There are worrying signs that the collapse in government revenue will reveal a budget in structural deficit, with Australia’s tax base insufficient to meet our long-term expenditure.

While today’s Business Outlook from Access Economics (thank for leaving us off your distribution list guys) doesn’t add significantly to our understanding of our dire economic predicament, Access does make the very good point that the impact of this recession on tax revenue is going to be “deeper and sharper” than in previous recessions.

Why governments are more exposed to recessions now than previously is an interesting issue. Company-sourced taxation now provides a much greater share of revenue as a proportion of GDP than it did in the early 1980s or the early 1990s. As exports have grown, companies’ exposure to international markets has too — even before the minerals boom. There are no figures to back it up, but my guess is that our corporate sector is more reliant on export revenue now and our tax system is more reliant on companies, meaning governments now depend more on international economic conditions.

One of the Government’s problems in this budget is that no matter how hard it cuts spending, it won’t get anywhere near making up for all that lost revenue. But there is a real need for significant reductions in long-term expenditure because, in the absence of the mining boom, our ongoing expenditure commitments may be greater than current taxation levels.

We’ve got to this point because the Howard Government got the balance between one-off handouts and long-term expenditure wrong. It used surging revenue to give lots of handouts, especially to pensioners, but not enough compared to the permanent increases in transfer payments and rebates it locked in as well, mainly to people who don’t need it.

This Government shares some of the blame as well. It started off okay with means tests for family payments, but its first act in this budget will be to exacerbate that by increasing the pension rate — the cost of pensioners increases every year anyway — and cutting income taxes further. The Government is also signalling that defence spending over the long-term will rise.

Add the ageing of Australia’s population and a structural deficit may not be too far away, if we don’t have one already. Ongoing spending and tax expenditures need to be addressed. We’re already rehearsed many of the middle-class welfare candidates for slashing. The complicating factor is that the current economy imperative is to boost Government spending, not curb it. Moreover, the country’s tax mix and its capacity to fund long-term spending are supposed to be the subject of the Henry Review, which doesn’t report until the end of the year. Against that is that the 2010 Budget will be in an election year, meaning cutting has to start happening now — and Government can announce measures but stagger their implementation to even up the political impact — or wait until 2011.

A new factor appeared in the mix this morning with the revelation that Treasury and the Government have decided to shift away from the usual forecast/trend approach to estimating revenue and try to predict the impact of the recovery on revenue in out-years.

Governments fiddling with parameters to finesse revenue is a bit worrying. In the best account of the Keating-Howard era, The Longest Decade, George Megalogenis discusses the lengths to which Paul Keating and Ralph Willis went to ensure the 1995 Budget forecast growing Budget surpluses, despite the stubborn persistence in the real world of a sizeable deficit. It took a new Government and John Howard and Peter Costello, in the first, and alas only, bloom of fiscal rigour, to fix that deficit (the normally estimable Megalogenis, incidentally today provides the first of what will probably be plenty of middle-class “we don’t feel rich” stories for the Budget).

The altered approach, backed by Ken Henry, serves the Government’s interest in demonstrating a path back to surplus, but also means the forecast for the year after the budget, 2010-11, will be below trend. It might also avoid a repeat of Treasury’s ongoing problem of underestimating revenue during buoyant economic conditions.

Diminishing deficits in the Budget forecasts might reassure finance markets getting toey about Australia’s foreign debt, but are mainly for show. The real basis on which the Budget will need to be judged is the extent to which it starts the process of curbing ongoing spending without withdrawing support for employment in a recession.

We’re all instant experts on Budget Night and will rush to deliver a verdict. But as last year’s Budget showed, the quality of the document doesn’t fully become clear for months afterward. It will be the same again this year.

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Peter Fray
Peter Fray
Editor-in-chief of Crikey
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