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Jan 19, 2011

How Labor found itself in a surplus trap

Labor’s abandonment of economic reform after 1996 has left it adrift and the party's adherence to its promised 2012-13 surplus reflects how it let its enemies define its economic credibility.

Labor carries much psychological baggage from the Howard years. In fact, it’s got the political equivalent of post-traumatic stress disorder. And the greatest damage accrued around economic management.

That’s why we’re having this faintly weird discussion around whether the projected Budget surplus should be abandoned to “pay for” the cost of recovering from the floods.

Labor’s abandonment of economic reform after 1996, as I argued at the end of last year, has left it adrift. This is one of the key reasons why this Government, under both Kevin Rudd and Julia Gillard, has been so bad at framing debates in a way that favours itself. As Paul Keating said – ironically quoted by Wayne Swan after the election last year — politics is an ideas market and if you run the ideas, you run the market. Labor’s dearth of ideas, and its inability to communicate those it has, means its opponents are running the market.

Labor in its first term did a spectacular job of economic management (well, Treasury and the Reserve Bank get most of the credit, but Wayne Swan and Kevin Rudd had the good sense to do as they were advised). But they ended up letting the Coalition make the Budget deficit the de facto measure of its economic competence, particularly during the election campaign. That the Coalition so badly fumbled this exact issue in its post-election discussions with the independents is one of the ironic instances of justice occasionally served up by politics.

But the Government’s oft-repeated commitment to return to surplus by 2012-13 come what may is its admission that it is stuck with a debate defined by its enemies in the Opposition and the media. The projected surplus itself is trivial – a bare $3b – but is therefore of enormous symbolic importance to the government, as if that $3b represented a vast gap between incompetence and astute economic judgement.

You can thank Paul Keating – the “bring home the bacon” version of the dim, distant past – and more particularly Peter Costello for this fetishisation of Budget surpluses. But it’s Labor’s fault that the significant, though hardly massive, fiscal impact of the floods (bearing in mind that the stimulatory “cost” of the rebuilding phase is only part of the fiscal impact, given the lost revenue from farms, miners and businesses who have had to halt business) is being seen entirely through the prism of what it will do the surplus.

The number — a projection two years away, in any event — itself doesn’t matter a great deal. The surplus is simply a tool of political debate, for all sides – even for the business community suddenly changing its mind about the need to curb government spending. That’s why Tony Abbott produces nonsense like the line that the NBN is a luxury that we can now no longer afford. Strangely, he didn’t mention the tens of billions we’re spending on Defence procurement, or the many tens of billion of dollars a year of revenue foregone on tax expenditures, or the tens of billions spent each year, enthusiastically supported by both sides of politics, on middle-class welfare. Even the most cursory glance reveals that there are a whole lot of luxuries in the federal budget.

The Government has one part of its fiscal consolidation strategy correct – to cap extra spending at 2%b real growth and bank upward revenue revisions. What it has been poor at is actually cutting expenditure, for all its insistence that it has made “tough decisions”. Some blame for this lies with the Coalition, which blocked cuts to one of the worst middle-class welfare rorts, the private health insurance rebate, and it’s true that the Government had to balance an uncertain global environment in its first two budgets. But no one believes that in Penny Wong we have a new Peter Walsh ready to spring forth and assail spending ministers, or that she’d receive much support from her Treasurer and Prime Minister if she did so.

A more intelligent debate, led by a Government that had its wits about it, would be around the need to roll back expenditure in politically-sensitive areas to get the Budget on a sustainable footing over the long-term. And all the more so given that, under even the mildest climate change scenarios, the cost of recovering from extreme weather events is going to plague future budgets much more frequently than we’re used to.

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47 thoughts on “How Labor found itself in a surplus trap

  1. JamesH

    Deficit fetishisation. Bah. If the private sector wants to run a surplus (by saving) and export earnings don’t cover it then the government must run a deficit or we get a recession. It’s a bleedin’ accounting identity, innit. The debate should be about whether the spending is value-for-money or not.

  2. ronin8317

    The Australian’s government have a good reason to be a deficit hawk. This is illustrated by this chart from Paul Krugman’s blog.

    http://lh3.ggpht.com/_VgJQTp0Bsf0/TTQ5-dwV2JI/AAAAAAAAACg/o0i3XF2gMts/australia_debt.jpg

    Our private sector is heavily indebted to foreigners, and we need to run a Government surplus to keep interest rate low. While it is nowhere near the monstrosity of USA, we have to consider the wisdom of borrowing so much money from overseas in order fuel our ever rising home prices.

  3. John Reidy

    As you mentioned previously the ALP hasn’t handled this well since ‘96 (and Beazelys Big Hole)…

    One line that occurred to me – that the coalition might run is that if the budget deficit is increased it won’t be because of the needed and good spending on the recovery but the bad wasteful spending on the NBN -even if between now and 2012 there isn’t much spending on the NBN.

    It is all about value for money, I am sure they could cut spending as mentioned above, still reach a surplus and pay for the recovery.

  4. geomac

    The medibank rebate like the funds to elite private schools achieves nothing of value to the public and should be scrapped. Every year they raise fees and premiums above the inflation rate. I,m in favour of schools struggling to provide basic facilities getting government funds but not schools getting an extra cricket pitch or chapel. Religious and extra sports facilities over and above basic requirements shouldn,t be the taxpayer funded. Its about education not look at me status. Abbott would be appalled if this was mentioned instead of the NBN but then he thinks politicians are under paid so whats his opinion worth ?

  5. C@tmomma

    And the best time to discuss a realignment in Budget and taxation priorities would be at the upcoming Taxation Summit. Especially in light of future provisions for Global Warming extreme weather events, if we are to take Climate Change at all seriously. I just wish that Julia Gillard would take the Training Wheels off Dr Andrew Leigh because what I have read from him thus far has been eminently sensible and put in such a way to counter the critics with unquestionable logic, which Keating was also able to do. Now is not the time for political niceties about political succession and seniority. The time to get the best economic talent for the government out front is now. The Opposition and the government’s opposition in the media and other areas of Private Enterprise in Australia sure won’t be waiting to put the boot in, justified or not. They have an election to win for the Conservatives. And with the Senate now in the hands of the Progressives, from July 1, they will be coming out all gund blazing to reverse the trend ASAP. So Gillard, the ‘Game On’ PM, will have to be on her game and do much better than she has thus far.

  6. John Anderson

    Bernard Keane is right to say that Labor is unable to effectively communicate its ideas. But I disgree that it doesn’t have ideas. Indeed, you could argue that it has too much on its plate, noting the delicate balance in the House of Representatives could scuttle some of them. What about the MRRT, the Murray Darling water trade-off, mental health, a price on carbon, the increase in the super guarantee and the related Cooper super reforms, rolling out the NBN, the health/hospitals reforms and the related GST trade-off and the plethora of education reforms that Gillard announced during the election campaign but largely ignored by the media? Some of these are huge economic reforms.

    Rather than Labor becoming a captive of the surplus fetish, Keane actually shows how Labor can have its cake and eat it too. That is to say, have a surplus and similtaneously fund the flood damaged infrastructure. For example, a reintroduced private health insurance reform package will pass the Senate with Greens support after 1 July 2011. There’s $2 billion over 4 years. All the MRRT proceeds [that’s billions of dollars] could be allocated to flood damaged infrastructure rather than just some of it. The company tax reduction could be deferred until the the flood bill s is paid for. There is some irony here given the pressure from business [the AIG] to spend up big to save jobs and small businesses and to hell with the surplus.

    As for middle class welfare, it will be a little easier to remove given the Greens’ opposition to most of it. It’s the House of Representatives that could be the stumbling block. So the flood costs are easily financed. What a budget surplus in 2012-13 depends is solid economic growth, the greatest threat domestically to which is the RBA’s penchant for lifting interest rates.

  7. Greg Angelo

    The problem with budget deficits is that they have to be funded, and that funding comes from borrowings and those borrowings have to be repaid. Counter cyclical expenditure financed from borrowings during a recession is sensible to take advantage of underutilised labour and capital resources with the benefits funded from future taxation where the beneficiaries of this expenditure happily repay borrowings whilst they enjoy the benefits. However deficit funding in a tight economy will only lead to inflation.

    As the United States is finding out you cannot run budget deficits forever. Eventually you fall into a debt trap were all you can do is fund the interest on the borrowings that you have made in previous periods. The borrowings to fund the profligate public expenditure on pink batts, the NBN, the BER and now the proposed disaster reconstruction will have to be repaid, and there are already indications that the Reserve Bank is having to offset inflationary pressure in the economy as a consequence of this expenditure.

    There is no problem with public-sector deficits in the short term, provided the capacity to repay is clearly understood. The projected return to surplus is only the beginning of process as the surplus is required to repay borrowings, should government set this as an objective.

    It is interesting to note that the US government has not run a balanced budget for decades and that over $13 trillion of debt has been built up as a consequence of a lack of concern for balancing public sector budgets. This is over USD 46,000 per capita, or about USD 120,000 per taxpayer. Australia’s federal net debt by comparison is relatively small at around $140 billion or about $6700 per capita or $20,000 per taxpayer. However the borrowings for the BER and the NBN will significantly impact on those values with net debt projected to rise to around $168 billion by 2013-14 or approximately 10% of GDP. This represents a net borrowings of around $150 billion under Rudd/Swan/Gillard stewardship with aprojected annual interest bill of somewhere in the vicinity of $10 billion per annum at current interest rates. Unless the budget returns to significant surplus enabling debt to be paid down, we will be saddled with this interest bill in perpetuity. Advocates of deficit funded (borrowing funded) spending without constraint should consider these matters carefully.

    Also those advocates promoting elimination of the health insurance rebate should note that in the past health insurance was tax deductible for income tax assessment purposes. and that elimination of this rebate would force many people out of private health insurance and into the public health system which would not be able to cope. Privately insured patients get a 30% rebate on their medical costs but are still funding the other 70% out of after-tax income.

  8. John Bruce

    It is so easy to throw around the concept of deficit. The fact that we could even consider it is due to not having a large outstanding debt while the rest of the world is going to pot. We should get serious about utilising our available funds to get the best value for the country. Rebuilding in all of the three eastern states which needs to happen now and is in the order of many tens of billions of dollars will provide a broad stimulus over a major part of the country. The odd $2billion saving here or there is almost insignificant compared to what the rebuilding and improvement required will cost. We should rechannel all funds from all non essential new projects including the NBN and any further school building other than for schools that have been devastated into this urgent immediate need and maintain fiscal responsibility. Further, we also to immediately enhance existing infrastructure such as roads and rail that were flood effected to ensure that our national arteries remain open. The next flood in Brisbane could easily be in the next 6 weeks before the end of this wet season.

  9. freecountry

    Budget surpluses are not a “fetish”. Like commercial entities, churches, and most large organizations in general, governments seek to expand themselves. Like most organizations, it is sometimes prudent for governments to spend more than they gain for limited periods of time.

    Unlike other organizations, governments hardly ever have to confront hard limitations on how much they can borrow, or how fast they can accelerate borrowing, because sovereign entities have almost limitless powers to defer the taxation of citizens until another day, or another generation, to pay it off. (Or so it seems, until Ireland or Iceland happens.)

    Also unlike other organizations, voters in a democracy crying out for more expenditure are usually under the mistaken impression that they can get something for nothing, by forcing a richer minority or foreign shareholders to take on most of the tax burden. Majority rules. Explaining that it’s nowhere near as simple as that requires economic explanations that most of the public, and even most journalists, either lack the patience or background to understand, or simply discredit as a bunch of “neoliberal” hocus pocus. To put it as simply as possible: the more uneven the tax burden, the more business tends to fail or move offshore, reducing tax revenue instead of increasing it, reducing the competition for goods available to consumers, and inflating away the value of real wages so workers become poorer even when their nominal wages are rising. (And John Anderson, that inflation is the reason the RBA has such a “penchant for lifting interest rates”.)

    I find it very strange the way the left insists that greed and reckless disregard of risk has broken the credibility of capitalism; while at the same time arguing that indulging people’s greed for public spending, and recklessly disregarding unknown risks to national solvency, is responsible economic management. Insisting that the call for surplus is a mere “fetish”.

    Public spending should shift urgently to areas which can demonstrably reduce costs and risks to the Australian public. Public transport, water management, soil management, energy supply, urban design, alleviation of export bottlenecks, and accumulating a strong capital fund of emergency money for a rainy day.

    All forms of spending should have sunset clauses, requiring periodic review in parliament. Tax revenue must be increased, not by increasing aggregate rates of taxation, but by increasing the base of taxation, through the above forms of spending, and through efficiency improvements in the way we tax. As I’ve said elsewhere, even a carbon tax might impose less deadweight distortion losses than some of the taxes we are using now (the worst of which is capital gains tax which is so dear to the hearts of anti-capitalists).

    Governments state and federal must wean themselves from their political addiction to implicitly guaranteeing house prices and suppressing the building of homes, because this causes a huge drain of people’s present and future income, into paying the interest for overseas loans from which banks fund their mortgages.

    In short, Labor has got to go, Wayne Swan is a bull in a china shop, and the Coalition needs a clean-out because Tony Abbott and de-facto deputy Barnaby Joyce show only a dim awareness of what needs to be done.

  10. ronin8317

    Not all debt are equal, and debt used to fund investment is different from debt used to fund consumption. In the case of housing, what used to be classified as consumption has turned into an investment, even though it doesn’t produce any goods or services. This is where the market fails. Unfortunately, it is not that easy to change course.

    Transfer payment via taxation is essential for social cohesion, and it is far cheaper to keep someone on the dole compared to imprisonment. It is however even better to create an environment where everyone has a job.

    In regard to the government retaining a ‘capital fund’, it is rather tricky. Buying government bond doesn’t make any sense, as you’re just shifting money from your left pocket to your right pocket. Buying bonds from another country introduce exchange and default risk, and you can’t put that amount of money in a bank account either. You could park it at the Central Bank as a last resort, however it is spend it on infrastructure (NBN, Murray Darling, Dams, etc), or not collect the tax at all.

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