Political volatility
1.4 Fiscal Context
Between 1970 and 1984, annual Australian Government payments grew from 18.3% to 27.6% of GDP (see Figure 1.4.1). Subsequently, payments moderated downward to around 23% and then fluctuated around an average of 24.8% of GDP up until the present day.
Figure 1.4.1: Australian Government payments and receipts 1970 to 2018
Source: Treasury Budget Papers, Budget 2015-16. Note: receipts are exclusive of Future Fund earnings.
Over the period 1970 to 2014, the Australian Government ran deficits in 27 out of 45 years, as marked in grey overshadow in Figure 1.4.1. The most recent excursion into deficit budgeting was caused by the GFC, which precipitated falling receipts, rising ‘automatic stabiliser’ spending and policy-led Keynesian spending. From 2009 onwards, there was a further deterioration of the government’s fiscal outlook as revenues failed to materialise.
Figure 1.4.2 graphs the dramatic changes to the fiscal outlook in successive official estimates from 2009 onwards.
Figure 1.4.2: The changing outlook—fiscal balance per cent GDP
Source: 2009-10 to 2015-16 Budget Papers 10
12 14 16 18 20 22 24 26 28 30
Receipts (% GDP) Payment (% GDP)
Budget
-5 -4 -3 -2 -1 0 1
per cent GDP
May-10 May-11
May-12 May-13
May-14 May-15
2009-10 2010-11 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17 2017-18 2018-19
22
A more detailed comparison appears in Table 1.4.1, which compares the outlooks in the past four budgets. Note the severe and continuing deterioration in the government’s fiscal position between 2012 and today, deficits are shaded in grey. Key figures are as follows, the planned surplus (as at May 2012) for 2012-13 blew out by around $22 billion, and the predicted deficit (as at May 2013) for 2013-14 grew from $18 billion to $50 billion.
Table 1.4.1: Budget aggregates 2012-13 and 2013-14 Budgets (nominal billion dollars)
Historical Figures Budget Estimates
2008-09 2009-10 2010-11 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17 2017-18 2018-19
Budget 2012-13 Underlying cash Per cent of GDP
Budget 2014-15 Underlying cash Per cent of GDP
Budget 2015-16 Underlying cash Per cent of GDP Source: Treasury Budget Papers No. 1 for 2014–15 and beyond.
The worsening fiscal position was caused by a combination of increased spending and less than anticipated revenues. The Parliamentary Budget Office has produced a graph that succinctly captures the spending situation by plotting together the growth in GDP and government spending for the period 2002-03 to 2012-13 (see Figure 1.4.3).
Figure 1.4.3: Growth in government spending and GDP
Source: Australian Government Spending Part 1, February 2013, Parliamentary Budget Office.
0%
Underlying spending (excluding fiscal stimulus) Real GDP
23
The recent deterioration in government revenues is due to several factors; including reduced company profits and sluggish nominal GDP growth (tax depends on nominal rather than real GDP levels). A key factor overall was the substantial fall in Australia’s terms of trade, as shown in Figure 1.4.4.
Figure 1.4.4: Australia’s terms of trade index
Source: ABS Australian National Accounts 5206.0.
The terms of trade measure the quantity of imports an economy can purchase per unit of exports. Concurrent with the mining boom, Australia’s terms of trade grew substantially, reaching a historical peak in September 2011 before falling 26% to its current level (as at December 2014). This year’s budget assumes the terms of trade will decline 8.5% in 2015-16, and rise by 0.75% in 2016-17. If a larger falls occurs, there’ll be added pressure on
government revenues.
The projected slow return to surplus shown belies the true situation. Much of the fiscal recovery arises due to fiscal drag, or bracket creep, the process by which inflation progressively shifts individuals into higher tax brackets. Fiscal drag shifts the burden of taxation away from companies and onto individuals, thereby reducing the incentive to work.
At the same time, fiscal drag lowers the balance point for progressivity in the income tax schedule.
In reality, future governments will almost certainly find it politically expedient to return at least some of the gains from fiscal drag by way of tax cuts. And if a future government wants to reform the taxation and welfare systems, fiscal drag provides a war chest to soften the blow of policy changes. So while it’s possible to rely on fiscal drag to redress the structural balance, doing so is suboptimal. What’s really required are long-term structural changes to government spending and revenues.
Deficits result in debt. Fortunately, unlike most other advanced economies, Australia entered the GFC with no debt. As a result, our accumulated and projected debt is far below
0 20 40 60 80 100 120 140
Dec-1983 Feb-1985 Apr-1986 Jun-1987 Aug-1988 Oct-1989 Dec-1990 Feb-1992 Apr-1993 Jun-1994 Aug-1995 Oct-1996 Dec-1997 Feb-1999 Apr-2000 Jun-2001 Aug-2002 Oct-2003 Dec-2004 Feb-2006 Apr-2007 Jun-2008 Aug-2009 Oct-2010 Dec-2011 Feb-2013 Apr-2014
26% decrease 20-year post A$ float average
108% increase
24
the daunting levels—typically 80-100% of GDP—faced by many European economies and the United States. Figure 1.4.5 shows the past and projected net Australian Government debt out to 2018-19 as assessed in May 2014 and 2015. The deterioration in our debt position over the past 12 months is apparent. Note that growth in the economy coupled with the assumed slow remediation of the deficit results in debt peaking as a share of GDP in 2016-17.
Although a net debt of around 17.5% of GDP is not extraordinary by international standards, it is far from desirable. If offsetting impact of the Future Fund is accounted for, gross debt will be closer to 30% of GDP. And remember, the Future Fund is hypothecated against the liability of otherwise unfunded public sector superannuation. Moreover, debt brings with it the substantial ongoing impost of interest payments and greater vulnerability in the event of another financial crisis or economic downturn.
Figure 1.4.5: Australian Government net debt
Source: Treasury Papers, May 2014 and 2015.
To put defence spending properly into a fiscal context, we turn now to examine the structure of Australian Government spending. Figure 1.4.6 shows Australian Government spending by function for 2015-16. As can be seen, defence spending accounts for a relatively small part of the total. The reputation of defence as a ‘big spender’ probably arose because it involves a small number of very large purchases rather than millions of small payments as occurs in health, education and social security. Note that in this chart defence spending excludes capital investment.
-5 0 5 10 15 20
1970-71 1972-73 1974-75 1976-77 1978-79 1980-81 1982-83 1984-85 1986-87 1988-89 1990-91 1992-93 1994-95 1996-97 1998-99 2000-01 2002-03 2004-05 2006-07 2008-09 2010-11 2012-13 2014-15 2016-17 2018-18
percent GDP
2014 2015
25
Figure 1.4.6: Australian Government expenses by function 2015-16
Source: 2015-16Budget Papers
Comparing defence spending with other components of federal (i.e. Australian Government) spending fails to take into account the additional public revenues expended at the state and local level. In 2011, for example, federal spending accounted for only around two-thirds of public spending (source OECD statistics). Taking local and state government spending into account, defence spending represents only 3.9% of public expenditure in Australia. Even this figure fails to properly put defence spending into context. The denominator in the ratio (general government expenditure) is highly dependent on the extent to which the
government intermediates between individuals and the providers of services such as health and education. The level of intermediation varies substantially between different countries, as demonstrated in Figure 1.4.7, which shows general government expenditure across the OECD.
Because of Australia’s relatively low level of general government expenditure, the
percentage devoted to defence is higher than it would be otherwise. A better way to capture the true scale of defence spending relative to the usual cited ‘opportunity cost’ areas of social spending, health, pensions and education is to compare defence spending to the total (public plus private) expenditure in those areas. This is done in Figure 1.4.8.
0 20 40 60 80 100 120 140 160 180
Mining, manufacturing and construction Agriculture, forestry and fishing Recreation and culture Public Order and safety Housing and community amenities Fuel and Energy Transport and communication Other economic affairs General Public Services Defence Education Health Other purposes Social security and welfare
billion 2015-16 dollars
35%
20%
16%
7.3%
6.1%
5.1%
26 Figure 1.4.7: General government expenditure 2010
Source: OECD Factbook, 2013.
Figure 1.4.8: Australian public and private expenditure in key functions 2010, circa 2009
Source: OECD Factbook, 2013 (Defence OECD figure is actually NATO European average for 2011). .
As is clear from the figure, defence expenditure is small compared with combined public and private expenditure in the four areas. Moreover, although Australia’s general government expenditure is small by OECD standards, our public plus private expenditure in these areas is fully commensurate with the aggregate OECD expenditure.
The critical point to observe is that defence is different from the competing areas of expenditure in a very important respect. Although a shortfall in government spending on social, health, pensions or education can be made up for through private spending, only the government can provide the public good of defence in practice. Thus, any shortfall in the provision of defence by the government can’t be remediated.
0 10 20 30 40 50 60 70 80
Ireland Denmark France Finland Austria Belgium Sweden Iceland Portugal Netherlands Italy United Kingdom Greece Slovenia Hungary Germany Spain Norway Poland Israel Canada Czech Republic United States Luxembourg Japan Estonia Slovak Republic Turkey Australia Switzerland Korea Mexico
per cent of GDP
0 5 10 15 20 25
Social Spending Health Pensions Education Defence
percent of GDP
Australian private expenditure Australian public expenditure OECD average expenditure
27