ECONOMIC POLICY, EMPLOYMENT AND STRUCTURAL CHANGE

June 2014

The structure of the economy – particular industries’ relative shares of GDP and total employment, but also the age, gender and full-time/part-time structure of the labour force, and the role and relative size of government – is always changing. It’s always changing because the forces for change bearing down on the economy keep changing. But those forces seem particularly numerous and strong at present.

So I want to talk about those structural changes, about how the government is responding to them with its economic policy, and about the prospects for the economy, particularly employment.

Sources of structural change

Among the many sources of structural change affecting the Australian economy, the two biggest and most general are globalisation and technological advance. Globalisation is the process by which the natural and man-made barriers between national economies are being broken down, partly by deregulation but mainly by advances in technology.

One part of globalisation is the rapid economic development of Asia, which is increasing our access to cheaper imports of manufactures, from clothing to electronic goods and cars, but also increasing the demand for our exports of minerals and energy. The growth of Asia’s middle class will increase demand for tourism, westernised foodstuffs and niche manufactured items.

The internet, the advent of e-commerce and the digital revolution are beginning to have big effects on industries such as recorded music, cinema, book selling and publishing, the post office and the retail sector generally, not to mention newspapers and the rest of the news media, and the advertising industry.

Households went through a protracted adjustment to financial deregulation – which greatly increased the availability of credit – and the return to low inflation in the early 1990s, which significantly reduced nominal interest rates, prompting a housing boom and leading households to greatly increase their housing debt, reducing the household saving rate to zero. But this untypical behaviour couldn’t go on forever. It started to end before the global financial crisis, but continued in earnest after it, with the household saving ratio returning to 10 per cent, where it seems to have settled.

Demographic change – the decline in fertility and the retirement of the baby-boomer bulge – is changing the economy’s ratio of workers to dependents, making a slower rate of growth over the next 40 years more likely as the participation rate falls for demographic reasons and highlighting the need to make the labour market more female-friendly and older worker-friendly.

Another structural change is climate change. The Labor government responded to this by introducing a carbon tax that was to turn into an emissions trading scheme in July this year. It bolstered this by raising the Howard government’s renewable energy target to ensure that 20 pc of Australia’s electricity comes from renewable sources by 2020. However, the Abbott government, which includes many climate change deniers, is seeking to abolish the carbon tax and replace it with ‘direct action’ in which businesses are offered incentives to reduce emissions. The renewable energy target is being reviewed by an avowed climate change ‘sceptic’.

The resources boom, stage III

But the biggest and most immediate structural change affecting both the structure of the economy and its year-to-year macroeconomic management is the resources boom, itself a product of globalisation and the rapid economic development of Asia, particularly China.

The resources boom began in 2003 and was divided into two parts by the global financial crisis of 2008-09. The boom has had three stages: first, much higher prices for our exports of coal and iron ore, causing our terms of trade to reach their best for 200 years. Second, a historic surge of investment spending to greatly expand our capacity to mine coal and iron ore and extract natural gas. And third, a considerable increase in the volume (quantity) of our production and export of minerals and energy.

The first stage is now over, with coal and iron ore prices reaching a peak in mid-2011 and the terms of trade falling about 20 pc since then. Now the second stage, the growth in mining investment spending, has reached a peak and begun to decline, making a negative contribution to growth. This is being only partly offset by the commencement of the third stage of the boom, the rising volume of mineral and energy exports as the newly installed production capacity comes on line.

The boom has greatly expanded our mining sector, taking its share of total production (GDP) from 4 pc to about 10 pc, although the industry is so highly capital-intensive its share of total employment is still only about 2 pc. The industry has been, and remains, highly profitable. Since its direct contribution to the employment of Australians is so small and since the industry is about 80 pc foreign-owned, it is important that it contribute to the economy by having its economic rent adequately taxed. The Labor government responded with a minerals resource rent tax, but mishandled its introduction, allowing the three main companies paying it to minimise their payments in the early years by getting generous tax deductions up-front. The Abbott government is seeking to abolish the tax.

The rapid expansion of the mining sector has required the transfer of labour and capital from elsewhere in the economy, a process of structural adjustment which the high dollar, brought about by the marked improvement in our terms of trade, has helped to facilitate by exerting painful contractionary pressure on our other tradeable industries, particularly manufacturing.

In its early stages, the boom presented the macro managers with the challenge of ensuring the jump in our real national income brought about by the high export prices didn’t lead to an inflation blowout as had happened with previous commodity booms. This possibility was avoided, particularly because our floating exchange-rate regime allowed a big rise in the dollar, which constrained our other tradeable industries, reduced inflation directly by lowering import prices and directed excess consumer demand into imports.

In the later stages of the boom, however, the macro managers now face roughly the opposite challenge: ensuring the fall in national income as export prices fall back, and the pipeline of mining and natural gas investment projects starts to empty, don’t cause the economy’s growth to slow too far and lead to a big rise in unemployment.

The need for the economy to make a ‘transition’ from mining-led growth to growth led by other industries and other categories of demand has been preoccupying the macro managers for at least a year and is likely to be their main focus of attention for at least another year. The falloff in mining investment spending is expected to subtract significantly from domestic demand in the coming financial year, 2014-15, and the following year. The need to encourage growth in the non-mining economy has so far been made more necessary and more difficult by the failure of the dollar to fall by as much as the fall in mining export prices and deterioration in our terms of trade had led us to expect. The dollar did fall back after April 2013, but in more recent times has been surprisingly strong, possibly because of the continuing ‘quantitative easing’ in the United States and elsewhere.

The continuing preoccupation with successfully negotiating the transition from mining-led to broader-based growth is the dominant consideration in the settings of both monetary policy and fiscal policy.

Monetary policy

Monetary policy - the manipulation of interest rates to influence the strength of demand - is conducted by the RBA independent of the elected government. It is the primary instrument by which the managers of the economy pursue internal balance - low inflation and low unemployment. MP is conducted in accordance with the inflation target: to hold the inflation rate between 2 and 3 pc, on average, over the cycle. The primary instrument of MP is the overnight cash rate, which the RBA controls via market operations.

After the GFC reach its height in late 2008, the RBA feared we would be caught up in the Great Recession that hit other economies, so it quickly slashed the cash rate from 7.25 pc to 3 pc. By October 2009, however, it realised we would escape the recession, so began lifting the cash rate from its emergency level, reaching 4.75 pc in November 2010.

In November 2011, the RBA decided the resources boom was easing and would not push up inflation. It realised growth in the non-mining sector of the economy was weak - held down particularly by the dollar’s failure to fall back in line with the fall in export prices – at a time when mining-driven growth was about to weaken. So it began cutting the cash rate, getting it down to a historic low of 2.5 pc by August 2013.

The RBA is trying to counteract the dampening effect of the high dollar by using lower interest rate to stimulate demand in other parts of the economy, particularly housing and consumption, but also non-mining business investment. It is having some success with housing investment, but not much with consumer spending and none with business investment. Barring a sharp fall in the dollar, it’s likely to keep interest rates low until it is confident the economy has made the transition to broad-based growth successfully.

Fiscal policy

Fiscal policy - the manipulation of government spending and taxation in the budget - is conducted according to the Abbott government’s medium-term fiscal strategy: ‘to achieve budget surpluses, on average, over the medium term’. This means the primary role of discretionary fiscal policy is to achieve ‘fiscal sustainability’ - that is, to ensure we don’t build up an unsustainable level of public debt. However, the strategy leaves room for the budget’s automatic stabilisers to be unrestrained in assisting monetary policy in pursuing internal balance. It also leaves room for discretionary fiscal policy to be used to stimulate the economy and thus help monetary policy manage demand, in exceptional circumstances - such as the GFC - provided the stimulus measures are temporary.

The Labor government proved unable to keep its promise to get the budget back to surplus in 2012-13, not because it was spending too much (though it did have big plans for increased spending in the second half of the 2010s), but because the sharp falls in mineral export prices slowed the growth in nominal GDP and so caused the recovery in tax collections to be far weaker than expected.

Mr Hockey’s first budget included many cuts in government spending, big increases in user charges for GP visits, pharmaceuticals and university education, a shift from indexing payments and benefits to wages to indexing them to prices, a return to indexing the fuel excise and a temporary deficit levy on high income-earners.

The budget deficit is expected to fall from $50 bil in the financial year just ending to $30 bil in the coming year, 2014-15, then to $17 bil the following year and $3 bil in 2017-18. The budget’s 10-year ‘medium-term projection’ shows it returning to a balanced budget in 2018-19, then with a surplus growing each year until it reaches 1.5 pc of GDP in 2024-25.

From a fiscal policy perspective the budget has two key features: 1) A slow pace of fiscal consolidation. The budget’s new measures and revisions to forecasts are expected to improve the budget balance by just $4 bil in the budget year and by $7 bil in each of the following two years, but by $26 bil in 2017-18. This slow start is intended to avoid the budget having a dampening effect on growth while the economy is expected to be growing at a below-trend rate.

2) A switch in the composition of government spending. While spending on transfer payments leading to consumption is reduced, spending on infrastructure investment is increased by $12 bil. About half this is spent on an ‘asset recycling initiative’ intended to encourage the states to increase their own infrastructure spending. The goal is to help fill the vacuum left by the fall in mining investment.

All this means the ‘stance’ of fiscal policy adopted in the budget is contractionary, but only to the most minor extent. The government knows the economy will be hit by big cuts in mining investment spending over the next two years, and so is delaying its plans to return the budget to surplus.

The outlook for growth and employment

The government is expecting the economy to grow by 2.75 pc in the present financial year, slowing to 2.5 pc in the coming year, but rising to 3 pc in 2015-16 and 3.5 pc in the following two years.

The economy’s medium-term trend rate of growth is 3 pc. This is consistent with growth in employment of 1.5 pc a year and the rate of unemployment at its lowest sustainable rate (the NAIRU) of 5 pc.

So below-trend growth this financial year and next is expected to see unemployment creep up to 6.25 per cent by June 2015, and stay high until it returns to 5.75 pc by June 2018.

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Uni 'deregulation' not what it's claimed to be

The greatest economic puzzle in the budget is Tony Abbott's intention to "deregulate" university fees in 2016. There's a lot more to it than many people imagine.

Punters who make no profession of understanding economics think fees will skyrocket. Advocates of the change, who think they know more than the punters, say increases will be constrained by competitive pressure.

The more economics you know, the less certain you can be about how things will turn out. But you can make a pretty persuasive case that, for once, the punters may be closer to the truth than the advocates.

Abbott and his Education Minister, Christopher Pyne, plan two main changes: the deregulation of fees and changes to the HECS loan scheme. I'll leave the loan changes for another day and focus on the fee changes.

At the same time as it permits unis to set their own fees for undergraduate courses, the government will cut its contribution towards the cost of courses by an amount that averages 20 per cent. It will then reduce the annual indexation of its contribution, switching to the consumer price index, which doesn't rise as fast as the unis' wages and other costs.

So the government's primary motivation is clearly to shift more of the cost of universities from itself and onto students. The 20 per cent cut will give the unis an immediate and pressing reason to use their new freedom to increase the fees they charge, and the less-generous indexation will maintain the pressure for further increases.

Even so, the man who recommended that unis be allowed to set their own fees, Andrew Norton, is confident the initial increase will be no more than $6000 a year, taking annual fees to between $12,000 and $16,000, depending on the course.

The government is confident its changes will increase competition between the unis, leading to greater diversity, innovation and quality, and giving us "a world-leading higher education and resource system".

The simple model of how markets work taught in introductory economics courses leaves may people with excessive faith in the ability of market competition to foster increased efficiency, constrain price increases and ensure customers get high quality.

Its promises are based on a host of limiting assumptions, which usually don't apply. It assumes a very large number of small firms selling a homogeneous product to buyers with "perfect knowledge" of the quality and other characteristics of what they're buying.

In the tertiary education "market", however, we have a relatively small number of large and larger organisations, selling differentiated products of uncertain quality. We have oligopoly rather than "perfect competition".

We know oligopolists compete, but usually try to avoid competing on price rather than marketing. They have a degree of pricing power and their competition takes the form of "rivalry" - focusing on the behaviour of competitors rather than the needs of customers.

It's misleading to describe giving unis freedom to set their own fees as "deregulation". Indeed, it's silly to imagine higher education is anything like a market. It's "firms" are owned by the state governments and highly regulated by the federal government. All its courses still have to be accredited by the feds which, they claim, guarantees that quality standards won't fall.

Even the unis' freedom to raise their fees - which the next government could reverse - comes with a string attached: fees charged to local students may not exceed those charged to overseas students.

There's no profit motive. And, as any academic will tell you, unis are highly inefficient, bureaucratic organisations dominated by administrators.

The safest prediction is that giving unis greater revenue-raising ability will lead to them employing more administrators.

How can uni fees be regarded as a "price" in the textbook sense when people are lent the money to pay the price under a concessional loan they won't have to repay for years?

In effect, universities have a government-regulated monopoly over a product that gives young people access to the country's highly paid jobs. What will they do when the price jumps - abandon all ambition? Demand seems highly "price inelastic" - unresponsive to price changes.

Our unis are protected from import competition by the high fees other countries charge foreign students. Within Australia, unis enjoy a degree of geographic monopoly. Sydney and Melbourne unis don't really compete for students. Living costs can be high if you move to a regional uni.

The sandstone unis will be able to charge a premium that reflects their higher status, more central locations and lovely campuses. In a normal market, other unis would charge less than the big boys.

The simple model assumes consumers ensure prices reflect differences in quality. But where it's hard to judge the quality of a product before you try it, many people reverse the causation and assume the higher the price, the higher the quality. This gives lower-quality producers an incentive to charge high prices.

In the early noughties, the Howard government allowed unis to raise their fees by 25 per cent. One small uni decided not to do so. It found its applications from new students actually fell. So the following year it put its fees up like all the others and its applications recovered.

In Britain, the Cameron government allowed unis to raise the 3000 pound annual fee they charged local students up to a limit represented by the 9000 pound fee charged to foreign students. Almost all of them took the opportunity to raise their fees to the maximum allowed. Applications dropped by 9 per cent in the first year, but rose in subsequent years.

On the basis of all this, my guess is the sandstone unis will raise their fees a long way and the less reputed unis won't be far behind them. Their notion of competition will be to make sure no one imagines a lesser fee than the big boys is a sign of their lesser quality.

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Why exactly are we punishing young jobseekers?

It has been easy for older people to see themselves as particular victims of this budget. And I confess I never expected to see any government courageous enough to pick on Grey Power the way Tony Abbott's has. In his efforts to get people into the workforce, however, it's carrots for the old and sticks for the young.

A major goal of this budget is to increase everyone's ability to contribute to the economy: "everyone who can contribute should contribute." Contribute doesn't mean paying a higher rate of tax, of course, but taking a paid job.

"This budget is about shifting our focus from entitlement to enterprise; from welfare to work; from hand-out to hand-up." Don't you feel better already?

To this end, the budget cuts benefits to sole parents and stay-at-home mums, reviews the assessment of some younger recipients of the disability support pension and imposes "compulsory activities" on recipients under 35, cuts the benefit received by unemployed people aged 22 to 24 from the dole to the youth allowance, imposes a waiting period for benefits of up to six months on people under 30, reintroduces Work for the Dole and introduces a "restart" payment of up to $10,000 to employers who take on job seekers aged 50 or over who have previously been on benefits, including the age pension.

Get it? Older people want to work, but suffer from the prejudice of employers, so they're helped with a new and generous subsidy to employers, whereas the young don't want to work when they could be luxuriating on below poverty-line benefits, so they're whipped to find a job by having their benefits cut and their entitlement removed for six months in every year until the lazy loafers take a job.

Just how having their benefits reduced or removed helps young adults afford the various costs of finding a job - including being appropriately dressed for an interview - the government doesn't explain.

But anyone who can remember the controversial statements Abbott used to make as minister for employment in the late 1990s will know he has strong views about the fecklessness of youth and the need for a pugilistic approach to their socialisation.

Consider this from a budget glossy spin document: "The government is reinforcing the need for young Australians to either earn or learn. The changes will prevent young Australians from becoming reliant on welfare.

"Because we want new jobseekers, especially those leaving school and university, to actually look for work, income support will only be provided once a six-month period of job hunting has been completed."

And if it doesn't work the first time, give them six months on Work for the Dole, then keep repeating the dose until it does. If that doesn't get 'em off their arses, nothing will.

Really? Young Aussie adults are that lazy and lacking in aspiration? No shortage of jobs, just a shortage of effort that a monetary boot in the backside will soon fix?

The notion that our young people should either be "earning or learning" has intuitive appeal, but a moment's reflection shows it can easily be taken too far.

How does it help to starve a youngster to the point where they're prepared to undertake some pointless training course? Is it really smart to take a university graduate who's having a few months' wait to find a suitable job and force them into a taxpayer-funded course on driving a forklift truck?

We've been hearing a lot lately about the difficulty older people have in finding re-employment. I'm sure there's much truth to it, and the government has acted. But we hear much less about the way the young suffer whenever times are tough and employers become reluctant to hire.

Everyone thinks a policy of reducing staff numbers by "attrition" is a relatively benign response to an economic slowdown. Big staff layoffs are avoided. But few remember this transfers the burden from people already in jobs to those seeking jobs, particularly those leaving education. The annual entry-level intake is the first thing to go.

Before Abbott turned up with his punitive solution to a problem few people realised we had, the Brotherhood of St Laurence began campaigning to raise public awareness of rising youth unemployment.

Unemployment among those aged 15 to 24 shot up in the recession of the early '90s, reaching more than 380,000 in October 1992. But by August 2008 it had fallen to less than 160,000. That was immediately before the global financial crisis. Since then it has climbed back to about 260,000.

The rate of unemployment among 15- to 24-year-olds is 12.5 per cent, more than double the overall rate. This means they account for more than a third of the unemployed.

And it's not just more of them: over the past five years the average duration of unemployment for young people has risen from 16 weeks to nearly 29 weeks.

The funny thing is, the executive director of the Brotherhood, Tony Nicholson, doesn't find much evidence these people are happy to live on the dole forever. "They aspire to a mainstream life - to have a home, to have some sense of family, to belong. A key part of that belonging is the desire to have a paid job."

Maybe the problem is not enough jobs rather than not enough effort. If so, putting them on a starvation diet may not do much to help.

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Hockey’s budget applies a chopper, not a brain

According to Treasury secretary Dr Martin Parkinson, the budget is replete with ''structural reforms''. According to his boss Joe Hockey, it will ''drive the productivity required to generate economic growth''. Sorry, not convinced.

As a vehicle for micro-economic reform, the budget gets less impressive the more I study it. Parkinson seems to be referring to reforms to the structure of the budget itself, which will build ''fiscal resilience'' over the coming decade.

That's true enough in terms of returning the budget to a sustainable surplus (business cycle permitting). In the process, however, the budget cuts will do little to raise the efficiency with which the government performs its own tasks, nor the efficiency of its interaction with private industries.

Rather than making what the government does more cost-effective, it just stops doing as much. It makes the federal government smaller, but not better. It's a giant exercise in cost-shifting: to people on pensions, to the young jobless, to university students, to the sick and, to the tune of $80 billion, to the states.

It's about crude spending cuts, not about using science to improve efficiency. Does anyone seriously believe imposing yet another temporary increase in the ''efficiency dividend'' on the public service will lead to cost savings without any decline in the quantity and quality of services provided to the public?

Hockey's talk of productivity improvement seems mainly a reference to the budget's increased spending on public infrastructure. I guess we shouldn't complain about the Liberals' belated recognition that adequate infrastructure increases the productivity of the private sector - it would be news to Peter Costello - but the money does need to be well spent to maximise the benefit.

Monuments and pork-barrelling do little for productivity. And I'm not convinced the Libs' bias - federal and state - towards expressways and against public transport is the way to get the greatest productivity gain.

Next exhibit on the micro-reform list would be the deregulation of university fees. The claim that this will unleash competition and so make the tertiary education ''industry'' a lot more efficient is so debatable I'll leave it for another day.

Along with Tony Abbott (St Ignatius, Riverview) and Christopher Pyne (St Ignatius, Adelaide), Hockey (St Aloysius, Sydney) has repudiated the Gonski reforms which would have put federal grants to schools on a needs basis. He's left grants to private schools unreformed and unmeans-tested, while grants to public schools will cover an ever-declining share of their costs.

Leaving aside questions of fairness (and partiality), this is a micro-reform negative. Adjusting grants to reflect students' disabilities would have done much to increase the skills, employability and workforce participation of kids at the bottom of the distribution. It could have been done more cheaply than Labor planned by reducing grants to privileged schools to compensate.

Medical services account for 9.5 per cent of gross domestic product, meaning we have few industries that are bigger, even though much of the industry is government-owned or heavily government-subsidised.

There is plenty of room for the reform of excessive schedule fees for certain procedures, perverse incentives and overservicing, particularly by the corporate sausage-machines that have been permitted to take over so much of general practice.

The doctors' union could be obliged to allow nurses and other health professionals to perform many routine procedures. Many evidence-based reforms could be implemented to reduce waste and increase productivity in public hospitals without reducing the quality of care.

Much could be done to reduce the cost of the pharmaceutical benefits scheme by taking a tougher line with foreign drug companies over generics and the ''evergreening'' of patents, not to mention the chemists' union.

Paradoxically, overseas experience says greater efficiency can be achieved by imposing a cap on the growth in total scheme spending, thus requiring medical representatives to make harder choices about which new drugs are really worth listing.

So what was done? Hockey introduced a $7 charge on GP visits, tests and scans that will be costly to collect and will get at the corporate overservicers by hitting every patient and will discourage the poor from seeing the doc, whacked up an already high co-payment for pharmaceutical scripts and slashed projected grants to public hospitals.

For good measure, Hockey stopped wasting money on all that preventive medicine stuff. Brilliant. Must have taken a genius to dream all that up.

Finally, ''corporate welfare''. The foreshadowed toughness didn't materialise, save for a brave decision to take the ethanol subsidy from a very generous political donor. But the opportunity for sharing the pain - and doing much to force change on a lot of corporate ''leaners'' - was missed.

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Sleights of hand in Hockey's budget

You have to look hard, but there are two logical sleights of hand in Joe Hockey's fiscal policy, as dutifully expounded by his Treasury secretary, Dr Martin Parkinson, in his speech this week.

Parkinson makes three important points that have tended to be lost in all the furore over Hockey's choice of victims in his efforts to get the budget back on track. I'll take issue with the last two.

The first is the "measured pace of fiscal consolidation". ("Fiscal" is a fancy word for the budget and "fiscal consolidation" is a euphemism for the spending cuts and tax increases needed to get the budget back into surplus.)

Parko's point is that, though Hockey has announced a host of decisions to improve the budget balance, many of them don't start for a year or three and the rest don't have much effect for a few years.

Relative to the estimates we were given in the mid-year budget review just before Christmas, the effect of the measures announced in the budget, plus any revisions to the economic forecasts, is expected to reduce the deficit for next financial year by just $4 billion (relative to nominal gross domestic product of $1630 billion).

The expected improvement in the second year, 2015-16, is just $7 billion, with the same improvement the year after. Not until the fourth year, 2017-18, is a big improvement of $26 billion expected to bring the budget back almost to balance.

See how gentle it is? Why so "measured"? Because the economy is still relatively weak - "below trend", in the jargon - and is expected to stay relatively weak for another year or two as spending on the construction of new mines and gas facilities falls much further.

So Hockey delayed the effect of most of his measures until he was confident the economy could absorb the shock without falling in a heap. This is exactly what the Brits and others didn't do - which is why it's both wrong and ignorant to refer to Hockey's measures as a policy of "austerity".

Parko's second point is that the budget measures involve a "compositional switch" in government spending. Hockey's cuts are aimed at "transfer payments" (transfers of money) that flow into consumer spending.

At the same time, however, he's actually increasing investment spending on new infrastructure by almost $12 billion over five or six years. Five billion of that is his "asset recycling initiative", which offers the state governments a 15 per cent incentive to sell off some of their existing businesses and use the proceeds to build new infrastructure.

So the incentive should lead to a lot more infrastructure spending than would otherwise have occurred. And, on top of that, we know investment spending has a higher "Keynesian multiplier" than consumption spending.

This change in the mix of government spending is happening by design, intended to help fill the vacuum left in the engineering construction sector by the sharp fall in mining construction. More proof Hockey is no economic wrecker.

But this year's budget papers include a new section giving the split-up of total government spending between "recurrent" spending (cost of keeping the show going for another year) and spending on investment, something forced on Hockey as part of a deal with the Greens to remove Labor's (silly) cap on total government borrowing.

What past governments haven't wanted to tell us is that about 9 per cent of their annual spending is capital, not recurrent. For the coming financial year this is $36 billion. More than half of this is capital grants to the states, 20 per cent is defence equipment and 14 per cent is building the national broadband network, leaving 11 per cent on the feds' own capital purchases.

The budget papers confirm the new government's commitment to the "medium-term fiscal strategy" first set down by the Howard government to "achieve budget surpluses, on average over the course of the economic cycle".

This is a good formulation, with one, now-more-salient weakness: its failure to distinguish between recurrent and capital spending. Hockey and his boss keep saying the budget has to be returned to surplus because we're "living beyond our means" and leaving the bill for our children.

That's true only to the extent we continue borrowing to cover recurrent deficits. To the extent we borrow to help cover the cost of infrastructure - which will deliver a flow of services extending over 30, 40 even 50 years - we're not living beyond our means (any more than a family that borrows to buy its home is) and not treating the next generation unfairly.

So setting yourself the goal of paying for all your infrastructure investment and having the government end the cycle with an ever-rising bank balance is fiscal conservatism gone crazy.

The second of the government's fiscal sleights of hand comes with Parkinson's third point: Hockey's plan involves creating "headroom for tax cuts".

In projecting government spending and revenue over the coming decade, the government has resolved to impose a cap on the growth in tax collections at 23.9 per cent of GDP. And government spending has been cut hard enough to accommodate that cap while still producing ever-growing surpluses.

Why? Because, we're told, "fiscal drag" (bracket creep) can't be allowed to run on forever. It would push low- and middle-income-earners into much higher tax brackets ("marginal tax rates") which would be both economically damaging and politically infeasible.

Fine. We've had to rely on years of bracket creep to correct the irresponsibility of Peter Costello's eight tax cuts in a row, but this can't go on for ever.

Did you see the sleight of hand? You don't need to cap tax collections just to counter bracket creep in income tax. Hockey is making room for much bigger tax cuts than that. And there's zero guarantee the chief beneficiaries of those cuts will be the low- and middle-income-earners who suffered most under the creep.

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Hockey's budget game plan: favour the well-off

Do you like paying tax? No, I thought not. Well, I have good news. The harsh measures in last week's budget were directed towards one overwhelming objective: getting the budget back into surplus without increasing taxes to do it. Indeed, Joe Hockey is working towards the day when he can start cutting income tax.

If you hadn't quite realised that, you could be forgiven. You've been unable to see it because of two distractors: the deficit levy and the resumed indexation of fuel excise.

But the levy is just a temporary pin-prick to the top 3 per cent of taxpayers who will pay it. And the price of petrol will rise by only about 1 cent a litre per year. The effect of the excise increase will be dwarfed by the ups and downs in the world price of oil.

The catch is this: you may hate paying tax, but don't be too sure Hockey's efforts to avoid tax increases and eventually make room for income-tax cuts will leave you ahead on the deal.

Why not? Because to avoid increasing taxes - and avoid cutting the big tax breaks some people enjoy - Hockey has concentrated on cutting back all manner of government spending. And most people - maybe all families bar the top 10 per cent or so - have more to lose from cuts to government spending made, than they have to gain from tax increases avoided.

That's particularly true when Hockey's efforts to cut government spending take the form of tightening means tests, moving to meaner rates of indexation and introducing or increasing user charges.

Don't think just because you voted for the Coalition Hockey is looking after you. It works out that low income-earners - generally the old, the young and the unemployed - are heavily dependent on government spending, and genuinely middle income-earners with dependent kids are significantly reliant on government spending.

Only high income-earners who've already been means-tested out of eligibility for most programs (e.g. me) have little to lose from Hockey's cuts. That's the reason for the deficit levy. Without it, it would have been too easily seen that high income-earners weren't doing any of Hockey's "heavy lifting".

Indeed, too many people might have twigged that the whole exercise was designed to have high income-earners as its chief beneficiaries. The spending cuts are permanent and many of them save more as each year passes. But the deficit tax is temporary.

Hockey wants us to believe he had no choice but to do what he did. I accept he had to get on with bringing the two sides of his budget back into balance, but he had a lot of choice in the measures he took to bring that about.

He chose to focus on cutting three big classes of government spending: health, education, and income-support programs (pensions, the dole and family tax benefits). Not by chance, these are the programs of least importance to high income-earners.

He carefully avoided cutting the programs of most importance to the well-off: superannuation tax concessions, the concessional tax treatment of capital gains and negative gearing, Tony Abbott's Rolls Royce paid parental leave scheme, the mining industry's fuel excise rebate and other "business welfare" and, of course, the high income-earners' favourite charity: defence spending.

And while slashing away at health, education and income support, he was also busy abolishing the carbon tax, the mining tax paid largely by three huge foreign mining companies, cutting the rate of company tax by 1.5 percentage points and exempting federal grants to private schools from his education cuts.

Hockey will tell you his net cuts to health, schools and age pensions don't actually take effect until 2017, after the 2016 election. This is the basis for his claim not to have broken Abbott's election promises. (Remember, all the proceeds from his cuts and charges in health care will go into the new medical research future fund.) It's largely true - though only for Abbott's "core" promises.

Even so, Hockey's most objectionable changes are the punitive treatment of the young jobless and the attack on Medicare's principle of universality. The measures that will do most harm to the Liberal heartland (including the children of high income-earners) are the changes to HECS and deregulation of university fees.

Some people are referring to Hockey's $7 patient co-payment for GP visits, tests and scans as a tax. This is quite wrong. It's precisely because it isn't a tax that it has been introduced. It's a user charge: use the service, pay the charge. By contrast, taxes are amounts you pay the government that bear no direct relationship to what you get back.

High income-earners want more user-charging (for pharmaceuticals as well as GP visits) because they're no great burden to the highly paid, but they reduce the need for higher taxes. They reduce the cross-subsidy from the rich to the poor.

I must warn you, however, of the one glaring exception to high income-earners' insistence that tax increases be avoided at all cost (to other people). The one tax increase they lust after is a rise in the goods and services tax.

Why? Because they believe it will be part of a deal in which the higher GST paid by everyone is used to pay for another cut in the rate of company tax plus a cut in the top rate of income tax.

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Less to the budget than meets the eye

The more of the budget's fine print I get through, the less impressed I am. It's not a budget so much as a flick-pass.

On its main goal of returning to surplus, you can accept the plausibility of its projections that budget balance will achieved by 2018-19 without being terribly impressed by the quality of its claimed "structural" savings.

The policy changes proposed yield savings over the four years to 2017-18 totalling $38 billion (on an accruals basis). Contrary to all the government's rhetoric, almost a quarter of these savings come from increased tax collections.

But get this: fully 46 per cent of the total savings come in the fourth year. Until then, net savings are quite modest. There are various reasons for this delay. One is political: Tony Abbott is keeping some core promises by not breaking them until after the 2016 election.

Another is macro-economic: Joe Hockey is delaying the big cuts until he's confident the economy will be strong enough to absorb them. Yet another is that the Labor government's back-end loading of its new spending programs meant some very big bills fell due in the year beyond last year's forward estimates (where they were harder to see).

But there's one more reason: 2018 is the first year when the expiry of various agreements allows the feds to really start screwing the states on grants for public schools and public hospitals. From then on, grants will be adjusted only in line with inflation and population growth.

This means almost all of Hockey's cumulative savings of more than $80 billion on payments to the states for schools and hospitals over the decade to 2024-25 occur beyond the forward estimates.

Before the election, Abbott and Hockey claimed repeatedly to be able to return the budget to surplus by eliminating waste. In truth, they've identified and eliminated little or no genuine waste.
Rather, they've defunded worthy causes (grants to charities and cultural activities, overseas aid), imposed new user charges (Medicare benefits, the real interest rate on HECS), whacked up existing user charges (pharmaceutical benefits, university fees) and tightened up means-testing (family tax benefit B).

But a lot of the longer-term savings come from lowering the indexation of payments from a wage-related index to the consumer price index. In the case of pensions, this will cause the relative value of pensions to fall continuously over time, pushing the aged and disabled below the poverty line.

In the case of payments to the states for schools and hospitals - whose main cost is wages - it leaves an ever-widening gap the states wouldn't have a hope of covering by increased efficiency, only from other revenue sources. (The cost of medical supplies grows much faster than the CPI.)

As well as meaner indexation, there's a lot of two or three-year pauses in indexing thresholds or payments (family tax benefit, some medical benefits schedule fees, the Medicare levy surcharge, the private health insurance rebate, grants to local governments).

Note, these are largely temporary savings to the budget, though there's some ongoing saving because of the lower base (in real terms) established before indexation is resumed.

And note this. Hockey justified his exclusion of the cost of superannuation tax concessions from his efforts to curb the allegedly unsustainable growth in the cost of population ageing by saying tax expenditures would be considered as part of the coming review of taxation. In truth, he did fiddle with tax expenditures when it suited him (the mature age worker tax offset and the dependent spouse tax offset).

See what this means? If the Coalition ever does get around to reforming the concessional tax treatment of super, capital gains and negative gearing - each benefiting mainly high income-earners - it will do so not as part of the effort to balance the budget, but as part of a revenue-neutral tax reform package where the savings are used to (I bet) cut the top tax rate, with increased collections from the GST shared between the premiers and a lower rate of company tax.

The budget was a giant attempt to get back to surplus solely by cutting spending and not increasing taxes. It failed. Not so much because of the temporary deficit levy or the resumption of indexing the fuel excise, but because the cumulative $80 billion saving from short-changing the states on schools and hospitals - almost a quarter of the total saving - will have to be covered by increased state taxation.

A tax increase flick-passed to the states is a tax increase avoided? Any serious increase in state tax revenue would have to be made possible by the feds, in any event.

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Budget's effect on economy: not as bad as it looks

The consumerist question about this week's budget is: how did it affect my pocket? The egalitarian question is: was its treatment of people at the bottom, middle and top reasonably fair? But the macro-economic question is: how will the budget affect the economy?

We know the economy has been, and is expected to continue, growing at below its medium-term trend rate of about 3 per cent a year, the rate that keeps unemployment steady. So will the budget help to speed things up or slow them down? In the economists' jargon, will its effect be "expansionary" or "contractionary"?

It may seem a simple question, but economists have various ways of attempting to answer it. One outfit asking itself this question is the Reserve Bank. The Reserve will take account of the budget's effect - along with various other factors' effects - on the strength of demand in the economy in making its monthly decisions about whether to raise, lower or leave unchanged the instrument it uses to affect the strength of demand, the official interest rate.

In making that assessment the Reserve takes a very simple approach: in what direction is the budget balance expected to change between the present financial year and the coming financial year that starts in July? And having determined the direction of the change, how big is it? Obviously, the bigger it is, the more notice we should take of it.

Taken at face value, the answers to those questions aren't ones most people would be pleased to hear. Joe Hockey is expecting a budget deficit of $49.9 billion in the financial year just ending and a deficit of $29.8 billion in the coming year.

That's an expected improvement of $20.1 billion - which may please those people who think getting the government's deficits and debt down as quickly as possible is the only thing that matters, but would worry most business people and economists.

Why? When governments spend more in the economy than they take out of it in tax collections - that is, run a deficit - they're contributing to the net demand for the production of goods and services that keeps the economy growing and increasing employment opportunities. Which, when private demand is weak, is a good thing.

(It would be a different matter if private demand were strong and the additional demand from the public sector was adding to inflation pressure.)

So the expected reduction of $20.1 billion in the budget's net addition to demand will have a contractionary effect which, taken by itself, will tend to make the economy grow even more slowly. And since the budget papers imply nominal gross domestic product will be $1632 billion in 2014-15, a $20.1 billion change represents 1.2 per cent of GDP - making it highly significant.

Oh dear. Doesn't sound good. But, as I say, this is taking the budget figures at face value - always unwise in economics. What's more, simply focusing on the direction and size of the expected change in the budget balance is a bit simplistic.

For a start, Hockey inflated the old year's deficit by choosing to make a payment of $8.8 billion to the Reserve Bank. This is just the government moving money between its pockets; it has no effect on demand.

If you ignore the one-off payment to the Reserve, the expected improvement in the budget deficit falls to $11.3 billion, which is equivalent to 0.7 per cent of GDP - but that's still a quite significant degree of contraction.

But here's where we start getting tricky. When you imagine that reducing the budget deficit by $1 will therefore reduce nominal GDP by $1, you're implicitly assuming that whatever the government does to bring that $1 reduction about won't have any effect on the behaviour of people who've had their benefits cut or their tax increased.

In the economists' jargon, you're assuming a "multiplier" of 1. In 2009, however, the Organisation for Economic Co-operation and Development published estimates of the multiplier effects of changes in various classes of government spending and taxation by the Australian government.

It found, for instance, that increased government spending on building new infrastructure would have a multiplier of 0.9 in the first year (and 1.3 in the second year, as the increased spending by the government prompted the eventual recipients of that money to increase their own spending).

By contrast, it found that, on average, an increase in government spending on "transfers to households" (such as a cash splash) had a multiplier of just 0.4 in the first year, rising to 0.8 in the second year.

Why? Because a lot of people would hang on to the money (save it, or use it to reduce their debts) rather than spend it, particularly at first.

This explains why the OECD's multiplier for a cut in income tax is only 0.4 - people would save most of it. Similarly, an increase in income tax would reduce consumer spending by only 60 per cent of the increase because some people would cut their rate of saving to "smooth" their consumption.

The OECD's various multipliers for Australia range from 0.3 to 1.3. If we use a narrower range closer to the middle of that range - 0.6 to 0.9 - and apply these multipliers to the 0.7 per cent of GDP we calculated earlier, we get an estimated negative impact on GDP of between 0.4 and 0.6.
This suggests the budget's negative effect on demand won't be too terrible.

And note this: most of the expected improvement in the deficit in 2014-15 comes from an expected improvement in the economy (more people paying more tax; fewer people needing assistance) rather than from all the tough changes Hockey announced on Tuesday night.

The lion's share of the budget savings don't come until 2017-18. Why? Partly for political reasons but also because, as he's long been saying, Hockey didn't want to hit the economy while it was down.
 

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Hockey's first budget: tough but unfair

This budget isn't as bad as Labor will claim and the Liberal heartland will privately think. It's undoubtedly the toughest budget since John Howard's post-election budget in 1996, but it's hardly austerity economics.

I give Joe Hockey's first budgetary exam a distinction on management of the macro economy, a credit on micro-economic reform and a fail on fairness.

Although Hockey has laboured hard to ensure few sections of the community escape unscathed, the truth is most of us have been let off lightly.

Only those people right at the bottom of the ladder have been hit hard - unemployed young people, the sick poor and, eventually, aged and disabled pensioners - but who cares about them? We've been trained to worry only about ourselves, and to shout and scream over the slightest scratch.

Someone in the top 4 per cent of taxpayers on $200,000 a year will be wailing over the extra $7.70 a week they'll be paying in tax. A single-income couple with kids will be losing a lot more than that, while someone under 30 denied the dole for the first six months will lose $255 a week.

And everyone will be angry about the resumption of the indexation of fuel excise, so worked up they forget it will raise the price of a litre of petrol by about one cent a year.

Anyone surprised and shocked by the budget can be excused only if last year's election was their first. Any experienced voter who allowed themselves to be persuaded that "Ju-liar" Gillard was the first and last prime minister ever to break an election promise should pay their $7 and ask a GP to check for amnesia.

If you thought a man who could promise "no surprises, no excuses" was a man who could be trusted to keep his word, more fool you.

Any experienced voter who didn't foresee that changing the government would mean this year's budget was a stinker, isn't paying enough attention.

Labor supporters want to believe that because Hockey and Tony Abbott are exaggerating about a "budget emergency" and "tsunami of government spending", we don't really have a problem. They are refusing to face reality.

After running budget deficits for six years in a row, we faced the prospect of at least another decade of deficits unless Hockey took steps to bring government spending and revenue back together. Failure to make tough decisions wouldn't have turned us into Greece, but since when was that the most we aspired to?

This budget is Abbott's admission that his claim to be able to balance the budget without increasing taxes was no more than wishful thinking. The Liberal heartland, however, schooled for years to give its selfishness free rein, is having trouble facing this reality.

Hockey's problem was that, with the economy weak and with big declines in spending on mining construction still to come, sharp cuts in government spending or big rises in taxes could have slowed the economy to a crawl.

This is why some of the biggest savings he announced - particularly on the age pension - have been timed not to take effect until 2017. It's also why he put so much emphasis on increasing spending on infrastructure, particularly by the states.

The economy is expected to be a lot stronger by the time Tuesday's measures take full effect. This carefully measured approach is what wins Hockey high marks for macro-economic management.

He claims his reforms will improve the economy's performance. His best measures along those lines are the increased competition between universities, the concessional loans to TAFE students, the loans to encourage youngsters to complete their apprenticeships and the grants to encourage employment of people over 50.

But some measures are likely to make things worse rather than better. The $7 patient co-payment for GP visits and tests is certainly likely to discourage visits - more by the poor than the rest of us - but if it dissuades people from seeking help until their medical problems are acute it may end up costing the taxpayer more than it saves.

The planned tighter means-testing and much less generous indexation of pensions will be defensible only if the planned review of the tax system leads to big reductions in the superannuation tax concessions going to retirees far too well off to get the pension.

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Labor sells its soul to fight deficit levy

If you needed any convincing Labor is a party entirely adrift from its supposed values and purpose, given over now to politicking, expedience and opportunism, just wait for its reaction to Tuesday's budget.

It will vehemently oppose Joe Hockey's deficit levy - no matter how watered down it is by then - and his intention to resume indexing the petroleum excise on the basis of no stronger argument than that they're broken promises.

These are two measures Labor should strongly support if it's sticking to its principles - one that makes the tax system fairer and one that supplements the carbon tax in fighting climate change.

If Labor were truly the social democrat, progressive party it wants us to think it is, it would advocate and fight for bigger government. Bigger not for its own sake, but because there are still many much-needed services and assistance yet to be provided, with governments best placed to provide them.

As we know, Labor can always think of new ways to spend money - the National Disability Insurance Scheme and the Gonski education reforms, for instance - but when it comes to raising sufficient revenue to cover the cost of these genuinely worthy causes, Labor's courage deserts it.

Its conservative critics accuse it of being a big-spending, big-taxing party but, in truth, it's a big-spending, low-taxing party - which can never understand why it has so much trouble balancing budgets.

Labor will carry on about Tony Abbott's ideologically driven plans to destroy the universality of Medicare, but when the scheme's cost grows strongly because the nation wants to take advantage of every new, expensive advance in medical technology, the very initiators of Medicare lack the commitment to do or even say the obvious: if you want better healthcare you have to pay more tax.

You'd think that, lacking the courage of its convictions, not having the guts to raise taxes (the proceeds from the carbon tax and the mining tax were immediately given back, mainly as lower taxes), Labor would be delighted when its opponents did have the courage to stare down the voters' disapproval.

But no, Labor's commitment to principle is now so weak it can't resist the temptation to exploit the unpopularity of an opponent implementing good policy.

By now I can hear the Laborites' plaintive cry: We're only doing what Abbott did! My point, exactly. The party that always claims the high moral ground has descended to the point where its highest claim is: we're no worse than Abbott.

Labor's further descent into political game-playing since it returned to opposition is proof that Abbott is the outstanding politician of his era. The man could not only turn his own side into a party of climate change-denying punishers of boat people and even Australian poor, he can inveigle his opponents into becoming a party than stands for nothing. Getting your own back isn't a policy that much appeals to Australian voters. Nor is opposing everything.

If Labor combines with the Greens to block Abbott's two tax measures in the Senate, it will be doing him a favour: I tried to make the budget fair, but Labor stopped me. So you won't have to vote against me after all.

By blocking a progressive tax change Labor would force the government to rely more heavily on bracket creep which, because of the strange shape of the tax scale Labor left, will now be highly regressive. Then it will be on to opposing any change in the goods and services tax because Labor is far too principled to support a regressive tax.

Speaking of the Greens, they've gone from naive purity (knocking back Kevin Rudd's original carbon pollution reduction scheme because he'd have no choice but to come back with a better one) to abject populism in opposing measures that make the tax system both fairer and more efficient.

Labor's professed outrage over Abbott's breaking of promises is utterly confected. I mean, have you ever known Labor to break a promise?

The supposed sanctity of election promises is a recipe for bad government.

No one who cares about good policy - as opposed to seeing their side get back to power - would think it smart to hold politicians to promises they should never have made, or which have been overtaken by events.

Much better to do something damaging to the economy or unfair to particular classes of people than to break a promise? Hardly.

The sensible answer isn't to insist on promises being kept come hell or high water, it's to insist politicians stop making promises they aren't certain they can keep.

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Selfish pseudo-economics fights deficit levy

If you want to see a classic example of selfishness posing as high principle, look no further than the fuss big business's high income-earners are making over the deficit/debt levy/tax expected to be imposed in Tuesday's budget.

Jennifer Westacott, of the Business Council of Australia, said "raising Australia's already high dependence on personal income tax will place an increased burden on workers [note that word] and could weigh down an already sluggish economy. If we are serious about lifting our productivity and competitiveness, we should be lowering taxes, not increasing them."

Dale Alcock, of the home builder ABN Group, said the tax could dissuade people from working hard to earn more. The "government needs to get its own house in order first and get its government departments working efficiently. Once you've done that, then come back and talk to us."

Sound like a convenient argument to you? Now try this for logic: he would prefer an increase in the rate of the goods and services tax that, by its nature, raised revenue from wealthy, high-consuming individuals, as opposed to a class-based deficit tax.

So a tax increase paid by everyone would be preferable - why? Would it be fairer? Better for the economy? - to a tax limited to high income-earners.

Innes Willox, of the AiGroup business lobby, said the levy "will only serve to dampen our economy at a time when we need growth". A one-off debt levy on "people who are working, who are contributing to our economy, who are spending at a time when our economy is already fragile, we think is deeply problematic".

So what are you saying, Innes? Better to take money off people who don't work - say, the elderly, the unemployed, sole parents with little kids? People who don't work don't spend? People who spend don't contribute to the economy? I'm not following you.

According to the Financial Review, a senior Liberal figure, who did not want to be identified, said the tax increase was not just a broken promise but poor economics and an attack on the Liberal Party's base.

"We didn't vote for a f---ing Abbott government to increase taxes, did we?" he said. Ah, do I detect a note of self-interest creeping in among the high-minded concern for the health of the economy?

Trevor Evans, of the National Retail Association lobby, said the tax would reduce discretionary spending and damage economic confidence. "A debt levy, even a temporary one, on medium- and higher-income earners would damage consumer confidence at a critical time," he said.

Great argument, eh? Anything you don't like the sound of - especially since you and your mates will be paying it - is a bad thing because you just know it will wreck confidence. My old boss Vic Carroll used to speak with cynical amusement about the "easily frightened fawn of business confidence". Do anything business doesn't fancy and the economy will stop dead.

Speaking as one who's been on the top tax rate since 1982-83 - when it was 60 cents in the dollar, and stayed there for another three years - and escaped it for just one year, 2008-09, when Peter Costello's salary sacrifice superannuation rort was at its height, all this is self-serving rubbish.

Yes, as a failed accountant I do keep a record of income tax I pay, though it goes back only to 1969-70. And do you seriously believe being on the top tax rate has discouraged me from working hard or aspiring to be editor?

Do you think money's the only thing I get out of my job? Do you worry I might quit Oz to be economics editor of The New York Times or The Wall Street Journal? (Tip: not many vacancies in the Big Apple for people who think they're hot shots from Down Under.)

Do you think being on the top tax rate - and hence a pretty flash salary - has discouraged me from saving much in the past 30 years? Do you think my obscenely taxpayer-subsidised super payout won't be as big as a lottery win?

And though all my fellow victims on the top rate don't get the ego reward of having their opinions broadcast to the world, do you think senior executives, people in financial services, city lawyers, medical specialists and the like get no satisfaction from being a winner in the socio-economic status race, or from having kowtowing underlings to boss about?

As best I can determine from the leaks seeping under the door of the Prime Minister's press office, Joe Hockey plans to impose a 1 percentage point tax levy on the part of individual taxpayers' earnings that exceeds $150,000 - or maybe $180,000 - a year.

If so, someone on $200,000 is facing a punishing tax increase of $500 a year, or $9.60 a week. Really? That's what's going to destroy incentive, swell the brain-drain and foster rampant tax avoidance, not to mention stuff economic growth?

Estimates by Ben Phillips of the University of Canberra point to about 650,000 people earning more than $150,000 a year, making up the top 7 per cent of taxpayers.

If the threshold turns out to be the higher $180,000, this would affect 400,000 people, making up the top 4 per cent of taxpayers. (Note how quickly the number of people affected falls as you move further away from the median taxpayer's income of about $55,000 a year.)

What gets me in all the propaganda above is the evidence the disease of fiscal monoculism has reached epidemic proportions. This is the sickness that allows people to see only one side of the budget.

A budget deficit, for instance, can only ever be caused by excessive government spending, never inadequate tax revenue. And though an increase in taxes would kill consumer demand, equivalent cuts in government spending would have no adverse effects. Can't see it, myself.

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Business self-interest and economic ideology a good fit

We will hear a few toned-down echoes of the report of the National Commission of Audit in Tuesday's budget but, apart from that, the memory of its more extraordinary proposals is already fading. For most Coalition backbenchers, that can't come soon enough.

But I think the audit commission has done us a great service. It has been hugely instructive. The business people and economists on the commission offered us a vision of a dystopian future.

It's a view of what lies at the end of the road the more extreme economic rationalists are trying to lead us down. If you've ever wondered what life would be like if we accepted all their advice, now you know.

It would be a harsher, less caring world, where daily life was more cut-throat, where the gap between rich and poor widened more rapidly and where the proportion of households falling below the poverty line increased every year.

Ah, but think of the advantages: we would have fixed the budget problem and started getting the public debt down without having to pay any more tax. And that's not all: we'd be left with a much more efficient economy.

Are the report's proposals the product of self-interest or ideology? Fair bit of both. To oversimplify, the business people would be motivated mainly by self-interest. They don't tend to be big on ideology - at least, not the sort that's internally consistent.

The economists, on the other hand, would be driven mainly by ideology. When you study economics you're taught a simple model of the way the economy works. It's supposed to be just a useful analytical tool, but it tends to take over the thinking of those who get jobs as practising economists. Those who become convinced the simplest version of this "neo-classical" model holds an equally simple answer to most economic problems, come up with policy recommendations just like those in the report.

The self-interest in the report is easily seen: it would fix the budget problem - and, don't be in any doubt, there is a problem - by taking money from low income-earners and middle income-earners, but not high income-earners.

The report fits perfectly with a wry observation from John Kenneth Galbraith, as paraphrased by the late John Button: "The rich need more money as an incentive and the poor need less money as an incentive."

But if you want to understand the ideology behind the report - what prompted the economists on the commission to advocate the harsh measures they did - you need to know a little about the strengths and weaknesses of the simple neoclassical model that fundamentalist economists take as their infallible guide.

It assumes that pretty much all you need to know about the economic dimension of our lives is that markets work by allowing prices to adjust and thereby bring the demand for and the supply of particular goods or services into balance. Except in rare cases, the main thing that would stop this process keeping the economy in balance and working well is government meddling in the market.

So the model predisposes those who take it literally to believe the less governments do the better. Government needs to be as small as possible, so if government spending exceeds its revenue from taxes, the only acceptable answer is to cut spending to fit. To solve the problem by increasing taxes would damage the economy.

The model is built on various assumptions. One is that all of us are "rational" (hard-headed, with perfect self-control), so we don't need governments stopping us doing destructive things (such as smoking or becoming obese) or even using payments to nudge us in the right direction. Indeed, we'd all be better off if governments gave us more freedom (and thus didn't need to make us pay so much tax).

Two other key assumptions are that we all operate as individuals and that what makes the economy work efficiently is competition between us. So the model casts aside the possibility that we're social animals who identify with groups and like acting in groups, even groups as large as "the community". Nor does it have any place for the possibility that sometimes co-operation between us gets better results than competition between us.

It assumes the notion of "shared responsibility" - of using the budget to require the well-off to subsidise the less well-off - could only discourage the poor from standing on their own feet and so make things worse on both sides of the deal.

This explains why the report's main savings come from making even tighter the already very tight means-testing of access to government benefits. It would abandon Medicare's most fundamental principle of universality - treating everybody equally and paying for the system via general taxation - to introduce co-payments and means-testing.

The model further implies that the more aspects of our lives that are run on market principles the better off we'll be. So it advocates greater competition between public and private schools, public and private hospitals, private health funds, universities and private education providers (as well as among big and small unis) and between rich states and poor states (South Australia and Tasmania).

It's change that would move us from one person, one vote towards one dollar, one vote. For those of us who have lots of dollars, what a paradise it would be.

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Audit report: much ado about a manageable problem

Don't be too alarmed by the startling proposals by the National Commission of Audit. Few of its recommendations will make it into the budget on Tuesday week. They were never intended to.

Ostensibly, the commission wants to reverse the tide of a century of federal-state relations, crack down on the age pension while leaving superannuation tax concessions unscathed, reduce Medicare to something mainly for the poor, hit middle-income families and make the treatment of welfare recipients much harsher.

Don't believe it. Truth is, almost all incoming Coalition governments have commissioned commissions of audit since Nick Greiner used the tactic in 1988. What all the federal and state audit reports since then have in common is that only a handful of their recommendations are ever acted on.

That's not their purpose. Rather, it's to claim that the previous, Labor government left the books in a terrible mess, thereby justifying an initial, horror budget - all Labor's fault - and the breaking of any election promises now found to be inconvenient.

In this case, the audit report is softening us up for the budget by raising the spectre of a much tougher budget than we're likely to get. It's Joe Hockey getting ready to leave unsaid: See, I let you off lightly.

Audit reports are never put into practice because they are commissioned from worthies who make radical proposals no politician hoping for re-election would ever implement. The cuts we do see in the budget will have been worked up by the professionals: Treasury and Finance.

This report's proposals go so far over the top - are so impolitic, impractical and improbable - that today is the last you will hear of most of its 86 recommendations.

What distinguishes this report from its predecessors is the blatancy of its commissioning. It comes from an "independent" inquiry effectively handed over to just one business lobby group, the one composed of the most highly paid chief executives in the country, the (big) Business Council.

Not surprisingly, the commission found ways to solve our budget problem at the expense of almost everyone bar the top "1 per cent" whose interests the council represents. Speaking as a near one percenter myself, there's little in its 86 recommendations that would make a dent on my pocket.

There's little in the report's analysis of the budget problem that is new. Not to anyone who had bothered to read Hockey's midyear budget review in December, Treasury's budget review published early in last year's election campaign or any of Treasury's three intergenerational reports.

Don't be in any doubt: we do face a genuine and worrying problem with the budget which, without unpopular measures, will remain in annual deficit for years to come and rack up an excessive level of public debt. It's not a problem yet, but it will become one and the best time to start making tough decisions is now.

What's new - and dishonest - is its claim that the problem is all on the spending side of the budget, whose projected growth is "unsustainable". Its solution is to slash spending that supports the living standards of low- and middle-income earners, while arguing that asking high-income earners to chip in by paying higher taxes is unthinkable.

It exaggerates the projected rapid growth in government spending by focusing on the 15 biggest spending programs, which happen to be the fastest growing, while ignoring the many other programs, expected to grow much more slowly.

It turns out total spending is projected to grow at the rate of 5.3 per cent a year, while the economy grows at 5.1 per cent. That says there's no big problem on the spending side.

In fact, the commission exaggerates the size of the problem by adopting the arbitrary assumption that the growth in tax collections is capped at 24 per cent of gross domestic product. It justifies this by claiming the cap is needed to avoid the evil of bracket creep, conveniently ignoring the scope for covering the cost of limiting bracket creep by cutting the many tax breaks enjoyed by the big end of town.

But none of this fiscal prestidigitation says the budget will be a cakewalk. It will be the toughest budget since the Howard government's post-election budget in 1996. Its bark, however, will be worse than its bite.

A lot of its toughest measures won't take effect until after the next election. And some of its most unpopular measures are unlikely to make it past a hostile Senate.

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Greed is the market's forgotten vice

Where do Easter and business intersect? Well, what about at greed.

According to Dr Brian Rosner, principal of Ridley Melbourne, an Anglican theological college, greed has been glamorised by the market economy and is a forgotten sin.

Maybe it's this that allows those Christians who are business people, economists and politicians to share their colleagues' commitment to unending economic growth and an ever-rising material standard of living.

In his book, Beyond Greed, Rosner defines greed as ''wanting more money and possessions'', a refusal to share your possessions and ''the opposite of contentment''.

Greed has always been with us, and insatiability isn't unique to modern Western civilisation, but we're certainly giving it a workout. To us, money is the simplest measure of whether you're winning at the game of life.

But what is unique to our age, according to another author, is the cultural acceptance, even encouragement of insatiability. A survey of regular churchgoers in America found that whereas almost 90 per cent said greed was a sin, fewer than 20 per cent said they were ever taught that wanting a lot of money was wrong, and 80 per cent said they wished they had more money than they did.

It seems that, by comparison with the past, greed is regarded as a trivial sin. A retired priest has recounted that, in his long years of service, all kinds of sins and concerns were confessed to him in the confessional, but never once the sin of greed.

But Rosner's having none of that. He says greed is at the heart of three major threats to our existence as individuals and societies: pollution, terrorism and crime.

Pollution is caused by human unwillingness to pay the price for the cleaner alternative (ain't that the truth, Tony). ''On any reckoning, climatic change due to the effects of pollution could cause major 'natural' disasters in the days to come,'' he says.

In most cases of terrorism, each side accuses the other of some form of greed, whether involving people, land or property. ''Greed also fits both sides of the equation in many cases of crime,'' he says. ''Thieves steal because they want more, and often because they perceive the victims as having more than their fair share.''

The greedy are those who love money inordinately, trust money excessively, serve money slavishly and are never satisfied with their possessions.

Rosner says greed is a form of religion, the religion of Mammon. Literally, mammon means wealth or possessions, but it could just as easily be taken as the biblical word for the economy. And if greed is a religion, that makes it a form of the greatest of all sins: idolatry. (First Commandment: you shall have no other gods before me.)

In Western society, the economy has achieved what can only be described as a status equal to that of the sacred.

''Like God, the economy, it is thought, is capable of supplying people's needs without limit. Also, like God, the economy is mysterious, unknowable and intransigent,'' he says. ''It has both great power and, despite the best managerial efforts of its associated clergy, great danger. It is an inexhaustible well of good(s) and is credited with prolonging life, giving health and enriching our lives.

''Money, in which we put our faith, and advertising, which we adore, are among its rituals. The economy also has its sacred symbols, which evoke undying loyalty, including company logos, product names and credit cards.''

Rosner says we have to distinguish between the legitimate enjoyment of material things, which the Bible takes for granted, and an illegitimate and unhealthy attachment to wealth as an end in itself.
But if we don't want to be greedy, what should we be? Contented.

''To be content is to be satisfied, to enjoy a balance between one's desires and their fulfilment. To be content is in effect to experience freedom from want,'' he says. But note, it's being content with your own lot, not those of others less fortunate than you.

And the other side of the contentment coin is giving. Rosner says that if Charles Dickens' Scrooge epitomises greed, giving is epitomised by Victorian jam maker Sir William Hartley. Hartley regularly and voluntarily increased wages, practised profit-sharing and supplied low-cost, high-quality housing to some of his employees and free medical attention to all of them.

He was also concerned for his suppliers, and would amend contracts in their favour if a change in the price of fruit and economic circumstances conspired against their making a decent living.

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Badly taught economics has high opportunity cost

Is it possible the discipline of economics is becoming so mathematical it's in the process of disappearing up its own fundament?

While you're thinking about that, let me take the opportunity to ask you a quiz question (it's a holiday weekend, after all).

You've won a free ticket to see an Eric Clapton concert (which has no resale value). Bob Dylan is performing on the same night and is your next-best alternative activity. Tickets to see Dylan cost $40. On any given day, you'd be willing to pay up to $50 to see Dylan. Assume there are no other costs of seeing either performer.

So what is the ''opportunity cost'' of seeing Clapton? Is it $0, $10, $40 or $50? Take your time (especially if you fancy yourself as an economist).

The opportunity cost of a decision is the value (benefit) of the next-best alternative. So the right answer is $10. When you go to the Clapton concert you forgo the $50 of benefit you would have received from going to the Dylan concert. But that's the gross benefit. You also forgo the $40 of cost, so the net benefit you forgo is $10.

If you didn't get the right answer, don't feel too bad. When two economists at Georgia State University, Paul Ferraro and Laura Taylor, asked that question of almost 200 economists attending a professional conference, almost 80 per cent got the wrong answer.

The answers they gave were spread across the four possible answers, with more than a quarter saying $50, apparently believing it was only the ''willingness to pay'' of $50 that was relevant.
The next most popular answer was $40, apparently because people thought the cost of a Dylan ticket must also have been the opportunity cost. Those who answered $0 must have concluded there could be no opportunity cost if the Clapton concert was free.

This left fewer than 22 per cent of respondents getting the right answer. And if that (along with your own failure to get it right) doesn't shock you, it should.

Opportunity cost is probably the most fundamental concept in economics. One introductory textbook lists it along with ''marginalism'' and ''efficient markets'' as three of economics' most fundamental concepts. Opp cost seems a pathetically simple concept, but non-economists keep forgetting to consider it - meaning they don't always make the best decisions about how to spend the limited time and money available to them.

And it seems the concept isn't as simple as we assume. If about 80 per cent of non-economists got the question wrong, that would be a pity, but not too surprising. But the respondents to the survey were, in the authors' words, ''among the most well-trained economists on the planet''. Two-thirds of the respondents had PhDs, with the remainder studying for their PhD.

What's more, more than 60 per cent of them had actually taught introductory economics courses. Those who'd taught the course were no more likely to get the right answer than those who hadn't, nor were those who'd attended one of America's top-30 graduate schools, nor those who'd graduated before 1996 rather than after it.

The only significant differences were in the economists' field of specialisation. Only the tiny number specialising in micro-economic theory got a halfway respectable score, followed well back by those doing applied micro. Worst were those doing macro or international economics.

The first reason for concern is what these results say about the quality of the teaching of economics at postgraduate level. After surveying students in seven top-ranking US graduate programs in 1987, David Colander, a leading researcher of the economics profession, concluded the programs emphasised mathematics to the detriment of empirical content and economic reasoning.

A commission on graduate education in economics in 1991 found that it generated ''too many idiot savants, skilled in technique but innocent of real economic issues''. This survey suggests little improvement since then.

Does it matter for economic research if economists can't identify opportunity cost? ''Obviously,'' the authors say, ''it matters for PhD economists who take jobs in the private or government sectors, in which opportunity costs are the fodder of daily decisions …

''Theoretical research rarely requires that an individual calculate an opportunity cost in the form of a word problem. Empirical research tends to focus more on appropriate techniques to make inferences about parameter values in models.

''But can economists be relevant in the world of ideas and policy if we cannot answer simple … opportunity cost questions?''

But whatever the failings of post-graduate teaching, there's also failure at the undergraduate level. The authors say the concept of opportunity cost is usually covered in the first week of introductory undergraduate classes and often deemed so straightforward as to not require further teaching time.

A Nobel laureate complained that ''the watered-down encyclopaedia which constitutes the present course in beginning college economics does not teach the student how to think on economic questions. The brief exposure to each of a vast array of techniques and problems leaves the student with no basic economic logic with which to analyse the economic questions he will face as a citizen.'' That was George Stigler, writing as long ago as 1963.

The authors say that ''if we are not able to instil in our students a deep and intuitive understanding of one of the most fundamental ideas that the discipline has to offer (and the idea whose frequent application could do most good in peoples' private and public lives) then we wonder what we can claim as our value-added to the college curriculum''.

It makes me wonder whether, in its preoccupation with using maths to make itself more ''rigorous'' and thus academically respectable, economics has lost its way.

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Why manufacturing in Australia has a future

Few things about the economy are worrying people - particularly older people and those from Victoria and South Australia - more than the decline in manufacturing. But many of our worries are misplaced, or based on out-of-date information.

For instance, many worry that, at the rate it's declining, we'll pretty soon end up with no manufacturing at all. And everyone knows that, unlike other states, Victoria's economy is particularly dependent on manufacturing.

But Professor Jeff Borland, a labour economist at the University of Melbourne, has written a little paper that sheds much light on these concerns.

It's true that manufacturing's share of total employment in Australia is declining. But this is hardly a new phenomenon, which suggests the end may not be nigh. Half a century ago, manufacturing accounted for a quarter of all employment. Today it's 8 per cent.

And almost none of that dramatic decline is explained by a fall in our production of manufactured goods. The great majority of the fall in manufacturing's share is explained simply by the faster growth of other parts of the economy, particularly the service industries.

It's true, however, there's been a (much less dramatic) decline in employment in the industry over the years. Employment in manufacturing reached a peak of 1.35 million in the early 1970s. Today, it's about 950,000. Of the overall loss of 400,000 jobs, about 200,000 occurred during the '70s, about 100,000 in the recession of the early '90s and the rest since the global financial crisis in 2008.

Many people would explain this decline in terms of the removal of protection against imports in the '80s and the very high dollar since the start of the resources boom in 2003. But, in fact, the great majority of it is explained by nothing more than automation.

How do I know? Because if you look at the quantity (or real value) of manufactured goods we produce, it reached a peak as recently as 2008, and has since fallen just 6 per cent. Nowhere have the machines of the computer age replaced more men (and I do mean mainly men) than in manufacturing. Is this a bad thing? It would be a brave Luddite who said so.

The consequence is a change in the mix of occupations within manufacturing, the proportion of machine operators, drivers and labourers falling by 10 percentage points since 1984, with the proportion of managerial and professional workers increasing by about the same extent. The proportion of technicians and tradespeople is little changed.

But there's also been a change in the types of things we manufacture, with the share of total manufacturing employment accounted for by textiles, clothing and footwear falling from 11 per cent to 4 per cent since 1984, while the share accounted for by food products has risen from less than 15 per cent to more than 20 per cent.

The share of transport equipment (cars and car parts) is down, but the share of other machinery and equipment is up by much the same extent.

The next thing that's changed a lot since 1984 is the location of manufacturing in Australia. Then, almost 70 per cent of manufacturing employment was located in NSW and Victoria; today it's down to 58 per cent. Then, NSW had more manufacturing workers than Victoria; today they have 29 per cent each. (Bet you didn't know that.)

But if the big two states now have smaller shares, which states' shares have grown? The two we these days think of as "the mining states". Western Australia's share has risen to 10 per cent, while Queensland's share has almost doubled to 21 per cent. (Bet you didn't know that.)

So far, South Australia's share of national manufacturing employment has fallen only a little to 8 per cent.

This tendency for manufacturing's distribution between the states to become more even over time, plus the much faster growth of other industries, has made all states less dependent on manufacturing for employment, as well as narrowing the gap between the most dependent (SA on 10 per cent of its total employment) and the least (WA on 7 per cent).

Whereas in 1984 Victoria depended on manufacturing for 21 per cent of its jobs, today it's 9 per cent. (See what I mean about out-of-date information?) Victoria's more dependent on the health industry (12 per cent) and retailing (11 per cent), with almost as many jobs in professional services as in manufacturing.

The wider conclusion is that, though the faster growth of other industries has made all states less dependent on manufacturing for jobs, this doesn't mean manufacturing's dying. Its actual output hasn't fallen much, though it's using fewer workers to produce that output.

The unwritten story is there've been big changes in what Australia's manufacturers produce: less stuff that relies on protection against imports and more stuff that fits with Australia's comparative advantage. You see that with food products - including things such as wine-making - now being the biggest category within manufacturing, employing 20 per cent of all manufacturing workers.

You see it also in the growth of manufacturing employment in the mining states - a spillover from the resources boom.

Manufacturing is undoubtedly suffering from the high dollar. But, apart from that, it's in good shape. It has shed some fat and is fitter and wirier than it has ever been, better able to survive in a harsh world.

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Our econocrats' vision is too narrow

Part of my job is making sure readers are kept fully informed about the messages our top econocrats are trying to get across to the public. They're usually much franker and clearer than the spin we get from our political leaders.

But just because I report their views faithfully doesn't mean I always agree with them.

As it related to the outlook for the economy, the message in the speech Treasury secretary Dr Martin Parkinson delivered last week fitted well with the messages we've been getting from Glenn Stevens and Dr Philip Lowe, of the Reserve Bank.

It's a warning that, between the slowdown in our rate of productivity improvement, the expected continuing fallback in mineral export prices and the reversal of the "demographic dividend" delivered by the baby boomers, "we face a significant challenge in maintaining the rate of growth in living standards that Australians have come to expect".

Specifically, Parkinson projected that, even if we assume labour productivity grows at its long-term average, the other two factors would cause real income per person to grow by just 0.7 per cent a year over the decade to 2023-24, rather than the 2.3 per cent "to which Australians have become accustomed".

So over 10 years our present annual real income of $63,600 per person would grow only to $69,000, rather than $82,000, leaving us only $5400 a year better off, rather than the $18,400 a year to which we've become accustomed.

To keep average incomes growing as fast as we've come to expect will require us to double our present rate of productivity improvement to 3 per cent a year.

Sorry, but I very much doubt we'll be willing to make the many controversial reforms needed to achieve such a transformation. More to the point, I'm not convinced we should.

The admonitions we get from our econocrats are far too relentlessly materialist and, hence, mono-dimensional. Whatever their professed "wellbeing framework", when the chips are down their advice is to make maintaining the rate at which our material standard of living is rising our highest priority, if not our only priority.

We're always being reminded of the pecuniary price to be paid for worrying about foreign ownership, or saving family farming or preserving the weekend. But the warnings never run the other way: the greater personal stress or relational problems or loss of leisure or greater social disharmony that could accompany going all out to maximise economic growth.

No one knows better than I do that you can't say everything you want to say in the time allotted for a speech or the space allotted for a column. But, even so, some obvious caveats and qualifications almost never rate a mention.

The most obvious is the environment. What reason is there to believe acting to maintain our rate of growth won't do significant further damage, even unacceptable damage to the ecosystem? How do we know continuing climate change - a problem about which we've decided not to make a genuine contribution to international efforts to combat - won't negate our productivity-raising efforts?

How can we talk about capturing a big share of the growth in Asia's demand for Western foodstuffs without mentioning climate change?

To be fair, their present political masters are so down on the environment that our econocrats aren't free to speak on the subject. Parkinson is facing the sack for having been chief designer of the emissions trading scheme (including the Howard government's version) and his successor - an outstanding Treasury officer - has already had the chop. It's a wonder Professor Ross Garnaut isn't behind bars - or at least had his office raided by ASIO.

Another obvious but never-mentioned caveat is the distribution of all this increased income. It's all very well to talk about increasing the average income, implicitly assuming the extra income will be shared in line with the existing distribution. Our experience of income growth over the past 30 years is that a disproportionate share ends up in the hands of the people at the top.

Why no mention of this when ordinary workers are being asked to support reforms that could cost them their jobs?

More basically, how do the econocrats know we'd find a slower rate of growth in our affluence bitterly disappointing? They don't. Their confident claims that we would are based on their faith in materialism, not evidence.

Most of us are condemned to spend 40 years of our lives working 40 hours a week. Why do econocrats never wonder whether making that work more satisfying would do more for our "wellbeing" than making extracting more productivity from our labour the only priority?

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Treasury's opportunities and threats facing our economy

It shouldn't surprise you that when the secretary to the Treasury, Dr Martin Parkinson, devoted half his major speech this week to "fiscal sustainability" - the tax increases and spending cuts needed to get the budget back on track - the media virtually ignored the other half.

But the budget isn't the economy. And in that other half Parkinson offered a revealing SWOT analysis of the economy, outlining its Strengths and Weaknesses, Opportunities and Threats. So let me tell you what he said (and leave my critique for later).

For people worried about what we do for an encore after the resources boom - about where the jobs will come from - Parko points to three big "waves of opportunity".

The first wave is the mining investment boom, which is ending but not leaving us high and dry. "With the capital stock in the mining and energy sectors now triple what it was a decade ago, additional productive capacity will drive strong growth in resources exports for several years to come," he says, although this will involve employing fewer workers than in the investment phase.

The second opportunity wave flowing from the vast economic shifts in Asia is rising global demand for agricultural produce. The Australian Bureau of Agricultural and Resource Economics and Sciences estimates that China's imports of fruit will treble by 2050. Imports of beef will grow by a factor of 10 while imports of sheep and goat meat increase by a factor of 19. Dairy will increase by a mere 165 per cent.

Asia already takes more than 40 per cent of our food exports. Parko warns, however, that our ability to gain a slice of its rising demand rests on continued productivity gains in our rural sector, supported by the right policy settings.

"Our handling of the concerns raised by foreign ownership of Australian agricultural land (and food manufacturing) in some parts of our community is one dimension of the agricultural policy challenge, along with our approach to trade policy, stimulating investment in on- and off-farm infrastructure and supporting research and development."

The third wave is the opportunities in the services and high-value manufacturing sectors brought about by the steadily increasing growth of the Asian middle class. It's estimated that, by 2030, just under two-thirds of spending by the world's middle class will come from the Asia Pacific region, compared with about a quarter today.

"To capture the benefits of the third wave, we will need to compete on the global stage for Asian demand for services and high-end manufactures on the basis of both cost and quality," he says. "We will also need to compete for foreign direct investment to help put the right export-related infrastructure in the right places."

But get this declaration from the economic rationalist-in-chief: "Contrary to how it is sometimes portrayed in the media, competing on the global stage does not mean driving down wages or trading off our standard of living. Far from it."

Parko says improving Australia's competitiveness in global markets means investing in the skills of our workforce so Australians have the opportunity to move into sustainably higher paid jobs, and investing in infrastructure that has a high economic return.

It means ensuring firms and their employees are freed from unnecessary regulatory burdens, and establishing the right incentives to encourage innovation and competition. "In other words, it means raising Australia's productivity performance," he says.

Which brings us to Parkinson's three big threats to our further economic success. The first is productivity improvement. He says that, even after you allow for temporary factors, there's been a slowdown in "multi-factor" productivity improvement that's broad-based across industries, suggesting that deeper, economy-wide factors are at play.

The second threat arises because, until mid-2011, the effect of this productivity slowdown on the rise in our living standards was masked by the rise in the prices we were receiving for mineral exports. But now the likelihood that these prices will continue falling means a "significant drag on Australia's national income growth" over the rest of this decade.

The third threat to continued strong economic growth comes from the turnaround in the "demographic dividend" delivered by the baby boomers. For about 40 years until 2010, the proportion of the population of working age (here defined as 15 to 64) grew a lot faster than the overall population because of the postwar baby boom, followed by a dramatic fall in the birth rate in the 1960s and '70s. This boosted economic growth.

"Over the next few years, this demographic dividend, which has been fading for some time, will actually reverse. The proportion of the population aged 65 and over is expected to increase to nearly 20 per cent in 2030, from 13.5 per cent in 2010."

As the population ages, the total participation rate - the proportion of people 15 and over participating in the labour market - will fall, despite the increase in the participation rate among older Australians. "This expected decline has already begun and will become more pronounced by the end of the decade," he says.

Productivity is the key long-run driver of income growth, but declining export prices and labour-force participation are expected to subtract from national income growth in future.

If we assume the productivity of labour grows at its long-term average, then income per person would grow over the coming decade by about 0.7 per cent a year, about a third of the rate to which we've become accustomed, he says. To avoid that, we'd need to sustain labour productivity growth of about 3 per cent a year, about double the rate we've achieved so far this century.

If we fail to make the reforms needed to achieve that rate of productivity improvement, by 2024 our income per person will have risen only to $69,000 a year, not $82,000. We'll each be $13,000 a year less affluent than we could have been.

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Bracket creep has become highly regressive

If you think you're having trouble coping with the rising cost of living now, just wait until you see what the politicians have in store for you over the next three years. In all likelihood, you'll be losing a significantly higher proportion of your pay in income tax, though people on low incomes will be hit a lot harder than those on high incomes.

This will happen because an increase in the overall tax we pay is inevitable, but it suits both sides of politics to avoid the obvious, up-front increase that would come from raising the rate of the goods and services tax (or from extending the tax to spending on fresh food, education and healthcare) and rely on what Malcolm Fraser called "the hidden tax of inflation" - otherwise known as bracket creep.

The pollies know voters much prefer any increase in taxation to be hidden from their view. Trouble is, the increase in "marginal" tax rates (the tax on the last part of your income, such as on a pay rise or some overtime) many workers face will be so big, you'd have to be pretty thick not to notice.

Treasurer Joe Hockey has been softening us up for the tough budget he's preparing for next month. Fine by me. But he's studiously avoiding admitting there's no way his spending cuts will get the budget back into lasting balance. He's pretending all the problem is on the spending side (and all caused by Labor), when he knows the problem on the budget's revenue side is just as big, if not worse.

Consider the facts. Collections from company tax - which account for about a fifth of total tax collections - aren't likely to grow any faster than the economy (gross domestic product). And collections from indirect taxes - which include the goods and services tax and excises on alcohol, tobacco and petrol - are likely to grow a lot more slowly than GDP.

Collections from excises are declining relative to the rest of the economy, partly because John Howard abolished the indexation of the petrol excise, but also because consumers' spending on alcohol and tobacco accounts for an ever-declining share of their total spending.

Collections from the GST are also in relative decline, because consumer spending has stopped growing faster than the overall economy (as it did when households were borrowing heavily) and because consumers' spending on items subject to the GST is growing more slowly than overall consumer spending. Putting it another way, private spending on untaxed education and healthcare is growing faster than our spending on taxed items.

That leaves collections from income tax, which account for about half the federal government's total collections. Assuming regular tax cuts, income tax collections will grow in line with GDP. Only if further tax cuts are avoided will continuous bracket creep mean income tax collections grow strongly enough to make up for the revenue-raising deficiencies of the GST and other indirect taxes.

Guess what? All the budget projections Hockey is using to justify big cuts in government spending assume no further income tax cuts. Without that assumption the underlying weakness on the tax side would be apparent.

His first reason for ignoring the budget's revenue-raising weakness is his need not to expose as wishful thinking the line Tony Abbott ran from the moment he became Liberal leader, that the Libs stood for low taxation, opposed all "great big new taxes on everything" (except the GST, of course) and should be voted for by anyone who didn't like the sound of the carbon tax or the mining tax.

Hockey's second reason is that any hint of increasing the GST (or any other tax) would allow Labor to do to Abbott what Abbott did to Labor. The party of higher government spending opposes the other side's new taxes for reasons of blatant political advantage.

But Labor also professes to oppose the GST because it's "regressive" - taking a higher percentage of low incomes than of high incomes. It must face the unpalatable truth that the past eight tax cuts have left us with a rate-scale that now makes bracket creep highly regressive.

Consider this. The average full-time wage next financial year, 2014-15, will be about $76,000. On the basis of reasonable assumptions about the growth in wages over the three years to 2017-18, you can calculate that someone on half the average wage would see the proportion of their wage that they lose in tax increase by 3.5 cents in the dollar.

For someone on the average wage the increase would be 2 cents in the dollar. On twice the average wage it's 1.1 cents. And on six times the average wage it's 0.8 cents.

Now that's regressive. Does Labor really think a rise in the GST would be much worse?

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