidy. Clawing more of that money back would make a big difference to the budget and allow greater spending on much more productive social programs.
“Much of the boost to super balances from tax breaks is never spent,” wrote the Institute’s Brandan Coates and Joey Moloney, “because most retirees are net savers. By 2060, one-third of all withdrawals from superannuation will be paid out as bequests. These inheritances tend to transmit wealth to people who are already well off, making Australia more unequal.”
Rip-off profits by mining companies have cost many billions over recent budget cycles. All the minerals being dug up from Australian soil are the property of the Australian people. Current royalty regimes allow the extraordinary profits from high minerals prices to go entirely to the companies. This can be rectified either with a resources rent tax that actually works (those we have favour the miners, not the nation) or with a more intelligent and flexible royalty regime. Maybe both.
That WA GST deal is another rort that has to go. A blatant political fix by former senior Liberals from Western Australia (Matthias Corman, Julie Bishop and Christian Porter) is delivering a massive and unconscionable windfall to one state at the expense (at the moment) of the federal budget. Across the forward estimates, this will cost almost $16 billion:
Negative gearing and the capital gains discount. Any asset can be negatively geared. Restricting it to new dwellings would raise a lot of money and help the housing shortage. Capital gains tax falls by half if you hold an asset for longer than a year. This was installed by Peter Costello to make rich people richer, at the cost to the budget and everyone else.
There’s a good case for making significant tax savings that won’t hurt the economy or compromise social equity. But the available evidence provides no justification for a headlong rush into either tax increases or spending cuts.
Too much of the commentary on this issue seems to regard national government budgets as somehow similar to household budgets: that revenue and expenditure have to balance. But national government finances just aren’t like that. We’re doing a great deal of damage by pretending that they are.
TAXING AND SPENDING
Australians pay little tax, compared with other rich nations. To come up to the OECD average, Australians would need to pay an extra 5% of GDP, or $122 billion.
Australia's total tax revenue has historically lagged behind most other developed countries. Data from the last 50 years shows that gap widening: not mainly because of which party was in power but because our tax revenue was hit much harder in the 1990s recessions and during the GFC. And it has not recovered from the GFC downturn 15 years ago.It’s often said – including by eminent economists like Ken Henry – that Australia relies far too heavily on personal taxes and not enough on indirect taxes, like the GST. And, as he has pointed out, bracket creep (where normal wage increases, even when they’re below inflation, push people into higher tax brackets) has meant income tax is the only tax growing faster than the economy.
That’s true – to an extent. When we look at the comparison between Australia and other developed nations, far more of our tax take comes from personal taxes (40% compared to 24%); corporate tax (19% to 9%) and property tax (10% to 6%). And indirect tax is comparatively low, though not amazingly so: 8% to 11%.
But look at the column on the far right: taxes to pay for social security. Most countries have contributory schemes, where employees (and sometimes employers) pay throughout their working lives for the pensions and benefits for retirement, healthcare and so on. Australia does not have these arrangements. (Our pensions and health benefits are funded from general revenue. Superannuation contributions are compulsory savings, not tax: the money stays in the individual’s account and remains his or her property. The government can’t get its hands on it. And, so far, super hasn’t made much difference to the need for the tax-funded age pension.)
But other countries’ social security contributions are taxes – mostly personal, partly corporate. When you take that into account, Australia’s tax mix looks far less unusual. The argument for massive change largely disappears.
Nor is income tax a particular drag on economic activity, at least compared with other countries. Income tax comprises a far smaller share of the cost of labour to employers than in all but three of the top 20 economies.
The only part of the argument that remains is that changing the tax mix could make the economy more efficient, by swapping taxes that limit economic activity for those which have less effect on people’s behaviour. But most of the favoured measures – like raising the GST and extending it to fresh food, education and health – are politically impossible and therefore irrelevant.
Changing the mix of taxes isn’t the main game. How much tax we pay overall is much more important. And we need a much more sophisticated understanding of the way debt affects the economy, whether budget repair is wise policy, and whether taxes are the only way of raising money.
DOES DEBT REALLY MATTER ANYWAY?
There are excellent reasons for believing that reduction of public debt is, on balance, damaging to the economy and that running a substantial budget deficit is actually good public policy.
The IMF’s recently-released World Economic Outlook report warned about the potential dangers of budget repair – or ‘fiscal consolidation’ as it’s known in the jargon.
For good reason, government debt is usually calculated as a percentage of annual GDP. It’s a pretty good measure of what the country can afford. The federal government’s gross debt is now at 37% of GDP and net debt is at 23%. As we’ve seen, that’s low by international standards.
Budget repair involves either increasing taxes or cutting spending: usually, both at once. That means taking money out of the economy and, necessarily, reducing economic output. So even though government debt may decrease, the ratio (as a percentage of GDP) usually doesn’t improve.
“Since fiscal consolidation can be expected to reduce both debt and GDP, the net effect of fiscal policies on debt ratios is far from obvious,” the IMF says. “Partly because fiscal consolidation tends to slow GDP growth, the average fiscal consolidation has a negligible effect on debt ratios.”
The benefit of all this to the budget is questionable. But the hit to economic activity, measured by lower GDP, produces many casualties. Thousands, maybe hundreds of thousands, are thrown out of work. Companies go bust. And, of course, less tax is paid.
In the minority of fiscal consolidation episodes that actually reduce debt more than they reduce GDP, concentrate heavily on cutting spending rather than increasing taxes.
“In advanced economies,” says the IMF, “successful consolidations tend to be balanced between spending cuts and tax or revenue increases, whereas those that are unsuccessful are biased toward revenue and involve fewer spending cuts.”
That means cuts to the big items of expenditure: welfare benefits, health services, education, transport, defence, public housing. And so on.
“On average, a debt ratio reduction episode lasts five years,” notes the report.
So we’re not talking about a short period of economic pain. It would be likely to go on for years – covering at least one election and perhaps two. Such an exercise would threaten the electability of any government taking it on. And it would only be defensible in a situation of extreme stress, when budget deficits were a bigger threat than austerity. Australia is not in that situation and will not be for the foreseeable future.
Debt reduction can have some seriously unpleasant effects. We haven’t had a global depression since the 1930s but, before then, they were fairly common. And they were usually associated with attempts by ill-advised governments to sharply reduce or to eliminate public debt. That wasn’t the only cause of depressions, and it wasn’t only in the US. Nevertheless, the list is a cautionary one:
Research by Olivier Blanchard, the IMF’s former chief economist, shows that government debt can actually help improve the debt-to-GDP ratio. It’s a highly technical argument, but it rests on what happens when, as is usually the case, the interest rates paid by the government is less than the rate of growth in GDP.recent paper by two Australian economists, Professors Begoña Domínguez and John Quiggin, sums up Blanchard’s conclusion this way:
“A government can sustain a positive primary deficit with a constant (or even declining) ratio of public debt to GDP … This creates the possibility of a fiscal ‘free lunch’. Governments can run primary deficits indefinitely, while maintaining a stable or declining ratio of public debt to GDP.”
Domínguez and Quiggin also address another important issue: how much room to manoeuvre does the federal government have before debt becomes too big? It’s called fiscal space. According to one definition, it’s about how much more you can borrow before investors start worrying about default and demand higher and higher interest rates to compensate for the extra risk.
We have ample fiscal space, the two professors conclude: “This provides a very favourable scenario for expansionary fiscal policy.” In other words, we should be spending more, not less, on the programs and services the country needs.
HOW TO MAKE MONEY
Taxation is not the only option governments have to raise money. They can create it out of nowhere. It’s called increasing the money supply and it happens all the time. It’s just not used as productively as it could be. The heart of the problem is the currently ruling notion that monetary policy is about interest rates and nothing else. That mindset robs us of a potentially important tool in running a healthy and productive budget and economy.
Ever since Hawke and Keating floated the Australian dollar in 1983, we have had monetary sovereignty – the ability to independently control money supply, interest rates and exchange rates. Like most modern advanced nations, Australia has a fiat currency that is not dependent on its relationship with gold, the US dollar or any other external measure. If we want to create more dollars, we can. And do.
But it’s how that money is used that matters. And the Reserve Bank has a very poor record.
During the Covid recession, the RBA created hundreds of billions of dollars with a simple computer entry. But they didn’t use this money to fund Jobkeeper and the other emergency pandemic stimulus measures. Instead – because of the single-minded fixation on interest rates – they bought up huge numbers of government bonds from banks and other investors in the secondary market. The idea was to put downward pressure on interest rates and, by giving huge amounts of money to the banks, hoping they would lend it out to businesses and therefore create economic growth.
But, in the environment of a recession, too few businesses wanted to borrow and expand. What’s the point in increasing production if not enough people want to buy the product? In the old adage, it was like pushing on a piece of string.
So the major commercial banks held on to a great deal of that money and deposited it in their accounts with the Reserve Bank, where it’s earning interest. The interest is of course, paid by the Reserve Bank.
What makes it worse is that the original bonds were fixed-interest, bearing a low yield. As Saul Eslake has pointed out, the banks have swapped a low fixed-rate asset for a variable-rate asset yielding interest returns that are much higher and growing with every increase in the RBA’s cash rate.
It’s a rort and it’s costing a lot of public money. The whole episode has also left an enormous amount of money in the economy at a time when the RBA is trying to cool things down to fight inflation.
It’s hard to escape the impression that the Reserve Bank sees its primary purpose as serving the interests of the commercial banks, and only incidentally those of the Australian people.
None of this would have happened if that newly-created cash had been used to buy new bonds directly from the Treasury. The money would have gone directly into programs that would stimulate the economy. Less would have been needed because that money wouldn’t need to be lent to businesses that didn’t want to borrow it. The RBA wouldn’t now being paying the banks for the RBA’s own money. There would still have been the same effect on lowering interest yields in the overall bond market. And the government’s debt position would have looked a good deal better.
Perhaps we need a rethink.