Should Australians be more concerned about budget deficits or big government?

We live in strange times. A few months ago, when the Australian government had little hope of achieving its promised budget surplus, it seemed likely to face severe punishment for fiscal mismanagement. Since then the short term budget situation has worsened, but the treasurer has been able to mount a plausible argument that this has happened as a result of factors beyond the government's control. Wayne Swan has been able to argue that 'we've had this sledgehammer smash into our revenues' as a result of the high dollar and lower commodity prices. The federal opposition, fearful of being labelled as favouring 'mindless austerity', has now walked away from its commitment to have a surplus in its first year of office. So, the government seems to be off the hook!

Rather than showing contrition, Wayne Swan seems to be taking advantage of the situation to engineer a change in public attitudes towards deficits. His recent criticism of European finance ministers for their austerity policies must have been intended largely for an Australian audience. Wayne must know that the Europeans have not chosen austerity. With few exceptions, European finance ministers would love to be able to follow his example of ongoing increases in government spending. Austerity has been forced upon them as a consequence of decades of profligacy.

I suspect that Wayne Swan is denouncing option A (austerity) so severely because he favours option D (deficits for a decade). The next budget should confirm whether or not my suspicions are well-founded. The big test is whether it presents a plausible route to budget surplus within a few years, or whether he tries to make ongoing deficits look respectable.

How might Mr Swan attempt to make ongoing deficits look respectable? He would probably find it difficult to argue in favour of never-ending fiscal stimulus: even Keynesians would have to acknowledge that fiscal stimulus for more than 5 or 6 years in a row could be difficult to justify. Perhaps he will attempt to advance a dodgy argument along the lines that low world interest rates provide Australia with the opportunity to borrow at low cost in order to pay for increased investment in human capital (implementing Gonski proposals for increased education funding) and help us to meet the challenges of the Asian century (whatever that might mean). He could suggest that such a policy would raise productivity and thus generate income streams that would enable the debt to be serviced without any problems. (I think the argument is dodgy because the Gonski proposals are unlikely to have much impact on productivity – but that is another story.)

Would the electorate buy such an argument for ongoing fiscal deficits? Jacob Greber has an interesting article in this weekend's Financial Review ('Swan changes his tune', p 16) in which he argues that voters may care about budget deficits far more than the government anticipates. He points to a Nielson poll suggesting that the percentage of voters viewing a surplus as a high priority rose after the government abandoned its promise of a surplus in the current fiscal year. A poll in February suggested that 54 percent of voters viewed a surplus as a high priority (up from 49 percent before the promise was abandoned), and 41 percent (down from 45 percent) viewed it as a low priority.

I hope Greber is right, but I think public opinion is likely to become more favourable to dodgy arguments for increasing government debt if a surplus can only be achieved during the next few years through tax increases or substantial cuts in government spending. I suspect a majority for voters would favour increasing debt to fund additional education spending if an option was presented to them in those terms.

In my view, Government debt is still at a sufficiently low level in Australia that it could not plausibly be argued that servicing that debt is likely to present a problem in the near future. The government's failure to achieve a budget surplus this year is only of consequence because it is muddying the waters about the importance of maintaining fiscal discipline as it runs away from that stupid promise. Irresponsibility is being heaped upon stupidity.

In my view there is reason to be concerned that the cautious attitudes that Australians have shown toward increasing public debt in recent decades could be quite a fragile phenomenon. John Daley has expressed a similar view in his report for the Grattan Institute, Budget pressures on Australian governments:

'There are concerns that this public attitude may be eroded by several years of budget deficits, and the accompanying rhetoric justifying this in both Australia and overseas. Public concern about deficits may also be affected by promises for specific costly programs and political attitudes projecting a belief in the ability of government to cure all social ills'.

Daley's report provides an excellent overview of the contribution of increases in different forms government spending to budget deficits. Growth in spending on health seems to present the biggest challenge.

However, Daley seems to be more concerned about the potential for budget deficits to increase than about the growth of government spending. He is at pains to point out that budget deficits can be a problem in countries with relatively low levels of government spending as a percentage of GDP and that size of government in Australia is relatively low by OECD standards. He argues on historical grounds that 'successful budget repair invariably involves both tax increases and expenditure reductions'.

Stephen Anthony's report for the Minerals Council, A roadmap for fiscal sustainability, seems to imply that we should be concerned about the growth of government spending over the longer term, even if tax revenue could be lifted sufficiently to prevent fiscal deficits from growing. His projections suggest that the federal government will still have a structural deficit a decade ahead even if it manages to restrain spending to a rate below the growth rate of the economy. His recommendations include elimination of up to $15 billion in poorly targeted outlays as well as institutional reforms to re-orient fiscal strategy around a structural budget measure designed to prevent spending from blowing out of control when commodity booms result in windfall tax revenues.

Andrew Baker's report for the Centre for Independent Studies, Target 30 – Tax-welfare churn and the Australian Welfare State, provides some clues as to where poorly targeted outlays might be found. The report suggests that around one-half of government welfare spending in Australia is due to tax-welfare churn, where government taxes middle and high income earners and then returns those taxes in the form of welfare benefits, usually with conditions and requirements attached. Baker argues for reductions in government spending in specific areas of churn, with savings returned to taxpayers through reduced taxes.

In considering whether Australians should be more concerned about the budget deficit or big government, some consideration should also be given to the question of Australia's ability to cope with big government. As I pointed out in Free to Flourish countries differ greatly in their ability to cope with big government. For example, Sweden seems to have been able to cope with government spending that is still around 50 percent of GDP without huge problems so far, whereas the Greek economy was exposed to a great risk of calamity before its government spending reached that level.

Where does Australia stand? It seems to me that the political institutions and public administration of this country are struggling to cope with existing responsibilities. It makes no sense for governments to be spending more and taking on additional responsibilities when they cannot even sort out which level of government has responsibility for what function.

That leaves me more concerned about big government than about the budget deficit. The federal government should be castigated for allowing government spending to increase faster than GDP.