A better way for the government to stimulate the economy

Are the measures in the Budget the best way to make progress on the structural issues Australia is facing? Ian McAuley and Miriam Lyons suggest a more assured way to revitalise the economy.

The fiscal boost in the Commonwealth budget – $33 billion or 2 per cent of GDP – is probably about right. The Australian economy is going through a difficult post-mining boom transition. Retail, media and other industries are facing disruptions of technological change, and the shock waves of the 1998 financial crisis are still rippling through the economy. Unemployment seems to be stuck above 6 percent (the budget forecasts see no relief), and there is plenty of spare capacity in the economy before inflation becomes a problem.

But there are two questions about the budget. The first is technical: Will that outcome be achieved? The second is more basic: Are the measures in the budget the best way to stimulate the economy? Are they just a fix to deal with immediate fiscal problems or are they grounded in an economic vision for our country? Is the budget only about poll-driven politics or does it help us deal with the hard problems we must confront?

On the first question, Treasurers almost always get it wrong. Wayne Swan fluked it in 2009-10 when the deficit outcome was within $1 billion of the estimate, but the general pattern since 2008 has been to underestimate the deficit. Treasurers engage in jawboning, hoping that their credibility and confidence can stir people into making politicians’ fiscal wishes come true. Hockey is out selling the budget with all the flair of a showground spruiker.

But the reality is that estimating the difference between two uncertain quantities – revenue and expenses – is prone to error. While governments can exert some control on expenses (until hit with a flood, a financial crisis or a difficult Senate), they have far less immediate control over revenue. Taxation revenue is very sensitive to business conditions over which governments have little direct influence.

In view of the optimistic economic assumptions in this year’s budget papers, the safest bets are that the deficit will exceed $33 billion. That won’t necessarily matter: if the economy does more poorly than expected it will need a bigger fiscal boost. It will matter politically, however, because ministers in this government, when in opposition, behaved as if management of the deficit is all that counts in economic management.

The second question is more important. Will this budget strategy, based on encouraging people to seek work and relying on small business to stimulate the economy help us make progress on the structural issues Manuela Epstein and Roger Beale raised in their contributions to this forum?

We suggest that there could have been a far more assured and fair way to revitalise the economy, with a program of debt-funded infrastructure investment and attention to collecting more taxation revenue over the medium term.

The first few days of the small business package have seen some unintended consequences. (Or were they intended?) If, as has been reported, tradespeople are rushing into department stores to buy furniture and appliances (there are even reports of home entertainment systems and washing machines being bought as business assets), it’s hard to see how that’s going to boost productivity. Business people more concerned with the health of their enterprises than with “having a go” at the tax system will want to be assured there is demand for their products before they buy new equipment and hire staff. The days of exuberance that characterised business and consumer behaviour in the lead up to the GFC are well behind us.

The Treasurer may be exhorting us to “go out and spend”, but more sober actors in the economy are getting ready to face tougher times. Banks are consolidating their capital base – the National Australia Bank’s $5.5 billion capital raising alone will take a sizeable chunk of money out of circulation. The Reserve Bank, in its hints that this month’s interest rate cut may be the last for a long time, is sounding cautious about household debt and rising house prices, and their warnings are echoed by Moody’s.

As any economics student knows, consumer and investment caution in the face of an impending slow-down or recession can make matters worse. But, as a more cautious treasurer might say, we cannot consume our way to prosperity, particularly when much of our discretionary consumption pays for imports, adding to our deficit on current account and doing little to stimulate the domestic economy. A little hardship now may be much easier to bear than a precipitous fall in house prices and a South American scale balance of payments crisis, if we do not live within our means.

A far better way for the government to have stimulated the economy would have been a program of spending on infrastructure – “hard infrastructure” such as FTTP broadband, national highways and railroads, an electricity network ready for entrepreneurs to supply solar, geothermal and wind energy, urban public transport – and “soft” infrastructure, including research and development and post-school education.

Of course that would involve borrowing, but as any businessperson knows borrowing is a way of strengthening one’s balance sheet with productive assets that can generate the income to service the debt. With an AAA credit rating, a historically low long-term bond rate, construction and engineering assets unemployed since the end of the mining boom and cautious investors seeking safe vehicles such as government bonds, there couldn’t be a better time for such a program, and in the first round of activity most of the stimulus could be directed to the domestic economy, with the by-product of avoiding an accumulation of foreign debt.

It’s unfortunate that the government seems to have successfully persuaded us to believe that debt is bad, and has so exaggerated our debt position, that it has not chosen this much more controllable method of fiscal stimulus – a method that can produce productive investment rather than a burst of turnover in retail shops and a stimulus to the Chinese manufacturing sector.

Of course a government cannot run a deficit forever – although de-facto that seems to be the government’s fallback as we see the prospect of fiscal balance becoming dependent on heroic economic assumptions. We need a credible public revenue plan that starts with a light touch and slowly builds up, preferably built into legislation so as to give assurance to creditors.

There is the hint of such an approach in the budget papers, which seem to rely on bracket creep to raise taxes, but that’s a regressive way to pull in public revenue. There are many other candidates for collecting more tax, particularly in the area of tax concessions for superannuation, private health insurance, highly-geared investments (“negative gearing”), family trusts, fringe benefit tax exemptions on employer-provided private vehicles, capital gains discounts for short-term speculation, to name a few areas where public revenue is leaking. Such concessions should be phased out, thus giving firms and individuals time to adjust, and ensuring the immediate fiscal boost is not compromised.  An ideal model is the government’s plan to re-index fuel excise, a tax that will accumulate over time, and which will actually make a modest contribution to reducing greenhouse gas emissions (though a comprehensive carbon tax would do a far better job).

There is a clear business case for any stimulus to be designed in a way that maximises the long-term benefits to the economy. But an ambitious, thoughtful program of infrastructure investment could also help reinvigorate the conversation about the broader role of the Commonwealth in a modern, open economy. As we point out in our new book, Governomics, we need more than responsible fiscal management from our governments. We need them to live up to the spirit in which our nation was named – to act as true custodians of our common wealth.

Ian McAuley and Miriam Lyons are fellows of the Centre for Policy Development. Their book Governomics: can we afford small government? was published earlier this month.