Labor hasn’t inherited any hidden budget black hole surprises. It is spending monuments created in their last period in office that now need to be tamed.
Newly minted Federal Treasurer Jim Chalmers and Finance Minister Katy Gallagher have hit the ground running with a warp-speed conversion to fiscal discipline. One wonders what was in the post-election briefing books that led them to speak of tackling the “dire” budget position and “huge” spending pressures.
The truthful answer probably is: not much that they didn’t already know. What was known about the fiscal position the day after the election was known before it. The 2022-23 budget numbers — themselves very recent — were confirmed in the pre-election fiscal outlook (PEFO) signed off by the Treasury and Finance Department Secretaries a month before the election.
Chalmers and Gallagher had a purpose in fronting the cameras with grim faces feigning shock and horror at what they had been told about the fiscal position on day one. It was to pivot away from their election stance as rapidly as possible in order to begin lowering expectations of what the new government can spend; walking away from promises or at least deferring their delivery; softening us up for spending cuts ahead; and pinning as much blame as possible on the previous government.
During the election campaign it suited Labor not to challenge the credibility of the Morrison government’s smooth and very long glide path towards a balanced budget and diminishing debt burdens underpinned by economic growth.
If they had said then what they are saying now, they would have been under pressure to specify the measures they would take to improve the budget outlook. To the contrary, they told the voters there was headroom for more spending and larger deficits than the government was proposing, while the ‘savings’ offered up were minor and electorally harmless.
A budget ‘black hole’ — in the sense of the deficit this year or next year being larger than previously estimated — is unlikely. In fact, indications are that this year’s deficit will come in under the last estimate.
But the absence of a black hole in the short term doesn’t mean there aren’t serious medium and longer term risks in the fiscal outlook, which Chalmers and Gallagher are right to highlight. In doing so, it is also for them to explain the inconsistency between their pre-election and post-election pronouncements on these issues.
The “dire” budget position, stated simply, is that the starting-point deficit is much larger than it should be in the circumstances of a tight labour market and rising inflation, while the path to budget balance and a shrinking debt burden is littered with hazards.
Prominent among the risks are lower than assumed productivity growth, higher than assumed interest rates on public debt, and a range of program-specific risks of rapid spending growth.
Productivity growth of 1.5 per cent a year has been assumed in budgets for many years but is not being achieved. Lower assumed productivity growth would have little impact on the budget in the short-term, but the cumulative long-run effects would be substantial.
Last year’s Intergenerational Report (IGR) gave a broad indication that if productivity growth was instead assumed to be 1.2 per cent, after 40 years net debt would be 22.7 percentage points of GDP higher than the base case projection of 34.4 per cent.
On interest rates, the IGR assumed that bond yields would gradually approach nominal GDP growth of 5 per cent, but in a scenario in which this happens more rapidly, gross debt would be 14 percentage points of GDP higher after 40 years. Meanwhile, the PEFO stated that the increase in bond yields since the budget, if sustained, would add some $12 billion to debt by 2026.
But the largest threats to budget repair come from program-specific risks of higher spending in the already fast growing areas of defence, the NDIS, aged care, child care, and grants to the states for schools and public hospitals — which account for half the estimated total increase in federal spending over the ten years from 2013-14.
The new Labor ministers should know this, because some of them helped plant the seeds for the rapid growth in spending when in government from 2007 to 2013.
For all their talk of the “dire” budget position they have inherited, some of their election promises would add more fuel to this spending growth over the years ahead, making correction of the budget that much more difficult.
If the new government could come to appreciate the size and composition of the spending problem in these terms, paradoxically there may be a better chance of a Labor government making inroads through program adjustments to curb the quantity of spending growth and improve its quality because the public trusts Labor more with social programs.
Prime Minister Anthony Albanese says he wants to follow in the footsteps of the Hawke/Keating government. If so, he should start by aiming to repeat the success of Hawke, Keating and Finance Minister Peter Walsh in slicing 4 percentage points off federal spending as a proportion of GDP over three years in the late 1980s.
Robert Carling is a Senior Fellow at the Centre for Independent Studies and a former World Bank, IMF and Federal and State Treasury economist.