Australia’s budget is in a spot of trouble. The ABS released its latest Government finance statistics this week and they show a slump in revenue.
This, to me, is not a crisis. It’s not good news, but just as you don’t judge a game of football on a 2 minute period, you don’t judge a fiscal situation on a quarter (or even a year, or even a group of years). You ned to judge the fiscal position in the long run.
I’m interested in this high-level measure, the tax-to-gdp ratio. And that’s an interesting thing, with a few moving parts.
Treasury has relatively recently begun spruiking it. (This began in the Rudd era, I believe, when he wanted to seem fiscally prudent while spending a lot.) It can be affected by deliberate actions of government, or by shifts in GDP and prices of key exports.
That spike in the red line at the end is now at risk, due to factors beyond the government’s control. In the 2014 Budget, the government announced it would increase revenue as a percentage of GDP, from 23 per cent to 24.9 per cent.
Given the way everything economic and budgetary has come up turds since, the MYEFO is likely to replace this optimistic assumption when it comes out (soon).
A 1 per cent fall in the terms of trade is estimated to have a $2.6 billion impact on the budget, according to published sensitivty analysis. And this week’s national accounts show an 8.9 per cent fall in terms of trade over the last 12 months.
So we’re likely to get a budget deficit that is expanding and a tax to GDP ratio that is falling.
So what should the government do? In the short-run, it should keep spending to prop up growth. But in the medium to long run it needs to do more.
“Given the deficit prospect, the government faces three choices: (1) Run a bigger deficit, (2) raise taxes, or (3) cut government spending… What the government should consider is raising taxes.”
Cutting spending is important where programs are ineffective, or where you’re trimming fat. That is crucial. But it won’t be enough. The Australian people want the government to do more, not less – we want important things like the NDIS and funding childcare and kindergarten.
I’d support raising taxes, slowly and in a clever way, to try to right the structural budget deficit.
This might seem like an impossible PR job for the government. But with the help of one man, it may not be.
The name John Howard is like a magic charm in contemporary politics. A man who wins four elections (96, 99, 2001, 2004) gets a lot of kudos in retrospect, even if he had a seriously easy incumbency, bountiful in threats to national security and bumps to government revenue.
Mr Howard presided over an era that saw the tax-to-GDP ratio rise over 24 per cent, even as he gave away income tax cuts as fast as he could. People remember that time fondly. The song that pleaded for us to not take a rose coloured glasses view of his legacy? That record broke.
The man is viewed (wrongly) as a fiscal genius.If I were Joe Hockey, and I was facing up to the fact I needed to to try to sell tax hikes, I’d stick his name on it.
“Reverting to a John Howard era tax-to-GDP ratio” sounds a lot more palatable than simply “hiking taxes.”
Thomas the Think Engine 
Not sure what you mean by “Treasury has relatively recently begun spruiking [the tax/GDP ratio]. (This began in the Rudd era, I believe, when he wanted to seem fiscally prudent while spending a lot.)”
The Hawke Government adopted a set of fiscal rules (known as the ‘Trilogy’) in its 1985-86 Budget that included a cap on the tax/GDP ratio. The adoption of fiscal rules by most subsequent governments is the reason the tax/GDP ratio has been more or less flat (in cyclically-adjusted terms) since then, after rising from WW2 to the mid-1980s.
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Thanks for the comment – I did not know that about the Hawke Government !
Perhaps the ratio was common prior to 2007 – it is a subjective memory. Still, but I feel I really never heard much about the ratio in the Howard era (which is when I worked at Treasury), but when it started plummeting in the GFC, suddenly I saw it everywhere!
In a way, I like it, because it is a less-sensitive measure than budget deficits and surpluses, and therefore less likely to distract policy-makers from making good policy in any fiscal year.
I’ve written before about how taking the focus off the binary surplus/deficit figure would be helpful: https://thomasthethinkengine.com/2014/04/14/why-labor-should-have-made-equality-a-key-budget-figure/
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I agree, I think it would be a good thing if there were much more awareness of, and debate about, the fiscal rules that governments adopt. It’s one of the most important decisions a government can make, but it’s barely noticed.
The Howard-era fiscal rules included a commitment that there would be “no increase in the overall tax burden from its 1996-97 level.” I have always interpreted that as meaning no rise in the tax/GDP ratio, which I believe is how it was intended.
We’ve effectively had a tax/GDP cap since the Hawke Trilogy in 1985, because each successive government has implemented fiscal rules that, among other things, commit to not increasing the ratio over that which it inherited from the previous government.
You might be interested in this old monograph by Michael Keating: http://www.assa.edu.au/publications/occasional/2004_No1_Increased_taxation.pdf
One caveat I’d put around the emphasis of the tax/GDP ratio rather than the budget balance is that both need to be evaluated over the medium-term. Using the ratio doesn’t get around that. Obviously in a recession, GDP falls, so the tax/GDP ratio rises due to changes in the denominator rather than the numerator. Tax/potential GDP would be a better measure, if we could somehow measure potential output with any degree of confidence.
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