Structural budget, and the role of taxing and spending

Rewriting Australia?s recent fiscal history has begun in earnest since the release of the Budget earlier this month, with some bodies blaming Howard?era tax cuts for the string of federal budget deficits.

The Parliamentary Budget Office (PBO) yesterday released an analysis (found online on this webpage) profiling the federal structural budget balance, stating the budget was in structural balance, or surplus, up to 2007?08 before falling to a deficit of up to 4.25 per cent of GDP in 2011?12.

It also estimated that two?thirds of the decline in structural receipts, from 2002?03 to 2011?12, was attributable to successive personal income tax cuts between 2003?04 to 2008?09.

In some respects the PBO analysis, and the related media commentary following the release of the report, raises more issues than settles them.

As with many other empirical studies of this nature, the results of this study depend, in large part, upon the assumptions and estimation techniques employed.

These include the calculation of an unobservable ?potential output? to separate temporary and permanent shocks to the economy, estimating lower and upper bounds for a structural terms of trade estimated by the PBO to be above long term historical trends, and using arguably outdated income tax elasticities.

It is also puzzling that the PBO backdates their structural budget balance time series only to 2001?02, replicating an earlier study in 2010 by Treasury officials, but not taking the series further back in time.

The restrictive time coverage of the study means that the important expenditure reductions by, say, the first and second term Howard governments, in their efforts to correct structural budget deficit left behind during the Hawke?Keating period, has been overlooked.

The argument that the size of the structural budget surplus had been in decline during the Howard years have further fuelled arguments made by the ?revenue lobby,? an organisationally loose but intellectually coherent coalition of interests comprising the ATO, Treasury, academics, politicians and some financial commentators, that taxes should not have been cut during that period.

However, criticisms of previous income tax cuts ignore the point that the Labor Party, firstly in opposition and then in government, initially embraced income tax cuts on the basis that it would expand productive capacity, chiefly through an expansion in labour force participation.

According to Swan in mid?2008, the first tranche of income tax rate reductions, along with other relief measures, alone were estimated to increase aggregate labour supply by 65,000 people in the medium term (though I do vaguely recall Swan referring to an even higher labour supply response in the past).

It follows that the effect of having foregone tax cuts would have been a smaller labour supply, than would otherwise be the case, translating into a slower rate of economic growth, a point absent in the arguments of those critical of income tax reductions.

The recent focus on revenues, including the poorly judged latest round of calls for increasing GST, is another attempt to divert public attention away from the ultimate cause of Australia?s fiscal problem, and that is excessive government spending.

Even taking the PBO?s debateable quantum of identified ?temporary? stimulus measures of $67 billion from 2008?09 to 2011?12 as a given, this spending, as far as I can tell, contributed a hit to the structural budget of at least two per cent over that period.

To be sure, foregoing the discretionary fiscal stimulus would not have eliminated the structural budget deficit as estimated by the PBO, since other policy decisions to ramp up expenditures, particularly in the social policy sphere, had been effected during the Rudd?Gillard period.

And as the PBO acknowledges, new expenditure pressures on the federal budget are now being locked in over time, as DisabilityCare and the Gonski school funding package are progressively implemented by the end of this decade and beyond. It is the expenditure bushfire, driven in particular by welfare state spending, that surely needs to be doused in this period of budgetary emergency.

Treasurer Swan may publicly declare a lament that if the tax to GDP ratio were higher his ability to achieve surpluses would have been assured, but it would not surprise if there is now, in perhaps the final months of this government, an emerging sense of regret, in Swan?s quieter moments, about the highly flawed embrace of runaway spending.

POSTSCRIPT: The Treasury Department has released an update of its 2010 study, which reads as a near?carbon copy of the PBO study (coincidence much?!). It can be found here.

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28 Responses to Structural budget, and the role of taxing and spending

  1. WhaleHunt Fun

    Blaming Howard and Costello will name save their balls when Abbott and Costello come chopping next year. These idiots should be exposing Swan. Exposing him as hard as they can so as to be able remain whole.

  2. WhaleHunt Fun

    will NOT save

    Stupid iPAd. Stupid user of iPad

  3. Rabz

    If ever there was an example of the ‘progressive’ flight from reality, this pointless bleating about ‘structural deficits’ is it.

    There is no reason whatsoever why this argument should even be taking place.

    labor have wasted billions of dollars, hence the $260 billion national debt and the goose’s massive ongoing budget deficits.

    This is the indisputable reality, you staggeringly stupid and dishonest leftist numpties.

    End of argument.

  4. Skuter

    Great post Dr Novak. I heard some commentator the other day talking about how Howard and Costello ‘neglected’ the supply side and conveniently ignored the labour supply effects of income tax reductions. Presumably, the said commentator would have preferred higher taxes and rail projects that generated higher costs than benefits.
    Where has the term ‘bracket creep’ gone in the current debate? In my view, the Howard Costello tax cuts were not much more than a bit of bracket creep foregone. When I started studying economics in the mid 1990s, bracket creep was central to the debate over income tax.

  5. Rabz

    In my view, the Howard Costello tax cuts were not much more than a bit of bracket creep foregone.

    Excellent point.

    And don’t forget the most significant HoWARd/Costello tax cuts of the lot – the reductions granted to compensate for the introduction of the GST.

    What a missed opportunity that was for our beloved progressives – a massive new consumption tax and no income tax cuts to boot – there’d be none of this whining discussion about ‘structural defects’ if that ‘courageous’ course of action had been taken!

  6. Julie Novak

    Rabz – yes, the overspending problem as, really, as clear as day, and one doesn’t need to go through the trouble of estimating the artifact of a structural budget balance to discover that point. The federal government expenditure-to-GDP ratio has increased over the life of the Rudd-Gillard government, so much so that it has overspent in the circumstances thereby borrowing heavily.

    Skuter – yes, thanks for the reminder, I do recall that the Howard income tax cuts barely compensated for the bracket creep effect. Agree that bracket creep effects within a progressive income tax rate structure still remains an important problem, even if professional economists in Australia have tended to ignore it, or downplay it, for a fair while.

  7. johno

    Spot on Julie.

    Australian governments DO NOT have a revenue problem. They have a spending problem.

    Cutting taxes is always good policy and governments should limit their spending to the revenue they have extracted from us.

  8. Rabz

    ‘structural defects’

    Oh dear. Channelling Homer, how embarrassment…

  9. Rabz

    Thanks Julie – not only that, it’s hardly as if receipts have been stagnant or decreasing, either, as Sinc has frequently pointed out.

  10. eb

    Skuter’s absolutely right. Except for the changes related to the introduction of the GST, the tax cuts did little more than compensate for bracket creep.

    Isn’t the assumption uuderlying this whole talk of “structural deficits” that spending cannot be altered. I’d have a “structural deficit” in my finances too if I bought two cases of wine every week!

  11. Skuter

    Agree that bracket creep effects within a progressive income tax rate structure still remains an important problem

    Unless you are a noble progressive of course. Then the discussion about taxation turns to how generous the government is to let you keep a portion of your income/profits/capital gains…

    I think most people in the street are tuning out from the attempt by the ALP to play the fiscal victim. This narrative cannot be reconciled with most people’s conception of reality.

  12. .

    Skuter,

    I’d argue they didn’t do enough re income tax reductions and falttening and trying to ween the sattes off payroll tax.

    The falling tax:GDP ratio with new taxes is testament to the fact that Gillard and Swan just don’t get it at all.

  13. Skuter

    Isn’t the assumption uuderlying this whole talk of “structural deficits” that spending cannot be altered.

    Basically, yes. It is an idea derived from Keynesian premises. The notion of potential output itself is a Keynesian concept. Of course in the Keynesian world, any cut to government spending detracts from growth and leads to excess capacity. To anyone with an Austrian bent (i.e viewing capital and labour resources as being heterogeneous with multiple but finite specific uses) the concept of a well-defined, stable ‘potential output’ or ‘full capacity’ is at best misleading and analytically useless.

  14. Skuter

    Dot, I want to see vertical fiscal imbalance addressed by restoring State revenue powers over income tax and boxing in the feds to their (very limited) original constitutional mandate.

    The falling tax:GDP ratio with new taxes is testament to the fact that Gillard and Swan just don’t get it at all.

    Hear hear brother. Glad I’m not the only one that feels like that…

  15. stackja

    The falling tax:GDP ratio with new taxes is testament to the fact that Gillard and Swan just don’t get it at all.

    Gillard and Swan just don’t want to get it at all. They want it all.

  16. H B Bear

    Perhaps the most promising thing coming from Abbott so far is an intention to look at the Federation itself. One of the ideological positions dropped by the Liberals (amongst so many) is as the party of State rights.
    Saying the GST is a State tax when WA currently receives only 55c in the GST dollar paid and expected to provide for the infrastructure requirements of 1,000+ people per week in net inter-state migration is a joke. Ideally the Federal government would refer income taxing powers jointly back to the States and vacate the health and education areas altogether. I wouldn’t hold my breath.

    Elimination of Federal/State duplication and waste together with truly competitive State jurisdictions could easily be the equivalent of the Hawke/Keating/Howard microeconomic reforms of the late 80s-early 90s.

  17. sunshine

    Economic downturn results in the terms of public debate getting wider . Not so many people are going to remain comfortably numb now . A labor win still remains very unlikely – the damage has already been done .So it will be interesting to see how the Abbott govt handles this new narrative emerging in the mainstream press. A long overdue real debate may be about to begin -austerity vs govt action .

  18. .

    What a load of gibberish.

    Austerity is a misnomer, taking in more taxes, spending borrowed money, driving up inflation to reduce real wages, reducing the future PV of income from investments – internventionism – is truly painful.

  19. Cato the Elder

    “Austerity” has been given the Maquarie Dictionary treatment. As used in Europe it now means tax increases, not spending cuts.

    We need to keep asking “Who do you trust to spend YOUR money wisely, the government, or yourself?”

  20. BM

    Illegal immigration, NBN, pink batts, BER, ABC, the Conversation, foreign aid, NDIS, Gonski, Clean Energy Fund… the list of waste goes on.

    But it’s a revenue problem!

    The only structural deficit is between Wayne Swan’s ears.

  21. Skuter

    BM, I prefer Rabz’s description for whatever is between Swan’s ears – ‘structural defect’…

  22. Pedro

    “It also estimated that two?thirds of the decline in structural receipts, from 2002?03 to 2011?12, was attributable to successive personal income tax cuts between 2003?04 to 2008?09.”

    Those complaints are so annoying. They might as well complain the top rate isn’t still 75%.

  23. Leo G

    “It also estimated that two?thirds of the decline in structural receipts, from 2002?03 to 2011?12, was attributable to successive personal income tax cuts between 2003?04 to 2008?09.”

    The 2003?04 to 2008?09 years had the highest (5-year) average of receipts (as a percent of GDP) of any other in the past 50 years. The past 5 years look more like the Whitlam years in that respect.
    The structural ‘inflection point’ was clearly at the transition to a Labor government, regardless of the cause.

  24. Pingback: Shock of the century : Hey… what did I miss? | Institute of Public Affairs

  25. Missing the bigger point… there hasn’t actually been income tax cuts since the supposed cuts didn’t even fully compensate us for bracket creep.

    Every year that the government doesn’t pass tax cuts, they actually allow for a subtle (but very real) income tax increase… since more and more people are pushed into higher tax brackets due to growth and inflation.

  26. Gowest

    The treasury also ignores the effect on their revenue from the business bashing carried on during this union greens dominated parliament.
    Blind freddie could work out where the deficits came from.
    If they want to blame Howard then they must also simulate the effect on revenue if they had kept workchoices and 20,000 less regulations and no RET/ carbon tax!

  27. Crowbar

    George Megalowhatsisname is one of the more blatant pushers of Costello’s structural deficit line… that the tax cuts were the cause, and yet every time Costello gave us a tax cut, there was George writing an article saying that they were an illusion because they weren’t bigger than bracket creep. Now, he says they were too big.

    And another thing: what is the point of comparing Swan’s expenditure as % of his GDP when all his low-quality expenditure via borrowings artificially inflated the GDP figure. It was in fact “borrowed GDP” not economy-driven GDP. I argue that the effect of deficits (especially stimulus spending) should be adjusted out of the GDP figure. In other words, why do we pat ourselves on the back about GDP growth over the Labor years when a lot of that GDP was simply borrow and splurge. What kind of metric does GDP then become? A nonsense.
    I nominate Costello for a “posthumous” World’s Best Treasurer!

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