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
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.)

tax expend
Source: Treasury tax expenditure statement 2014

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.

Why this could be the summer Joe Hockey turns Keynesian.

Next year’s budget offers the Government a horrible array of choices.

The government was badly burned by this year’s budget. Ideas like the GP co-payment saw their popularity plunge in May, and they’ve been in an election-losing position since.

polls
Source: the inestimable Edmund Tadros, AFR.

They burned their fingers badly, and what’s worse, didn’t even grab substantial fiscal gain from it. The Treasurer’s office is staring down the barrel of a budget with another big deficit next year.

If they try to push the budget back to surplus, the public will have their worst fears confirmed – these guys really are mean!

So the Treasurer can’t cut too hard.

The alternative – running a deficit and being proud of it – looks unpalatable. But there are ways to change one’s tastes …

Australia’s growth in the last quarter was poor, falling to 0.3 per cent.

gdp grwoth
Source: ABS National Accounts

There is a big school of thought in economics that says when growth is poor, governments should spend to prop it up. This is broadly known as Keynesianism, named for John Maynard Keynes, who was a major theorist of the great depression. The more contemporary theorists are known as New Keynesians

Spending to support growth is common. That’s what Kevin Rudd and Wayne Swan did in the GFC, giving us school halls, insulation and $900 cheques. The Rudd stimulus left Australia with a medium-sized amount of debt, and arguably prevented Australia from falling into recession alongside the rest of the western world.

The opponents of this policy included one of the national daily papers, The Australian. They hated it in 2009, and they hated it even more by 2013 and 2014.

But by 2015, might their rigidities soften? The political needs of the current government may demand it. The only way to not commit political hara-kiri while setting a framework for the 2015-16 Budget will be to adopt a far more generous way of thinking.

Torn between two forms of cognitive dissonance, “I am setting the national Budget in a wholly political way” and “I am a late convert to the need to support aggregate demand,” I suspect Mr Hockey may be tempted by the latter.

This summer, as he lies on his towel, listening to the Pacific Ocean waves crash on the beach, Joe Hockey may well be turning the pages on a biography of Keynes. Perhaps the same one Mr Rudd read in 2009. It might be the thing that saves him.

Bill Shorten should probably zip it about next year’s budget deficit.

Next May, Tony Abbott and Joe Hockey are going to feel very uncomfortable indeed. They’ll be bringing down a Budget that is completely the opposite of what they hoped for.

The 2014-15 Budget was full of spending cut plans and forecasts of rising tax revenues. The spending cuts are mainly in shreds on the floor of the Senate, and the rising tax revenue projections got vapourised by weak growth and falling iron ore prices. The few measures they did pass, like a temporary tax hike on high income earners, aren’t likely to be enough.

The Abbbott/Hockey game plan was to get their horror budget out of the way early. But the ghost train didn’t stop at the station, and it looks like they’re stuck on the ride as it enters the tunnel once again.

The Budget, when it comes out, is going to include some large negative numbers. They were expecting deficits of $30 billion this year and $17 billion next year.

deficit

But revenue fell hard in the most recent quarter as growth fell to 0.3 per cent.

Budget update

I expect the government will be forced to admit the deficit this year is very much like the last Labor year (around $50 billion), and that the 2015-16 one will be at least twice the size they expected.

What’s worse for them is this – the more they try to correct this scenario, the worse their reputations become.

I wouldn’t want to face the dilemma Hockey faces – try to put the budget on track and cement once and for all the impression of having a heart of stone, or try to salvage a bit of popularity while letting the nation’s finances spiral away. Perhaps he will happily give up his job to Mr Turnbull.

So, from a fiscal perspective, Opposition leader Bill Shorten has been given a free kick in the goal square. This is political gold!

But should he go hard on this topic? Should he try to drive a fiscal stake through this government’s heart?

I see three reasons he should not.

1. Don’t perpetuate Deficit-phobia.

The fear of deficits is extremely corrosive to our national debate. Governments are absolutely petrified of borrowing, for fear of being accused of running a deficit.

Interest rate the government faces on a 10-year loan. Source: Bloomberg
Interest rate the government faces on a 10-year loan. Source: Bloomberg

The cost of borrowing, right now, is exceedingly low, and the benefits of borrowing could be very high. Almost everyone thinks Australia could use a big whack of infrastructure to set it up for the next century. Obsessing about spending only what you earn is for people who can’t get credit, or for people whose expenses are smooth and predictable. A mid-size first world nation can get credit cheaply, and might want to occasionally build a huge project. In those cases a deficit should be celebrated.

If Shorten accusing Abbott of incompetence because of the existence of a deficit, then he further limits the policy options of all governments of all stripes.

2. Focus on something important.

Budget day I argued in April that Labor should have made equality a big budget figure. You could hoard all the relevant data on equality until Budget day, brief the right people that an important measure was coming out that day, and then boom, get some cut through on a topic that wasn’t so meaningless.

If Mr Shorten goes after Mr Abbott on the defict, he adds his imprimatur to the idea that managing a deficit is the most important job a government can have. Assuredly, it’s part of the government’s role. But to place it at the centre of responsibilities is to show a distinct lack of imagination. Find something important and make Budget day about that instead.

3. Tying your own noose.

If Mr Shorten wins government in late 2016 and the deficit is all he’s talked about for the preceding three years, he’ll be forced to fix it, fast. That could prove uncomfortable for him.

Mr Shorten’s approach will depend to some extent on what Mr Hockey has planned. We will know a but more about that once the mid-year economic update (MYEFO) comes out.

It was exactly 51 weeks ago that I wrote about the first MYEFO that Mr Hockey brought down, which was clearly setting the stage for big cuts. I wrote this

“What is the last “cut” that is heralded as a major political reform? Howard strangled the dole payment down below some estimates of the poverty line, but that’s oddly omitted in his hagiography. Even right-wing economist Judith Sloan has argued the dole should now be raised.

When we list the economic reforms that have made Australia great we include microeconomic reform, floating the dollar, an inflation-targeting central bank and the GST.  Not cuts.

If the Abbott government’s first term economic reforms can mainly be labelled “cuts”, what will be its legacy?”

It will be very interesting to see what themes we can read into this year’s MYEFO (perhaps coming out next week, and required by law before the end of January).

The man to sell tax hikes to the Australian people … is John Howard.

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. 

Budget update

 

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.

Tax to GDP ratio

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.

The most senior figure in Australian economics, Max Corden, strips the issues back to their essentials in the Conversation today.

“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.

John Howard, Prime Minister 1996-2007

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.”

Hockey on house prices: Two incomes now necessary.

I went to the Melbourne Institute economics conference yesterday and heard Joe Hockey speak at lunch. He’s not bad on his feet. Even when he’s not across the detail, he bluffs well. He seems likeable and projects passion.

But he said something I couldn’t quite believe.

Let’s face the reality. Unlike our parents, our generation and the ones that follow will not be able to afford a house in a capital city on just one income.”

This little message came in the middle of a spiel about how the paid parental leave scheme would pay women to raise kids. I wondered if it was a slip-up. But no. He said it again later.

“Try living in any capital city in Australia on just one household income. It’s nigh impossible. But the mortgage still keeps coming in. And the bills still keep coming in.

While this matched my own experience quite neatly – I don’t own a house and wouldn’t consider buying one without going halves in it – I doubted a Treasurer should accept it as a fact.

But perhaps the problem is too far gone. Here’s a table I made that shows who might be able to afford what.

But perhaps the problem is too far gone? Here’s a table I made that shows who might be able to afford what. (The cheapest house I could find in Melbourne was this one bedroom unit in Noble Park for $160,000.)

house prices out of reach
The average house (~$550k) is unaffordable on the average wage

When lone-person households are our fastest growing demographic group, making up 24 per cent of Australian households, and single parent households are raising over a million children (961,000 single parent families representing 15 per cent of all families), house prices rises seem less like a boon to the economy and more like a social welfare disaster.

Systems that permit stability of tenure for renters should be introduced as a matter of urgency. Housing affordability is at least partly a policy question. As a starting point, Treasurers should talk about low housing affordability as a problem, not as a fact.