A good budget means setting some rules and adhering to them

Across the western world, budget discipline has been hard to find.  

This especially the case in America, where the response to a government shutdown over spending issues appears to be resolved by even more spending.  

Indeed, the President is now floating the prospect of mailing out $2,000 cheques to voters. Apparently, the Americans have forgotten de Tocqueville’s warning about bribing voters with their own money.  

While things are better in Australia, the budget has still swung wildly in recent years. First, into deficit during the pandemic, then back into surplus following the post-pandemic inflation surge. Current projections are for long-term deficits. 

Fixing that problem requires more than just a short-term commitment to spending reform. It also requires the readoption of fiscal guardrails: a set of agreed rules fit for the challenges of the times, to guide and constrain the development of government budgets.  

In fact, there are good reasons to adopt two sets of rules. The first, tighter set of rules would govern a medium-term budget consolidation to remove excesses of spending, deficit financing and borrowing in the current budget outlook.  

The second set of rules would keep the budget on the rails over the longer term. 

There is a long history of fiscal rules, but the overall record is patchy, with governments lacking the fortitude to stick to rules when the going got tough. 

The Hawke government’s 1985 fiscal trilogy achieved a strong adjustment from deficit to surplus with an emphasis on cutting spending in real terms.  

But that unravelled in the early 1990s recession, and rules did not make a comeback until the Howard government in 1996. 

The most enduring rule since then — a balanced underlying budget on average over the economic cycle — could be said to have held until about 2011, averaging out the Howard government’s surpluses and the Rudd/Gillard governments’ GFC deficits.  

But since then, fiscal performance has gone off the rails. 

Rudd/Gillard were slow to reduce deficits, more energised as they were by new spending initiatives such as Gonski-formula school funding and the NDIS.  

The Coalition governments that followed struggled to deliver on their own tough rules, starting with the Abbott/Hockey 2014 budget that vowed to end the culture of entitlement and instead went down in flames.  

The struggle continued until the Morrison government finally had a balanced budget to boast of in 2018-19 — and then came the massive shock of Covid-19, which saw the fiscal rule book tossed out the window.  

Now, four years after the pandemic ceased to weigh heavily on the budget, there are still no rules worthy of the name. 

The Albanese government shows every sign of wanting to be free of the constraints that rules impose. 

It is true that fiscal policy doesn’t need rules if discipline is ingrained, but that is hardly the situation in 2025.  

Rules can help instil discipline by denying governments the ever-present temptation to over-spend and over-borrow.  

But the denial is self-denial. Rules are a form of self-discipline to counter the systemic over-spending biases.  

Unless governments have the will to impose this discipline on themselves, rules are just window-dressing. In fact, to have rules but not obey them is worse than not having rules at all, because it undermines credibility. 

As noted above, two key sets of rules are needed. The first would be applicable and appropriate to get the current budget situation back within acceptable limits. The objective would be to reduce the structural deficit to balance within three to four years. 

Although this seems like a significant challenge there are precedents that can be drawn on, both in the 80s under Hawke and Keating and the 90s under Howard and Costello. 

The best way to achieve this is to adopt a real spending freeze until the budget is balanced. This means capping the growth of nominal spending to the mid-point of the Reserve Bank’s target range for inflation, namely 2.5%.  

On the tax side, the commitment would be to keep tax receipts within current forward estimates unless economic conditions, such as commodity export prices, result in higher revenue, which should be used to speed up the budget balancing act. 

For the longer-term equilibrium, the rules are less restrictive but no less important. The primary goal is to maintain a balanced budget on average over the economic cycle, with surpluses in times of buoyancy. 

To achieve this spending growth should be capped at 2.5% plus trend growth in population and productivity, so that real per capita spending growth would be determined by productivity growth rather than exceeding it as in recent years. 

On the tax side, the cap for trend nominal growth of tax receipts is explicitly linked to the spending growth cap, while accepting that actual tax revenue will vary above and below trend depending on fluctuations in the drivers of revenue. 

Importantly, these rules reflect the fact that government spending is the most important variable to control.  

Experience and research suggest that when spending is not tightly controlled the budget slips into deficit — and that the alternative of tax increases does lasting economic damage. 

The fiscal rules should be enshrined in legislation by way of amendment of the Charter of Budget Honesty. And they should be monitored independently by the Parliamentary Budget Office, which should also report on performance against the rules. 

Australian politicians have been allowed to skate by on fiscal strategy for too long. The pandemic was obviously an important contributor to that, but far from the only one.  

A good budget has come to mean one with a lot of handouts, not one that sets up the country well for economic growth. 

Not to mention the importance of a solid fiscal foundation in a crisis, as Australia was lucky enough to find out in 2008.  

Compliance with the rules is the best contribution fiscal policy can make to economic stability, the investment essential for productivity growth, and higher real incomes for everyone. 

Robert Carling is a Senior Fellow at the Centre for Independent Studies and author of Keeping Budgets on the Rails: Rules for Fiscal Responsibility. Simon Cowan is Research Director at the Centre for Independent Studies.