A realistic strategy for federal budget repair

A federal election is an opportunity to take stock of how Australia is doing, where it’s going, and what governments can do about it. This series, written by program directors at the Grattan Institute, explores the challenges facing Australia. In this last piece of the series: budget repair.

The persistent budget deficit is one of the re-elected Turnbull Government’s biggest challenges. But as revealed by the long list of zombie measures that the last government proposed and the Senate refused to pass, the politics of budget reform is never easy. Success will require tough decisions, and powerful public persuasion.

As the government chooses its budget priorities, inevitably it will look for measures that can be implemented without parliamentary approval or that other parties in the Senate are likely to approve. But given the scale of the budget problem, it will also have to identify reforms that other parties do not support (at least initially), and then carry the day by making the case for them with the public.

The size of the budget problem

In building that public support, the first step is to come clean about the scale of the problem. Successive Commonwealth governments have relied on over-optimistic projections that expect revenues to recover quickly, and spending to grow only slowly. The May 2016 budget was the seventh to project a drift back to near surplus, primarily as a result of bracket creep, over the following four years. It was also the seventh budget in which the actual outcome for the current year showed minimal improvement over the year before. For eight years, budget deficits have persisted at about 2-3% of GDP.

Most analysts believe that current budget projections are unduly optimistic. Over the last eight years, such projections have been used to justify a softly-softly approach to budget repair with few net savings. Both sides of politics have introduced significant savings measures, then used pretty much all the proceeds to fund new priorities rather than to reduce the budget deficit. To build public support for actual budget repair, the Government needs a more realistic set of economic projections. These should assume that Australia’s future will reflect the experience of most developed economies since before the global financial crisis, with corporate investment, real economic growth and inflation all lower. To counter optimism bias, the slowdown should be presumed to be permanent until proven otherwise. With such projections, the government has a chance of persuading the public that tougher budget measures that impose net costs are needed. The need for budget repair The Government will also have to explain why budget repair matters. Again this needs plainer speaking. Australia is exposed to a downturn in the global economy – and there are plenty of reasons to fear it will happen. Budget repair now will make it easier for governments to employ fiscal defence in a downturn. If they want to use deficit funding to lift economic activity in difficult times, as the Rudd Government did in 2009, then they must deliver surpluses when growth has recovered. The budget deficit is also unfair to future generations. About half of it is a result of increases over the last decade in net transfers to households aged over 65. Spending per older household on health and the Age Pension has grown faster than the economy; income taxes per older household have fallen in real terms as a result of superannuation tax breaks. Every year we run a deficit at current levels, younger households will have to pay an additional $10,000 in tax over their lives to pay back the principal and interest. Finally, government should highlight the mounting cost of interest on the accumulating debt – at present 4% of Commonwealth income, or as much as it spends on public hospitals. What is achievable? The Government’s slim majority in the House of Representatives, and a large and diverse crossbench in the Senate, will not make budget repair easy. Worthwhile spending reductions that require legislative change are unlikely to pass easily, since inevitably they will involve cutting services to someone, creating political opportunity for opposition parties. The Government could buy change by supporting the wish lists of minor parties, but experience from the Gillard years shows that such horse trading, while productive, can be expensive. So the Government will need to build a budget repair strategy that puts a priority on the big things and makes the most of what is politically possible. It should progress measures that don’t require specific parliamentary approval, favour measures where Parliamentary approval is plausible, and build public support for important reforms. Other changes should be deferred, or ditched outright to preserve political capital for winnable wars. The Government should abandon potential budget savings that are unlikely to win support from either other parties or the public. For example, there is little prospect of increasing the GST this parliamentary term. Many of the “zombie” measures from the May 2014 budget should be put out of their misery. A realistic strategy for budget repair Note: Excludes budget savings measures not yet legislated but likely to have bipartisan support, such as increases in tobacco excise. Medicare levy assumes a 0.5 percentage point increase. Improving hospital efficiency, such as such as by establishing a national efficient price for hospital procedures, assumes savings will be shared between the Commonwealth and the States. Raising Age Pension and superannuation access ages assumes savings once the policy changes are fully implemented. Source: Various Grattan Institute reports; Commonwealth Budget papers (various years); ALP election costing documents; Productivity Commission, Grattan analysis. Changes that don’t require specific legislation First, the Government should reduce spending that does not require specific legislation. Healthcare, as the fastest-growing area of government expenditure, should be a particular focus. Its growth can be contained in ways that do not compromise the quality of care. For example, the Commonwealth can manage chronic disease better, and reduce waste by paying less for inefficient hospital care. There are also a myriad of spending programs, each benefiting a particular interest group, dangerously expensive as a whole. The election campaign has increased the size of the task, with its ample giveaways, often for minor transport projects and sporting facilities, particularly in marginal electorates. Ramping up the budget rhetoric should make it easier to resist such demands next time around. The political middle ground Second, the government should look for genuine political middle ground, as it did with the changes to the Age Pension means test passed by the last Parliament with support from the Greens. Once the composition of the Senate is confirmed, government legislation will most likely need the support of either the ALP, or the Greens plus one or two independents, or virtually all the independent nine or 10 senators. Given the disparate backgrounds of the Senate crossbench, reaching across the aisle to the ALP, or the Greens, may be easier – and it might work. With such a Senate, some of the new Turnbull Government’s best chances to improve the budget in this Parliament will be to increase taxes – such as by reducing the capital gains tax discount, or raising the Medicare Levy to pay for rising spending on health services. The problem here will be with the Coalition party room, as illustrated by the backbench push to overturn the changes to superannuation tax breaks proposed in the May Budget reveals. To succeed, the Government must abandon the fiction that there is no revenue problem. Both the politics of budget repair and the sheer size of the budget gap mean that the Commonwealth needs to both contain spending and boost revenues to return the budget to surplus. Ironically, revenue increases – primarily through bracket creep – have been the dominant plan for budget repair under all Treasurers over the last eight years. Building public support Third, the Government could propose budget savings that are unlikely to obtain immediate bipartisan support, but may win out as public opinion and political reality force other parties to fold. For example, the Labor Party ultimately agreed to proposed changes to research and development tax incentives just before the election. Surveys suggest that people understand the need for budget repair, and can be persuaded to slay sacred cows such as negative gearing. Among possible savings, Grattan Institute reports have identified increasing the age of access for the Age Pension and superannuation and including owner-occupied housing in the Age Pension assets test as being among the best opportunities to achieve Budget repair. Other welfare priorities should include recovering more of the costs of aged care from those who benefit, and constraining the growth of carer payment, since these are among the fastest growing costs. Abolishing the Senior Australian and Pensioner Tax Offset (SAPTO), or just restricting its tax benefits to pensioners, could raise up to $700 million a year. In health, government needs to build the case for reforms to the Medicare schedule list, pathology pricing, and pharmaceutical pricing. Commonwealth funding for higher education is also increasing, and retaining a demand-driven system will require the Commonwealth to recover more of the growing HELP debt by lowering the income repayment threshold, and recovering debts from estates. Obviously, the public will need persuading on these reforms. Discussion papers and public argument should build popular momentum for change so compelling that the Labor Party or the Greens follow where the people led them. This approach increases the importance of outside stakeholders: media, think tanks, and peak lobby groups. It increases the importance of following the evidence – it is pretty difficult to win over the public when even the experts are opposed. Institutional changes Institutional changes can also help to build the public argument for budget repair. Amending the Charter of Budget Honesty to force governments to bring down budgets that produce a surplus within the forward estimates would counter the “long-termism” that defers difficult decisions. Governments should also be required to produce long-term projections that spell out the impact of long-term decisions, countering the tendency to hide the impact of significant decisions just outside the forward estimates period. A budget strategy Hoping for the best is not a budget management strategy: it simply shifts the costs and risk of budget repair onto future generations. To make more progress than its predecessors, this Turnbull government will need to prioritise ruthlessly, make tough calls, compromise with other parties, and persuade the public where it matters.