budget – Thomas the Think Engine

What Mr Hockey will do next.

Last night on ABC’s 730 program, the Australian Treasurer demonstrated that he has a lot of changing still to do.

Mr Hockey insisted the government would press on with a stringent Budget full of cuts. He bemoaned the total government debt and the legacy current generations are leaving behind. His catchphrase of choice with respect to cuts was this:

“We have no choice!”

But the loudest message was that he had not fully understood the events of recent weeks. He appears to think that the Government’s problems are all about Tony Abbott, because he insisted that all he needed to do was better explain his policy choices to the electorate.

Of the two – Abbott and Hockey – it is Abbott who got closest to the fire and Abbott who has learned the most. Abbott has spoken about listening more, to both the public and the party room. Mr Hockey may think that is yet more spin. But I doubt it is. The 2015 Budget is going to be designed with a lot less guidance from Hayek and a lot more from Roy Morgan. The problem is that Joe Hockey doesn’t realise that yet.

So Mr Hockey is going to have to adapt. Adapt or perish. If and when he adapts, in some small part of his being he may wish he’d been rolled as Treasurer on Monday.

But in his 730 Report interview he said several times “the customer is always right.” Let’s generously assume that motto means he can and will adapt.

So what will he do in this new, constrained environment where ideology is out and the Budget is worse than it has been for a long time?

Worst case scenario as estimated by Deloitte Access Economics

If commodity export prices keep falling, Hockey could beat Wayne Swan’s record of highest Budget deficit ever ($54.5 billion in 2009-10.)

The new, chastened, post-realisation Mr Hockey will be faced with a set of unenviable choices. He can let the deficit blow out, he can cut spending, or he can raise more revenue.

The most unenviable part of his dilemma is that he will probably have to do all three. Suffer the ignominy of a great big budget deficit, trample all over his own principles by raising taxes, and risk the wrath of the electorate by making more cuts.

Mr Hockey’s task in the next few months is to make this something other than a political suicide note.

After surprising the hell out of the electorate with his first budget, he won’t be allowed make the same mistake again. You can be pretty sure that the key ideas in the document to be released on the second Tuesday in May will have been given a thorough airing.

Cuts will be thin on the ground. Reinforcing the message that the Coalition slashes and burns will not be welcome in the party room. That leaves a gaping hole of a deficit.

Unless he can somehow arrange to include tax increases. If he wants to stop the deficit increasing, Hockey’s best option is to look at tax expenditures. You can cut tax expenditures and simultaneously claim you are not levying new taxes. (A tax expenditure is just a big exemption to tax, so cutting a tax expenditure raises more revenue.)

As you can see, the numbers involved are real. Many many billions. GST and the family home are probably no go areas. But some of these tax expenditures – on superannuation and capital gains – overwhelmingly help the Coalition’s older, richer, higher marginal tax rate base.

Politically, removing or changing them may be the best option, because the Government has lost the centre, and needs to regain it. Tax hikes that hurt working families will be off the agenda in 2015.

This will go against almost everything Joe Hockey believes in, except his belief that his government should win the next election. But as I wrote last year, Joe Hockey is likely to resolve his cognitive dissonance in favour of an election-winning strategy. There’s always another choice.

Is this Budget pushing 50,000 people out of work?

Australia’s economy seemed to be repairing itself, right?

Unemployment was finally falling.

Job ads were rising.

Growth was out of the doldrums.

Corporate profits were rising and the stockmarket too.

So how come the Budget forecasts the unemployment rate to worsen?

The documents released by Joe Hockey last night forecast unemployment rising from 5.8 per cent up to 6.25 per cent by 2014-15. That would represent around 50,000 people out of work.

It makes this forecast despite expecting a fall in labour force participation and a rise in growth in our “major trading partners,” from 4.6 per cent to 4.75 per cent.

There’s been plenty of good news recently. I thought unemployment forecasts might go the other way. In fact unemployment forecasts haven’t improved since MYEFO, despite this:

“Since MYEFO, the near-term outlook for the household sector has improved. Leading indicators of dwelling investment are consistent with rising activity, while household consumption and retail trade outcomes have improved recently, consistent with gains in household wealth.”

No change since MYEFO? That surprised me. Unemployment forecasts often change between a MYEFO and a Budget. For example, 18 months ago, that MYEFO tipped unemployment of 5.5 per cent in 2013-14. Twelve months ago – at the following Budget – the world looked worse and the forecast was 5.75 per cent.

This time, all the good news since MYEFO seems to be nullified by the government’s surplus rush.

The qualification in this sentence is perhaps important:

“The timing and composition of the new policy decisions mean that the faster pace of consolidation in this Budget does not have a material impact on economic growth over the forecast period, relative to the 2013-14 Mid-Year Economic and Fiscal Outlook (MYEFO).”

You could read that like this: ‘All the good news on the economy in the last six months is about to be wiped out by austerity.’

The Budget talks a lot about lower investment in the resources sector. It notes in passing that non-mining businesses are waiting to see what happens. It doesn’t note that a slashing budget might frighten them out of investing. (There are exceptions of course: a business selling new work outfits to School chaplains would be wise to get a new warehouse, ASAP.)

The Budget’s unemployment forecasts are higher than the consensus economics forecast (see chart at right). Perhaps because they wouldn’t cut so hard at the moment the economic recovery is gaining momentum.

All spending helps short-run growth, whether that’s government or private. That’s Keynesianism for you in a nutshell.

The government is apparently allergic to Keynesian concepts of economics. They rail against the spending that flowed during the global financial crisis: cheques for $900, funding for insulation, school halls. All they see is the years of deficits. They can’t see a counter factual where Australia’s economy hit the skids.

But this allergy is now apparently inflaming the ranks of unemployed.

This budget is austere:

“The headline annual pace of consolidation is 0.7 per cent of GDP over the forward estimates. Abstracting from the one‑off nature of the Reserve Bank of Australia transaction, the pace of consolidation is 0.6 per cent of GDP.”

If you’re thinking, “I’m okay because I have a job,” consider this:

“Subdued wage growth is expected to continue until the spare capacity in the labour market is absorbed. The wage price index is forecast to grow by a still subdued 3 per cent through the year to the June quarters of both 2015 and 2016.”

Also know that your taxes will pay more unemployment benefits. Despite cuts to access to the dole, total spending on it is forecast to rise because of the change in the unemployment rate.

Essentially the budget is pushing more people into a position where they need the dole, but then compensating by – for some – whisking it out of their grasp.

Four really awesome, quite left-wing ideas from the Commission of Audit

1. Letting states raise income tax to pay for services.

States have responsibility for things people really care about, like schools.

The Commission proposes dividing up the ability to levy income taxes between states and the federal government. (States lost this power in WW2). States would start off with a 10 per cent rate, which they could then move up or down. If implemented in Australia, there’s plenty of reasons to believe this would result in higher taxes and higher quality of services. People move house to access better schools all the time. State governments live and die on stories about ambulance waiting times.

Competitive federalism is a classically liberal idea. But these days one could argue the left, broadly defined, has as much claim as anyone to be the custodian of that tradition. Providing the right amount of government services efficiently is as much a left-wing idea now as right.

You give your money to the federal government they will only spend it on fighter jets and diplomats. You give money to state governments, they spend it on schools and hospitals, roads and transport.

The states have been, in the last 50 years, more red than blue. Anyone who doubted states leaned left before the last SA election got a big surprise when they gave Labor another chance. Putting more tax and spending power in the hands of a demonstrably more left-wing level of government will likely lead to more spending on – and better outcomes in – health and education.

If we had a lot of border towns, there would be big risks of distortion where states had different tax policies. Luckily most Australian population centres are far from the borders. The Gold Coast (QLD) is the closest big town to a border, being 23km from Tweed Heads (NSW).

This idea is the only really big game changer in the whole report. Every thing else is about levels of spending or ownership of entities. This one is about the fundamentals of our Commonwealth, and it is not a bad idea. Locating responsibility for expenditure and responsibility for taxation in the same level of government makes perfect sense. Of course commentators are opposed, and it will be, ahem, looming understatement, tricky to get off the ground.

2. Paid Parental Leave to clock out at incomes of $58,000, but keep the surcharge on the profits of big business.

This week, Tony Abbott cut maximum wage matching for the PPL from $150,000 to $100,000. (I estimated this would impact the payments of around 5400 women.) The audit commission argues it should be far lower, at Average Weekly Earnings, or $57,460. But the tax introduced to pay for the scheme should be retained, it argues, and spent on child care.

No upper middle class welfare, and higher taxes on big business? It’s like Bob Brown himself wrote this part of the Commission’s report.

3. Cutting a promised boost to Defence spending.

The Government, in its madness, has promised to boost defence spending to 2 per cent of GDP. Why 2 per cent? Not because that’s proven to be the level we need to keep the barbarians from the gate, but just because.

The Commission rightly argues we should choose our spending level based on strategic and fiscal need, not on easily memorable even prime numbers. (It then waters down the strategy-first argument by saying the government should prioritise: “reducing the staffing size of Defence headquarters in Canberra, including senior staff, to 1998 levels;”).Nevertheless, the government’s 2 per cent of GDP pledge is a shocker of an idea, and the Audit rightly sends it out on to the firing range where it belongs

4. Benchmarking the ABC.

Now, this one is a bit of a stretch. The government is clearly looking for opportunities to cut. But if you benchmark honestly, and compare the ABC to its peers, you’re going to find it hard to do anything but conclude they are very very frugal and represent a good return on investment.

This excellent analysis finds the ABC spends 14c per Australian per day. The BBC gets 39c per Briton per day. Canada’s public broadcaster also gets 14c a day, but it has advertisements. The ABC, is the runaway winner. The article adds that it is 4 per cent of the price of subscribing Foxtel.

The ABC gets $1.2 billion in revenue, which it uses to run 12 radio stations, a 24 hour news channel, two main channels, a kids station, an international station called Australia Network, abc news and opinion online, etc. Channel 7 has revenue of just over $1.2 billion, which it earns for running 7, 7Two and 7Mate.

While the ABC pays its top stars up to $356,000, I have it on impeccable authority that ABC Melbourne journalists have to BYO teabags to work.

I cannot imagine how a benchmarking exercise would find anything other than great opportunities to invest in the ABC.

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The Commission of Audit report contains some other ideas I regard as excellent, like cuts to industry assistance, better e-government and slashing the hell out of DFAT. It also contains ideas I oppose wholly, like restricting access to Medicare, and cutting the minimum wage.

The full set of Phase One recommendations is here. Use the comments section to let me know any other parts that catch your eye!

A deficit tax: Now we really do have a Budget Emergency

Tony Abbott is floating a special deficit tax. If you earn over $80,000 you’ll be up for an extra $800 in tax next year.

Here’s four reasons it’s a bad idea, (and one reason it’s not so bad).

1. We do not have a Budget Emergency. Yet. Our deficits are small and our debt is manageable. What we do have is a looming structural trainwreck as health spending rises while labour force participation falls. A short-term Budget deficit tax fixes the non-problem, while ignoring the real problem.

2. Raising taxes while the economy is in poor shape won’t help the recovery. Australia’s growth has been meagre and our unemployment rate rising for most of the past few years (with a blip down in April’s numbers). Smart economics says to spend more and tax less when you’re trying to induce a recovery. This is Keynesianism.

3. Keeping the focus of the budget on the deficit (simple, easy to understand, irrelevant) misses the opportunity to make the budget about something important.

4. If we are so allergic to a deficit of a few billion, we may never borrow again. With Australia’s long-term government bond rate at 3.93 per cent, borrowing is cheap right now. If we are ever to build any infrastructure round here, we need to borrow money. (Infrastructure costs a lot now and pays off in the long run, so if buy it using cash current generations subsidise later ones). Insufficient borrowing will mean the country comes crumbling down round our ears.

BUT

5. It’s hard to imagine Treasury proposing this idea to the government, except perhaps as a second-best alternative to slashing a lot of programs, and only if the government was hell-bent on returning to surplus immediately. Where you do discern the fingerprints of the department is in the progressive design of the tax, that would mainly slug high-income earners:

[It would] “cost earners on $80,000 at least $800 a year rising to an extra $8000 a year for those earning $400,000 a year.”

Hitting the high income earners may work for Mr Abbott politically too. He hurts only people who are likely to vote for him anyway, keeping western Sydney sweet. That means the people with the highest tendency to consumer their income won’t be hurt, so the economic effect of the tax will be more muted than if it were shared equally.

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Apparently there is a backbench rebellion against Mr Abbott’s paid parental leave scheme, which has s price tag of $5.5 billion, and is genuinely not a clever policy. I’ve written before about the economics of cutting it – reducing eligibility from incomes of $150,000 to $100,000 doesn’t make much of a saving – you’d need to be much bolder.

Why Labor should have made equality a key budget figure.

The Budget comes out on 13 May, and when it does, one thing is for sure. Everyone will get in a flap and a lather over the wrong things.

The Budget is a whopping lump of documentation, and many of the people sent to cover it are inexpert in matters fiscal.

So at the end of the day, an inordinate number of stories will be simply about “the deficit.”

It’s one of only a few simple numbers in the whole Budget. Earnings minus Spending, delivering a binary result: Surplus/Deficit. Good vs Bad. It’s quite graspable.

But it is very hard to find experts that care about each year’s budget deficit. (1, 2, 3, 4.)

Forecast deficits are more important, but the actions that need to be taken to get the ship in order long-term are often counter-productive if you want a surplus ASAP.

Stressing over one year’s budget deficit is akin to stressing about the score in a five minute period of a game of football. Sure, the end result is made up of periods just like this one. But experts understand that the game turns over a longer period than just five minutes.

Sometimes you are kicking into the wind, and a deficit score can be okay. Sometimes you run a deficit on purpose, to prop up the economy or grease the wheels of reform.

Raising funds to cover a deficit is easy and cheap at the moment.

Headlines that scream Deficit! and Surplus! – complete with a cartoon of a treasurer either pulling out his pockets to show they are empty, or otherwise evilly grinning and hoarding cash – would be better spent focusing on what matters.

The way to train people’s focus onto certain matters is to measure and report them.

“If you can’t measure it, you can’t (media) manage it,” as they say.

Labor had the opportunity to remake the focus of the Budget, but lacked the foresight.

They could have put the budget balance in size eight font and tucked it away down the back. Obviously you can’t take away the food bowl and expect the media to sit there wagging their tail. You’d need to give them something else.

When in power, Labor could have chosen any number of other measures to make the focus. Productivity, the need for tax reform to fund the NDIS and Gonski, composition of revenue, efficiency of government service delivery broken down by department, or even equality.

Politically speaking, this last one might have been quite useful.

The Australian economy has been characterised by a fall in the compensation of employees (COE), relative to profits.

The National Accounts, from where these graphs come, note: “The profits shares recorded since the late 1980s are at a distinctly higher level than those reported at any time since 1959–60.”

I do not suggest that at the moment there is a crisis in equality in Australia, but I suspect many people think Australia could do better. And there is a choice to be made as Australia equips itself with policies for the next decade. Do we want to be Sweden or America?

People realise policies that promote freedom and small government can lead to inequality of outcomes. Mostly they accept that, until the inequality is bad enough to undermine the society expected to enjoy that freedom.

In the US, inequality is so bad that Walmart now is forced to declare as a material risk to its earnings, any changes to Government welfare cheques that would further impoverish its customers. (from the Wall Street Journal).

It’s hard to have a mass market business if the mass market is so poor. And in America, the focus of inequality is no longer on the 1 per cent but the 0.01 per cent.

The evidence is not finalised but much of it is pointing in one direction – rules that promote equality inside a market economy are correlated with happier people. The Labor party has as its assistant Treasurer a man who authored a lot of the research on inequality in Australia, Andrew Leigh.

The Budget is the best time to try to introduce a new concept or issue into the economic debate, because that is when the greatest number of Australians are paying attention. Using the budget to shape the environment in which economic policy is played is going to yield better long-run outcomes than playing another round of The Deficit/Surplus Game.

Even if the other side gets back in and removes that statistic from the Budget, the public – by then attuned to expect this data – gets the sense the new team is hiding something.

If the Coalition wants to be smart, they can pick a concept (assuredly not inequality, but perhaps labour productivity, days lost to industrial action, rising health spending or a measure of how free Australian markets are) and use that as a central theme.

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