Sleepwalking into a deficit experiment

There are theories that it is possible to sustain an economy despite running a long-term budget deficit. But volunteering to be the guinea pig for such an experiment doesn’t seem a sensible thing to do.

The danger for Australia is that unless some fundamental long-term thinking and policy making is done, we could find ourselves sleepwalking into just such an experiment.

As I’ve written elsewhere, Australian Federal Government expenditure has exceeded revenue every year since 2008. The 2016-17 budget deficit is forecast at $36.5 billion and, once confirmed in next month’s budget, will be the country’s ninth straight deficit.

Running a deficit in the short term isn’t a bad thing and in some cases it may be the sensible to do so, especially if spending is funnelled towards needed infrastructure that will pay back dividends in the future. Indeed, the Government’s budget has been in deficit in 21 of the last 35 years despite achieving relatively stable growth over this period. The major problem isn’t the deficit itself, but why it is likely to persist - our ageing population.

The deficit in the current cycle of consecutive deficits blew out to around $60 billion in 2009-2010 real dollars, which is almost twice what it reached in the previous deficit cycle of the early 1990s (when the deficit peaked at around $34 billion in 1993-94 real terms). Last year the government forecast a $28.7 billion deficit for 2017-18, which is at the lower end of the recent run of deficits. However, the last run of deficits in the 90s lasted seven years and we are now running into a 10th straight year of deficits.

So while attempts are being made at reeling the deficit in, the way back towards a surplus is still looking long and arduous. The last budget forecast a return to surplus in 2020-21, but that seems to be unlikely. Although the Government is keen on curbing costs, there is only so far it can go in winding back spending. That means much of any deficit reduction will need to be done by increasing revenue. However it isn’t clear to me what the government will do to increase revenue by enough to make the deficit significantly smaller.

High commodity prices and low interest rates have helped underwrite our spending so far, but both are temporary. Although commodity prices are recovering from their lows, the boom days appear to be behind us. Pressure on interest rates is also likely to grow. The US Federal reserve has increased rates twice in the last five months, once in December and then again in March.

For the moment the Government can still borrow cheaply by selling low interest bonds to cautious investors who have a high demand for low risk investments. Even if low interest rates were to persist, however, the related issue of the Federal Government debt levels also needs to be considered. Since 2010, net debt has risen from about 6 per cent of GDP to around 18 per cent of GDP. Borrowing may come cheap, but in the long term there are a range of other factors to consider as well.

The biggest single problem for the budget is that much of the deficit appears to be structural, which means the deficit isn’t just a function of fluctuating economic conditions that can be expected to even out over the longer term. The deficit instead is significantly influenced by the hard reality that our population is inexorably ageing, and we have yet to work out a way of how to pay for it.

As Australia’s population gets older more people become dependent on social security, and more people also need access to public healthcare. The Government’s spending on healthcare and social security is now approaching $10,000 for every person in Australia, which in real terms has almost doubled from $5,500 in 1992-93. Spending in these two areas now accounts for over half of the total budget spend.

Ageing population a double hit to budget

In turn, as the ageing population pushes up health and welfare costs, an older Australia may also reduce Government revenue because there are less people of working age paying taxes. This means the budget is squeezed on both spending and revenue.

Back in the early 1990s some 11 per cent of Australians were aged over 65. That has now increased to more than 15 per cent, and based on Australian Bureau of Statistics predictions, by 2040 it will be more than 20 per cent.

This is the deep structural issue surrounding the budget that so far no government seems to be trying to tackle in any serious way. An inability to address this issue means that future governments will face the prospect of having to cut spending in the health and welfare portfolios that people see as being critical to their wellbeing.

In terms of revenue raising, it seems sensible to consider policy options such as reducing tax concessions on superannuation savings and capital gains. These concessions may well be a luxury that future generations will be required to address.

We also need to be taking real steps to facilitate people working and earning taxable income for longer. That will mean encouraging employers to take on older workers and expanding opportunities for people to re-skill. By keeping people in the workforce for longer, the government can slow the growth in social security spending and support income tax revenues needed to offset higher health costs.

But longer term we need to be talking about things like what a sustainable health system looks like, and how our social security system can be adapted to an older population. These are complicated and long term issues which governments should be thinking about more.

So come budget night on 9 May, the most pressing problem isn’t how soon the Government may be projecting a return to surplus, but what the plans are for addressing deeper structural changes. Even if we do somehow return to surplus within the next four or five years, we still need to tackle these structural changes that won’t just go away.

In the 21st episode of the University of Melbourne’s podcast series The Policy Shop, University of Melbourne Vice-Chancellor Professor Glyn Davis investigates Australia’s persistent budget deficit and asks “where has all the money gone?”

He is joined by Professor John Quiggin, Australian Laureate Fellow in Economics at the University of Queensland, and Professor Judith Sloan, Honorary Professorial Fellow at the Melbourne Institute of Applied Economic and Social Research at the University of Melbourne.

Listen here

Banner Image: Australian Prime Minister Malcolm Turnbull (R) and Treasurer Scott Morrison (L) talk to the media. SAEED KHAN/AFP/Getty Images