Who knew? The price of better government is higher taxes

Have you noticed? Since the change of government, the politicians have become a lot franker about the budgetary facts of life. And now the Parliamentary Budget Office has spelt it out: it’s likely that taxes will just keep rising over the next 10 years.

The great temptation for politicians of all colours is to make sure we don’t join the budgetary dots. On one hand, they’re going to improve childcare and health and education, do a better job on aged care and various other things. On the other, they’ll cut taxes.

In short, they’ve discovered a way to make two and two add to three.

The attraction of that relatively new institution, the Parliamentary Budget Office, is that it reports to the Parliament, meaning it’s independent of the elected government. Each year, sometime after the government has produced its budget, the office takes the decisions and figurings and examines whether they are sustainable over the “medium term” – an econocrats’ term for the next 10 years.

They do this by accepting the government’s present policies and mechanically projecting them forward for a further six years beyond the budget’s published figures for the budget year and the following three financial years of “forward estimates”.

Note that these mechanical projections are just projections – just arithmetic. They’re not forecasts of what will happen. No one but God knows what will happen to the economy over the next year, let alone the next 10.

No one putting together the Morrison government’s pre-election budget of April 2019 – the one saying the budget would soon be “back in black” – foresaw that the arrival of a pandemic 11 months later would knock it out of the ballpark, for instance.

Projections don’t attempt to forecast what will happen. Rather, they move the budget figures forward based on plausible assumptions about what the key economic variables – population growth, inflation, for instance – may average over the projection period.

So, projections are not what will happen, but what might happen if the government left its present policies unchanged for 10 years. They give us an idea of what changes in policy are likely to be needed.

Media reporting of the budget office’s latest medium-term projections focused on its finding that, if there are no further tax cuts beyond the stage three cuts legislated for July 2024, the government’s collections of personal income tax may have risen 76 per cent by 2032-33.

The average rate of income tax paid by all taxpayers is projected to reach 25.5 cents in the dollar before the stage three tax cut drops it to 24.1 cents. But then it could have risen to 26.4 cents by 2032-33 – which would be an all-time high.

Why? Bracket creep. Income is taxed in slices, with the slices taxed at progressively higher rates. So, as income rises over time, a higher proportion of it is taxed at higher rates, thus pushing up the average rate of tax on all the slices.

Like the sound of that? No. Which is why the media gave it so much prominence. But there’s much more to be understood about that prospect before you start writing angry letters to your MP.

The first is that, according to the projections, even with such unrestrained growth in income tax collections, the rise in total government revenue wouldn’t be sufficient to stop the budget deficit growing a bit, year after year.

Why not? Because of the strong projected growth in government spending. That’s the first thing to register: the reason tax collections are likely to rise so strongly is that government spending is expected to rise so strongly.

Why? Because that’s what we want. The pollies know we want more and better government services – which is why no election passes without both sides promising to increase spending on this bauble and that.

What neither side ever does in an election campaign is present the bill: “we’re happy to spend more on your favourite causes but, naturally, you’ll have to pay more tax to cover it”. Indeed, they often rustle up a small tax cut to give you the opposite impression: that taxes can go down while spending goes up.

The budget office’s projections suggest that total government spending will rise from 26.2 per cent of gross domestic product in the present financial year to 27.3 per cent in 2032-33. This may not seem much, but it’s huge.

Nominal GDP – the dollar value of the nation’s total production of goods and services, and hence, the nation’s income – grows each year in line with population growth, inflation and any real increase in our average standard of living. So, for government spending to rise relative to GDP, it must be growing faster even than the economy is growing.

Briefly, the spending growth is explained by continuing strong growth in spending on the National Disability Insurance Scheme, the growing interest bill on the government’s debt, and the rising cost of aged care.

This being so, there seems little doubt we’ll be paying a bit more tax – a higher proportion of our income – most years over the coming 10, and probably long after that.

But that’s not to say things will pan out in the way described by the budget office and as trumpeted by the media. For a start, it’s unlikely any government would go for six years without a tax cut.

It’s true that governments of both colours rely heavily on bracket creep – aka “the secret tax of inflation” – to square the circles they describe during election campaigns; to ensure two and two still add up to four.

But they’re not so stupid as never to show themselves going through the motions of awarding a modest tax cut every so often – confident in the knowledge that continuing bracket creep will claw it back soon enough.

The next point is that the overall average tax rates the budget office quotes are potentially misleading. Every individual taxpayer has their own average rate of tax, with high income-earners having a much higher average than people with low incomes.

But when the budget office works out the average for all taxpayers – the average of all the averages, so to speak – you get a number that accurately described the position of surprisingly few people. It’s like the joke about the statistician who, with his head in the oven and his feet in the fridge, said that, on average, he was perfectly comfortable.

There are plenty of things a government could do to reduce the tax concessions for high income-earners (like me) and to slant any tax cuts in favour of people in the bottom half, which would allow it to raise much the same revenue as the budget office envisages without raising the average tax rate paid by the average (that is, the median) individual taxpayer by nearly as much as the budget office’s figures suggest.

Fearless prediction: just such thinking will be what leads the Albanese government to make a start next year by rejigging the size and shape of the stage three tax cuts.

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We won’t be paying back government debt, but we WILL be paying

If you’re one of the many who worry about how we’ll pay off the massive debt the Morrison government has incurred during the pandemic, the Parliamentary Budget Office has reassuring news.

The budget office – which is responsible to the whole Parliament and so is independent of the elected government – has prepared its own projections of the budget deficit and debt over the decade to 2032.

It’s also assessed our “fiscal sustainability” over the 40 years to 2061, testing the budget against 27 different best, worst and middle scenarios with differing assumptions about economic growth, the level of interest rates on government debt and the size of our budget deficit or surplus.

It finds that the federal government’s debt is projected to keep growing until it reaches a peak equivalent to about 50 per cent of gross domestic product in 2029. After that it’s projected to keep growing in dollar terms, but at a slower rate than the economy is growing, so that it slowly declines relative to the size of the economy, to reach 28 per cent of GDP in 2061 in the middle scenario.

We don’t pay off any debt unless we get the budget back into annual surplus. But this happens only in the best-case scenario, where the debt is completely repaid by 2058. Don’t hold your breath.

So the budget office’s reassuring news is not that we’ll be able to repay the debt – it’s unlikely we will – but that it accepts Scott Morrison’s assurances we don’t have to repay it to keep out of trouble. That, unless our leaders go crazy, we can outgrow the debt and that the interest bill isn’t likely to become a significant burden on taxpayers even though the debt remains unpaid.

These are not controversial propositions among economists. If you find them hard to believe then – forgive me – but you don’t understand public finances as well as you should. It’s a mistake to think that a national government of 25 million people has to live by the same rules as your household.

Households must pay off their debts before they’re too old to work, but governments go on forever and always have most of their population working and paying taxes. Their populations keep growing and getting a bit richer every year, so they can keep rolling over their debts.

They can do what no household can do: pay their bills not by working but by imposing taxes on other households. So stop thinking governments have to pay off their debts the way you and I do.

And stop thinking our kids will be lumbered with massive government debts; they won’t be. Indeed, it won’t be government debt our kids and grandkids will hold against us, it’s our generation’s failure to act early enough to stop global warming.

But that’s not to say government debt doesn’t matter or that it comes without a price tag. In its projections over the next decade and its scenarios over the next 40 years, the budget office assumes that the “shocks” causing ups and downs in the economy in the future will be no worse than those we’ve experienced over the past 30 years or so. Maybe; maybe not. As well, it assumes that present and future governments will be no more reckless spenders than governments have been over past decades.

It judges that our deficit and debt position will be sustainable over the next 40 years – will cause no need for “major remedial policy action” (no horror budgets) – “provided fiscal strategy is prudent”. We can continue to run budget deficits provided they’re “modest”.

We’ll need “a measured pace of fiscal consolidation”. Translation: if governments stop trying to keep deficits low, all bets are off. So governments will need to avoid wasteful spending. And they’ll need to ensure tax collections are sufficient to cover most of any growth in government spending.

It’s here I think the budget office’s projections of an ever-diminishing budget deficit out to 2032 are hard to believe. They’re based on assumptions that government spending grows no faster than the economy grows, but tax collections grow a lot faster than the economy.

How? By letting bracket creep rip. The tax cuts we’ve been promised for 2024 will be limited to high-income earners, and will be the last we see for the decade.

That’s not hard to believe. What’s hard is believing governments can keep the lid on government spending for another decade. We know we’ll be spending hugely more on nuclear subs and other defence equipment, on aged care and on the National Disability Insurance Scheme.

So how is government spending supposed to grow only modestly? Because spending on social welfare – age pension, family tax benefits, disability support pension, JobSeeker and sole parent payment – will fall as a share of GDP.

Get it? The only way we’ll keep on top of our debt and deficit is by driving the disadvantaged further into poverty. If we’re not that heartless, we’ll be paying a lot more tax – whatever we’re promised at the election.

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Economy to blame for part of the expected budget blowout

When you ask people who work in the House with the Flag on Top why the budget deficit has gone up or gone down, most will tell you it’s gone up because the government decided to spend more money, or it’s gone down because the government decided to spend less money.

When you live in Canberra, the budget looms large and the economy is something far distant in Melbourne or Sydney or somewhere. The budget is the steering wheel by which those in the national capital control the economy of you and me, they think.

When you consider how close they live to all the economists in Treasury and all the distinguished economists at the Australian National University, it's surprising how little so many Canberrans understand about the economy.

The truth is, the nation’s economy – almost all of which exists outside the ACT – is far bigger and more powerful than the budget of the federal government (even after you throw in the budgets of the eight states and territories).

So, though it’s true that changes in the federal budget can have a big influence on what happens in the economy, it’s just as true that what happens in the economy can have a big influence on what happens to the budget.

To be clear, there’s a two-way relationship between the big thing that is the economy and the much smaller thing that is the budget. What’s done to the budget affects the economy, but what you and I - and the businesses we mainly work for - do to the economy has a big effect on the budget.

On how much tax we end up having to pay, and on the benefits – in kind as well as cash – the government has to pay us. How many kids we have and send to school. Whether they decide to go on to university or TAFE. How old we get and need the age pension and go to doctors and hospitals more often. Whether we lose our jobs and need to be supported by the dole. And all the rest.

With the virus and the consequent recession changing everything, this week we were supposed to get an emergency update on the state of the economy and the budget from Treasurer Josh Frydenberg. But he’s put it off until late next month.

Not to worry. On Friday the independent Parliamentary Budget Office stepped into the breach and produced “medium-term fiscal projections” of the effect of the coronavirus and the policy response to it.

Starting with the forecasts in the mid-year update published in December as its base, it used the Reserve Bank’s recently published forecasts for the economy (in lieu of Treasury’s) to estimate the expected change in the federal budget’s receipts, payments and underlying cash balance brought about by the crisis.

Its headline finding was that the crisis may cause the federal government’s net public debt to be between $500 billion and $620 billion higher than it would otherwise have been by 2029-30. That would be equivalent to between 11 and 18 per cent of gross domestic product.

But no one knows what the future holds, and projections 10 years into the future are so speculative as to be useless. They’re actually a bad thing because they give the uninitiated (including the politicians) a false sense of certainty.

The report’s way of putting this is to say its results are “indicative only” – which is an econocrats’ way of saying that, at best, they give you a rough idea of what might happen. So let’s just focus on the guesstimates for this (almost over) financial year and the next two, ending with 2021-22.

They show the budget deficit for this financial year is now expected to be $67 billion worse than formerly expected. The budget balance for the coming financial year may be $191 billion worse and for 2021-22 may be $56 billion worse. That’s a total deterioration of $314 billion.

Now, the explicit policy decisions of the government in response to the virus are expected to account for only $187 billion of that total. This accounts for almost all the expected increase in government payments, leaving the expected fall of $126 billion in tax collections and other receipts making up the remainder.

Get it? About 40 per cent of the overall deterioration came from the recession, caused by the fall in tax collections – individuals earning less income and paying less income tax; companies earning lower profits and paying less company tax; consumers buying less and paying less goods and services tax – leaving the government’s own actions accounting only for the remaining 60 per cent.

As economists put it, about 60 per cent of the expected deterioration in the budget balance over three years is “structural”, whereas 40 per cent is “cyclical” – meaning it will fix itself as the economy recovers.

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Frydenberg must lift Treasury’s game on spending control

I read that our new Treasurer, Josh Frydenberg, has already understood the chief requirement of his office: the ability to say no to ministerial colleagues wanting to spend more on 101 worthy projects.

Sorry, Josh, but if you’re hoping to be a successful treasurer in the years beyond the coming election, you – and your Treasury minions - will need to do much better than that.

It takes strength, but zero brain power, to say no to everything in the belief that, though a fair bit will get through, enough won’t to keep the budget on track for the ever-growing surpluses projected from 2019-20 onwards.

As we’re reminded by the Parliamentary Budget Office’s report on those projections out to 2028-29, the Abbott-Turnbull government has done a good job in restraining the growth in its spending so far.

Whereas in the 14 years to 2006-07 the Keating and Howard governments racked up real spending growth averaging 3.2 per cent a year, in this government’s term real spending growth so far has averaged just 1.5 per cent a year.

Trouble is, it’s hard to see any government maintaining such an extraordinary degree of restraint – repression? – for many years to come. That’s particularly likely to be so once the budget’s back in surplus and the net public debt is falling.

(A tell-tale sign of the been-there-done-that syndrome is Scott Morrison “doing a Swanny”: portraying the forecast return to tiny surplus by June 2020 as already in the bag.)

After such a period of discipline, the pressure to let out the budgetary stays will be huge. Yet the forward estimates for the four years to 2021-22 imply real spending growth averaging just 1.8 per cent.

This is composed mainly of increases in spending on the national disability insurance scheme of more than 0.6 percentage points of gross domestic product, more than 0.1 points for defence and almost 0.1 points for aged care, offset by falls of about 0.2 points each for road and rail infrastructure, pharmaceutical benefits, and the family tax benefit, and falls of about 0.1 points each for the disability support pension, veterans and public debt interest payments, plus a fall of 0.3 points for administrative costs.

The projected increases are easier to believe than the projected falls. Those for spending on infrastructure and pharmaceutical benefits are creative accounting. The tougher criteria for the disability pension won’t withstand the rise in the age pension age to 67, nor any economic downturn.

And, of course, the huge saving in public administrative spending assumes that after more than a decade of annual cuts to staffing costs, the “efficiency dividend” can roll for another four years without any noticeable loss of efficiency.

The Coalition’s rule that ministers proposing new spending programs must also propose equivalent savings from within their portfolio seems to do most to explain the low real growth in spending overall.

But this, too, is a discipline that will be ever-harder to sustain for a further decade. The way Morrison is dishing out dollars to fix political pressure points, it’s likely to take a beating just between now and the election.

What worries me is the way Treasury and Finance’s approach to spending control is so old-school, so blunt-instrument, so hand-to-mouth, so no-brainer.

Just Say No. Just tell every department to find savings, and cut their admin costs by yet another 2.5 per cent, then look the other way while they make short-term savings at the expense of our future.

Treasury and Finance see spending control as an act of being tough and unreasoning and opportunist, not one involving any science or learning or expertise.

It’s as though, stuck on a sheep run in the middle of NSW, obsessing about macro-economic management, they’ve been oblivious to the advances in spending control techniques made by applied micro-economists at universities around Australia.

There’s the campaign of Dr Richard Tooth (from a consulting firm) for price signals to encourage better driving, there’s Professor Bruce Chapman’s invention of the income-contingent loan which, as Professor Linda Botterill keeps saying, could be applied to drought loans and much else.

There’s all the work health economists put into the developing case-mix funding of hospitals, and the unending stream of smart suggestions coming from the nation’s leading health economist, Dr Stephen Duckett, of the Grattan Institute.

Then there’s former professor Andrew Leigh’s championing of using randomised control trials to discover what spending works and what doesn’t, there’s more rigorous and transparent use of benefit-cost analysis to evaluate infrastructure projects, there’s greater use of “behavioural insights” teams, there’s more emphasis on preventive medicine and there’s exploiting the long-term budgetary savings offered by greater investment in early childhood development.

Now, many of these advances have been taken up, at least in some modest way. But, to my knowledge, because they’ve been pushed by other people, not because Treasury and Finance have shown much interest. They’re asleep at the wheel.

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Budget office fills vacuum left by politicised Treasury

I see the federal Auditor-General has been less than complimentary about the Turnbull government’s cashless welfare card. The cheek! I say the man should be removed and replaced by a Liberal Party staffer forthwith.

Always provided the staffer has done at least a year or two of accounting at uni, of course. Wouldn’t do for voters to gain the impression his chief qualifications were his years of loyal service as a ministerial flunky.

If this ironic scenario seems over the top, it’s not way over. If the present Auditor-General actually had incurred the government’s serious displeasure, it would be more likely to wait until his statutory term had expired before replacing him with someone less likely to provide it – and us – with critical advice.

You don’t have to be very long in the workforce to realise that one of the hallmarks of a bad manager is his (or occasionally her) penchant for surrounding themselves with yes-men. See that happening and you know you’re in the presence of a disaster waiting to happen.

But installing a tame auditor-general wouldn’t be a big step beyond the flouting of convention and good governance we’ve seen the government engaged in over the past two weeks.

Following Tony Abbott’s unprecedented dismissal of the secretary to the Treasury in 2013, and his replacement with hand-picked candidate John Fraser, Malcolm Turnbull and Scott Morrison have now completed the politicisation of Treasury.

What an accomplishment for Malcolm to include when he boasts in his memoirs about the glorious achievements of his reign.

With the sudden resignation of Fraser, he was replaced by Philip Gaetjens, whose service as chief-of-staff to Peter Costello and then Morrison himself was interspersed with his time as secretary of the NSW Treasury, appointed by the O’Farrell government after it sacked the apolitical secretary it inherited from the Keneally government, Michael Schur.

The timing of Fraser’s departure was portrayed as all his own inconvenient idea, which may well be true. But, with the federal election so close, it reminds me of a trick practised by the self-perpetuating boards of the mutual insurance companies of old.

Any director not wishing to serve another term would resign just a few months before his term expired. This would allow the board to select his successor, and that successor’s name to go onto the ballot paper with an asterisk beside it, certifying to the voting punters that he was a tried-and-true incumbent.

Morrison then topped off this innovation in Jobs for the Boys by installing Simon Atkinson, a former chief-of-staff to Finance Minister Mathias Cormann, as a deputy secretary in Treasury.

Worse, Atkinson got the job to replace Michael Brennan, who’s been moved up to be the new chairman of the Productivity Commission, which has had a long and proud tradition of independence, giving fearless advice to governments of both colours.

We’ll see how long that lasts. Morrison tacitly admitted Brennan’s appointment was questionable by using his press release to make Brennan sound like a career public servant, conspicuously failing to mention he’d been a staffer for two Howard government ministers and a Liberal Victorian treasurer, not to mention a candidate for Liberal state preselection.

My greatest fear is that the next Labor federal government will use this bad precedent to behave the same way, thus making the politicisation of government departments and supposedly independent agencies bipartisan policy. What a great step forward that would be.

Fortunately, as trust in the professional integrity of Treasury forecasts and assessments declines, the vacuum is being filled by the rise of the Parliamentary Budget Office, which has the same expertise as Treasury, Finance and the spending departments, but is independent of the elected government.

Just last week it produced a most revealing report on the sustainability of federal taxes, one Treasury would have had trouble getting published even in the good old days.

Its message is that there are structural vulnerabilities limiting the future revenue-raising potential of most federal taxes, with the main exception being income tax and that eternal standby of dissembling politicians on both sides, the supposed evil they only pretend to disapprove of: bracket creep.

This is the last thing either side would want us thinking about before the election.

After all, thanks to the budget’s chronically overoptimistic forecasts and what-could-possibly-go-wrong 10-year projections of endless budget surpluses and ever-falling public debt, they can afford to turn the coming election into a tax-cut bidding war.

Vote for me and I’ll cut taxes more than the other guy.

The budget office has punctured that happy fantasy. After the election, whomever we vote for will have to find a way to cover not just the cost of ever-growing but untouchable spending on health, education and all the rest, but also the tax system’s built-in inadequacies.

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