The rush of new spending proposals by the Gillard government in education and social services has once again raised questions about the long term sustainability of Australian public finances.
Most notably the government has signalled its aspiration to implement a national disability insurance scheme and a new school funding regime, which according to some estimates could cost the commonwealth and states an additional $13 billion per annum.
But just how these programs will be funded, when the budgets of the commonwealth and most states are presently in disrepair and likely to remain so for some time, was one of the central themes of a speech presented recently by federal Treasury Secretary Martin Parkinson.
While acknowledging that competing demands for new and additional government spending should be politically prioritised, Parkinson largely channelled his predecessor Ken Henry to claim that rising public expenditures are next to inevitable.
Accordingly in the Parkinson view of public policy the only way to afford additional spending in the long term is for Australians to yield in their tax opposition and just accept more tax and other revenue increases.
There is no question that the present government has taken such advice to heart, as shown by its preparedness to extend the commonwealth taxing base to mining and carbon dioxide emissions, but the tax‑and‑spend message of the government’s chief economic advisor shouldn’t go unchallenged.
In effectively arguing that Australia’s share of government expenditure to GDP ratio will keep rising in the foreseeable future Parkinson stated ‘while we are getting richer, our expectations for more goods and services delivered by governments are also growing.’
This statement is central to Parkinson’s view on the future of public finances, and is essentially a modern slant on what is known in economics as ‘the law of rising state expenditures’ as laid out by German socialist Adolph Wagner in the late nineteenth century.
Most economists today tend to elevate Wagner’s law to the status of an immutable truth, but numerous empirical studies including for Australia show it is unclear that the law explains why government expanded when it did.
This is because other factors affecting the supply of government, including the imposition of taxes on income and property or the weakening of constitutional constraints such as federalism, have also increased the momentum of public sector growth.
To the extent that demands from voters happen to influence government growth, it is arguably not increasing income that has been central in driving these demands.
It is, rather, the incentives for individuals and special interests to call upon, and vote in favour of, concentrated benefits, such as middle‑class welfare, corporate subsidies and other handouts, which not only spread tax costs over others, but effectively lessen the need to secure incomes from their own personal exertions in competitive markets.
It is not surprising, then, that many public choice studies suggest the relative size and scale of government observed today to be greater than that demanded by the median‑ranked voter across the political preference distribution.
Even if we accept Parkinson’s statement, and Wagner’s law which inspired it, at face value, it is not inevitable that a positive correlation between wealth or economic development and government spending growth will continue to hold.
This is because rising incomes available to most citizens, together with technological developments and the globalisation of service provision, enable people to increasingly choose low cost non‑governmental service providers in fields currently dominated by governments.
In Australia we have seen growing student enrolments in Catholic and independent schools, and the increasing use of private hospitals to provide a wider array of intensive medical treatments.
Growing numbers of people are availing themselves of cheap and effective health care through the burgeoning medical tourism industry, while the emerging online education industry promises to fundamentally change schooling, tertiary and vocational educational services as we know them today.
Combined with the gradual erosion in public sector services reliance is the increasing mobility of capital and labour in a globalised modern world that places significant pressures on the ability of governments to collect tax revenues.
While tax mobility was emphasised by Parkinson in his speech, he omitted the point that the existing tax system, combined with increasingly prescriptive regulations and wasteful government expenditures, diminishes the ability of those who don’t relocate to earn sufficient incomes upon which governments rely for their revenues.
Even the ‘spending strike’ by Australian consumers lacking economic confidence in recent years is limiting the total amount of GST revenue redistributed by the commonwealth to the states.
It is surprising in this context that Parkinson recommended that states increase their payroll taxes to enable them to increase their own‑source spending, even though such measures would raise the costs of hiring labour and so provide disincentives to increase employment.
All in all, one very good reason why tax‑and‑spend proposals should be challenged is that a relatively larger size of government, which tax‑and‑spend inevitably entails, will compromise economic performance sending Australia a few steps closer down the European road of stagnation.
Shouldn’t Australia’s preferred economic and fiscal model be to avoid anything modern Europe has tried, meaning Australia should therefore reduce government spending and tax burdens instead?
There are plenty of proposals on the table to trim government size, so it shouldn’t be beyond the wit of politicians, with the support of their senior bureaucrats, to reform the public sector and avoid the long term fiscal crunch of projected deficits and debt.
That Parkinson failed to outline any convincing counterweight to the tax‑and‑spend inevitability thesis reveals just how far Treasury has fallen concerning the quality of its policy advice over the years.