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Federal Budget 2013: Why our unsustainable structural deficit must be tackled

All Australian governments, and ultimately all Australians, are faced with making tough decisions in their budgets. Without significant reductions in government expenditures and the services they provide…

Governments have been increasing expenditure, despite shrinking tax revenues. But our structural deficit is unsustainable and must be tackled. Image sourced from www.shutterstock.com

All Australian governments, and ultimately all Australians, are faced with making tough decisions in their budgets. Without significant reductions in government expenditures and the services they provide or an increase in taxation to fund government expenditures, current policies will lead to larger and larger structural budget deficits.

For example, the Grattan Institute projects a combined structural deficit for the Commonwealth and the states (and territories) of at least 4% of national income, or $60 billion a year, by the early 2020s.

Another report from modelling firm Macroeconomics, commissioned by the Minerals Council of Australia, also predicts decades of structural deficits unless governments rein in their outlays.

An increasing structural deficit is inconsistent with the bi-partisan policy of budget balance over the economic cycle; it is unsustainable; and it threatens the ability of governments to assist the economy to recover from inevitable future international and domestic shocks.

Recurrent expenditure by the commonwealth and state governments in 2012-13 is about $500 billion, or 33% of GDP.

Intergenerational reports prepared by the Commonwealth and by some of the states project government expenditure share will increase over the next few decades under current policy programs.

With higher incomes and new technology, Australians are demanding more and more health expenditure, with most funded by governments; ageing of the population is considered to be a relatively small contributor to higher health costs.

The Grattan Institute projects an increase in government expenditure on health by the early 2020s of about the equivalent of 2% of GDP; and this is similar to the increase over the past decade.

Full implementation of the NDIS would be a major additional expenditure.

Ageing of the population is projected to increase welfare payments and aged care, even after allowing for the build-up of pre-paid superannuation. Proposed increases in parenting payments, Newstart, and so forth would add further to welfare outlays.

Government expenditure on education is expected to increase as a share of GDP, and more so if initiatives such as the Gonski proposals are implemented. State governments face a large backlog of expenditure on infrastructure for growing populations. Most other government expenditures, including on defence, law and order, are projected to draw about current shares of GDP in the future.

Most, if not all, current and proposed government expenditures are valued by citizens. However, their provision involves an opportunity cost of labour and other resources reallocated from private sector expenditures on food, housing, recreation, and so forth. Taxation is the process for this reallocation of income from private to public expenditure.

Taxation revenue as a share of national income has fallen from about 34.5% in 2007-08 to a low of just above 30% in 2010-11 and about 32% in 2012-13 for a number of reasons. Changes to the personal income tax rate schedule by each of the Howard, Rudd and Gillard governments, reduced personal income tax. Lower capital gains tax post the GFC also is likely to continue.

Company income tax has declined with slower growth of corporate incomes, and with increased depreciation allowances associated with the mining investment boom. Indirect tax revenues as a share of GDP have fallen in the case of the GST, due to an increase in the household saving ratio and also to tax base exemptions for income elastic products; from non-indexation of the petroleum excise rates; and the end of the property boom has reduced conveyance duty.

Revenue from the minerals resources rent tax has been much smaller than projected, and it seems likely that revenue from the carbon tax (or more accurately the sale of emission permits) will fall from 2015-16.

In the real world of economic cycles the ever widening gap between an increasing government expenditure share and at best a constant taxation share of national income prepared under average economic circumstances shown in the intergenerational reports and the Grattan Institute is likely to underestimate the budget deficit.

An economic downturn, either with international and domestic causes (or both), almost certainly will occur in the future as in the past. Downturns result in larger fiscal deficits and new expenditures which prove difficult to unwind.

Over the longer run, fiscal deficits, and more importantly increasing fiscal deficits, are unsustainable. They incur higher debt interest payments; higher interest rates for private sector investors; reduced flexibility and effectiveness in responding to economic recessions and crises; and their eventual repayment becomes higher taxes and imposts on future generations.

Governments at all levels and of all colours must involve themselves and the public in a serious policy discussion of how to turn around the trend to rising and unsustainable budget deficits. Improving government productivity, for example by reducing wasteful overlapping of commonwealth and state programs for education and health, can assist, but it would not be enough to bridge the gap.

Ultimately, a revaluation of different expenditure programs and their options and/or higher taxation will be required. The mix of tax increases and expenditure reductions require society to make judgements about the relative roles of government and the private sector, and about the relative merits of more or less limited income and resources allocated to government goods and services versus private sector provided goods and services.

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47 Comments sorted by

  1. Bruce Wallace

    Registered Nurse

    Under John Howard, I think there were 7 income tax cuts in a row, and I think 1 under Rudd. So that is 8 cuts in income tax.
    Surely we could peg a bit back.
    Surely we could get rid of all of the middle class welfare. Welfare was not meant for this.
    Surely we could increase the medicare levy slightly.
    There are many measures that we could take that could help balance the budget.

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    1. George Naumovski

      Online Political Activist

      In reply to Bruce Wallace

      They were tax cuts for high income earners such as millionaires/billionaires and the business elites. These cuts also included massive subsidies so many of them do not pay tax and actually get money back!

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    2. Bruce Tabor

      Research Scientist at CSIRO

      In reply to Bruce Wallace

      Agree Bruce. Ross Gittins does a superb job of demolishing the treatment of the Gratten Report by the main stream media (MSM) and most economists:
      http://www.rossgittins.com/2013/04/beware-one-eyed-budget-brigade.html
      The report said both spending cuts AND TAX INCREASES are required. But the MSM and most economists ignore the need for tax increases.

      The ridiculous generosity of the massive tax cuts to the rich under Howard and to some extent Rudd (including the stupid superannuation tax reductions, profusion of mid-to-upper class welfare, income tax reductions, and capital tax reductions) have created -surprise - a long term structural deficit.

      It would be incredibly unjust if the poor, the sick, the disabled and the dying were to pay for this largesse, as they do in the US.

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    1. Greg North

      Retired Engineer

      In reply to Denise Wenderoth

      Gee Denise, don't know where Paul started out on his one percent solution in that article but with all the Austerian bashing to start with and claiming that has not worked being kind of cart before the horse I could not bother seeing what he reckons about one percent.

      In reality it is very much Keynesian free wheeling spending that has got developed and other nations into so much bother. Even the GFC is said by some to have its roots in making housing affordable to those who could not afford it…

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    2. Liam Hanlon

      Student

      In reply to Greg North

      And the GFC had absolutely nothing to do with the huge financial sector deregulation that occurred under Thatcher and Reagan following Friedman economics? Yeah it was allowing a few extra homeowners that caused the GFC...

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    3. Ted Stead

      Consultant

      In reply to Greg North

      "...doing exactly what Keynes ( if that is what his name was ) would have thought great" - not sure if there are any Keynes scholars here, but I think you're completely misrepresenting his work.

      Additionally, the only 'means' a sovereign currency issuing nation like ours has to worry about are 'real' resources. not financial ones.

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    4. Jerry Cornelius

      logged in via email @hotmail.com

      In reply to Greg North

      Nonsense, from top to bottom.

      The GFC was caused by the piling up of private debt. So first of all, get your debts straight: Keynes advocated demand managment by GOVERNMENT spending. The GFC was caused by collapse of PRIVATE debters and the banks holding that debt.

      Secondly, the past 30 years has seen a general retreat from anything vaguely Keynesian in the developed world. We have all backed away from demand management toward deregulation and price managent. The modern economy - with it's…

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    5. Robert McDougall

      Small Business Owner

      In reply to Liam Hanlon

      i would agree that the lack of regulation and the dismantling of things like Glass-Steagle was the major factor in allowing the GFC to develop, that and collusion between the companies packaging CDO's and the ratings industry.

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  2. Philip Laird

    Academic at University of Wollongong

    As Paul Burke observed in his piece on 1 March, in 2001, the Howard Government froze fuel excise at about 38 cents per litre. Had the automatic
    twice yearly indexation continued, at CPI, fuel excise would now be in the order of 50 cents per litre. Coupled with the introduction of fuel rebates
    for the use of diesel by heavy trucks, the cost to the budget is now about
    $4 billion per annum.
    Australia's motoring clubs have launched a pre-election campaign to further increase road funding - which…

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  3. Ronald Ostrowski

    logged in via Facebook

    Bruce, in 2007 the incoming Rudd Government inherited a structural deficit from the Howard Government, which ignored infrastructure spending during the height of the mining boom, but opted instead for massive middeclass welfare spending for electoral gain. I am of the neo-Liberalist persuasion and find the LNP's position on middelcalss welfare an ideological aberration, particularly when it was initiated by a political movement which in the past championed individualism and encourages self-reliance. Amazingly, they consider themselves as being on the 'right'.

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  4. Neil Gibson

    Retired Electronics Design Engineer

    The facts are that even with the 12 billion dollar "loss" of revenue Government receipts this year are up 7% on last year. Even with inflation that is a healthy increase ! Claiming reduced revenue as a reason for a huge deficit is ridiculous. You would not put Swan in charge of a chook raffle.

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    1. Peter Evans

      Retired

      In reply to Neil Gibson

      Yes they are up but revenue per capita has barely kept pace with in inflation for the life of the Labor government and has increased at about a third the pace it did in the last 5 years of the Coalition government. This suggests that a large proportion of the increase in total revenues this financial year is down to population growth and inflation and that they have not kept pace with the growth in the economy. Final result is less to spend than you would expect with the steady economic growth we have experienced.

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    2. Ngoc Luan Ho Trieu

      logged in via Facebook

      In reply to Peter Evans

      Yes, we should discuss the budget expenses and revenues in real and per capita terms to iron out inflation and population growth. Thanks for bringing these point up to TC.

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  5. Andrew James

    Doctor

    I guess one reason why no-one wants to increase taxes is that the Howard tax cuts were pretty immediately captured in private debt; so they are busy propping up house prices and bank shares. Clawing that back in taxes is going to be very unpopular. Of course you don't need taxation if you spend nothing but the blithe assertion that goverment needs to reign in spending is always proffered as if they are just hosting lavish parties and need less canapes. Its called the education, health, welfrare…

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  6. Lincoln Fung

    Economist

    I largely agree with the remark that "The mix of tax increases and expenditure reductions require society to make judgements about the relative roles of government and the private sector, and about the relative merits of more or less limited income and resources allocated to government goods and services versus private sector provided goods and services."
    Personally, I think there should be a ceiling of taxation revenue to GDP ratio to constrain any government irrespective to their political persuasions…

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    1. Tony Grant

      Student

      In reply to Lincoln Fung

      IPA? That's how it reads to me and the underlying belief of an incoming Abbott government?

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    2. Lincoln Fung

      Economist

      In reply to Stuart Smith

      Thanks Stuart.
      To answer Tony, no I am no IPA. I am an independent economist.
      What I see is there seems a need to have a hard budget constraint, so politicians don't have easy and lazy ways to through money at everything when a problem arises by raising taxes.
      Once there is a hard budget constraint, politicians will have to compete for better policies within that given budget framework to address problems efficiently and effectively and find the best solutions for them.
      As the author stated the levels of taxation should be determined by the taxpayers together with politicians.
      Should politicians think the previously agreed level needs to be changed, they seek another mandate thorough dialogue with the taxpayers. Nevertheless, there should not be too frequent changes to the overall levels of government revenue and taxation.

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    3. Bruce Tabor

      Research Scientist at CSIRO

      In reply to Lincoln Fung

      Firstly, you're in luck Lincoln. Australia has one of the lowest proportions of government revenue to GDP in the OECD. We are already below your magical 30% figure.
      "In 2010, Australia’s tax-to-GDP ratio was 25.6 per cent — below the OECD average of 33.8 per cent."
      http://www.treasury.gov.au/Policy-Topics/Taxation/Pocket-Guide-to-the-Australian-Tax-System/Pocket-Guide-to-the-Australian-Tax-System/Part-1
      Apart from new members of the OECD (Mexico, Chile, S.Korea, etc) with poorly developed social-security systems, the nations that beat us (USA) or are near us (Japan, Ireland), have massive shortfalls in revenue compared to expenditure.

      Secondly, I would question your assumptions. Scandinavian countries, despite high tax rates, have been able to strong sustain long-term economic performance. I agree though, efficiency is important, but an effective social health, education and welfare safety net should not be lost in the drive for efficiency.

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    4. David Arthur

      resistance gnome

      In reply to Bruce Tabor

      You know why Scandinavian nations maintain strong economies with high tax rates? Because they don't just export raw materials, they design, manufacture and export high value-added goods.

      Australia, on the other hand, exports ~$35 billion worth of iron ore, and the ~$25 billion worth of metallurgical coal, which the receiving nations use to make ~$180 billion of iron and steel. Having done that, they get serious about value-adding the iron and steel ...

      Crikey, just turning that iron ore to steel in Australia would be a hell of a boost to Australian jobs (less welfare requirement) and Australian export income (larger tax base).

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  7. Ted Stead

    Consultant

    Goodness. The government tries to introduce a mining tax to fix some of these issues, which gets overturned by the help of the Minerals Council, who then create a report about how the issues will not be fixed! And then a professor just references it as if it's OK!

    "...bi-partisan policy of budget balance over the economic cycle..." - we run a permanent current account deficit (which will only increase as mining investment collapses), and save a proportion of our income. The sectoral balances…

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  8. Tim Kottek

    logged in via Facebook

    Now I wonder what difference it would make to "significant reductions in government expenditures and the services they provide or an increase in taxation to fund government expenditures" by changing it to "significant reductions in government expenditures and the services they provide or an increase in CONTRIBUTION to fund THE COMMONWEALTH"
    I know it's fashionable if somewhat unAustralian to BLUDGE

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  9. George Naumovski

    Online Political Activist

    A fair and realistic tax system needs to be implemented. Taxes such as the original mining tax “RSPT” and other taxes as such should have been done.

    Millionaires/Billionaires and the business elites get massive tax cuts, subsidies, write offs and many other loopholes so they actually don’t pay tax.

    A low income earner “the majority of working Australians” pay a higher rate of tax for their wage compared to higher income earners due to higher income earners actually get more money “so when higher income earners cry that they pay more tax they still take home double/triple amount of money compared to a low income earner” and it’s the perks/loopholes/subsidies/middle class welfare they receive and it’s the majority who pay for it while they get very little to nothing.

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  10. Greg North

    Retired Engineer

    " An increasing structural deficit is inconsistent with the bi-partisan policy of budget balance over the economic cycle; it is unsustainable; and it threatens the ability of governments to assist the economy to recover from inevitable future international and domestic shocks. "
    Inconsistent it may be but Gillard announcing it is full steam ahead is no surprise seeing as she is finished come September and her love for Tony Abbott knows no bounds for the difficulties she will pass on.

    " Governments…

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  11. Stuart Smith

    logged in via Facebook

    You can be sure that whatever fiscal changes a government makes [regardless of ideology] clever accountants will work out a way around them so that the effectiveness of the changes are undermined. Trying to come up with a system that eliminates fiscal loss and maximises overall gain seems to me akin to trying to catch the wind in your hands.

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  12. Joseph Bernard

    Director

    Surely we can achieve more by using smarter by design.

    Over the years i have witnessed that a good design will always reduced the effort and hence profit by an order of magnitude. That is benefits are a an order of 10-100 times.

    education for example can be so easily improved by a system promoted in this Ted talk

    Sugata Mitra: Build a School in the Cloud

    http://www.youtube.com/watch?v=y3jYVe1RGaU

    One simple workshop, once a week can dramatically increase our children's interest and learning and especially their ability to collaborate. But for some reason simple logic is too hard for our complex world.

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  13. Ngoc Luan Ho Trieu

    logged in via Facebook

    I think future fiscal strategy needs more focus on GST. A leitmotive of GST, among others, is to get back for the Australian economy and its people part of the benefits enjoyed by consumers (residents and non-residents) resulted from Australians' hard work of building, maintaining, conserving...one of the largest natural resource supply system and one of the best socio-economico-enviro infrastructure in the world. The GST system should have a broader base. Exports of minerals belonging to the Australian…

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  14. Jerry Cornelius

    logged in via email @hotmail.com

    The premise of this article is false. The federal government is NOT revenue constrained.

    What the author proposes is large scale cuts to aggregate demand. He proposes this at a time when the non-resources sectors of the Australian economy are faltering. Further cuts in aggregate demand will cause our slowing economy to tank completely, and we'll have the recession we avoided in 2008-9.

    It's worth looking at the growth figures for that period. The fiscal stimulus of the Federal Govt prevented…

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    1. Toby Paltridge

      logged in via Facebook

      In reply to Jerry Cornelius

      I was just about to post a similar comment, Jerry! Thanks for explaining the false premises upon which this article is based better than I could.

      This mistaken belief that sovereign national governments that control their own currency are equivalent to households in terms of needing to finance their expenditures needs to end. It completely warps political debate and enforces an incredible degree of unnecessary suffering on the population.

      For those who want an explanation of why the Australian Federal Government does not have to finance its expenditure, you should read this: http://bilbo.economicoutlook.net/blog/?p=2562

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  15. Jerry Cornelius

    logged in via email @hotmail.com

    Question for the author. You said:

    'An increasing structural deficit is...unsustainable...'

    Can you please explain the precise circumstances under which the Federal Government of Australia would be unable to 'sustain' its expenditure? In particular, I'd be interested to hear when exactly the Commonwealth Govt would be unable to redeem a debt denominated in A$.

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  16. David Arthur

    resistance gnome

    Here's a few ideas.

    1) Shrink the States back to the size of the founding colonies, plus their water catchments. The rest of Australia becomes governed by two tiers only, with Federal and Regional (in Eastern Australia, river catchment-based?).

    2) Hospitals become Commonwealth responsibility only, ie get the States out of it altogether.

    3) Post-secondary education (tertiary and TAFE) funded by payroll taxes based on employee qualifications. NB must include overseas qualifications, so that…

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  17. ian cheong

    logged in via email @acm.org

    So we get Henry to review the tax system. He makes sensible recommendations. We ignore doing anything much of what he mentions. Now that everyone has forgotten, we want to fudge around the edges of the broken bits to be politically expedient. Henry recommended getting rid of the Medicare Levy and structural tax offsets. Now we are looking at increasing this non-progressive tax to get more revenue for Medicare and the NDIS.

    All of this from a government supposedly in caretaker mode.

    I still…

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    1. Toby Paltridge

      logged in via Facebook

      In reply to ian cheong

      Governments don't have the same spending constraints as households and business, though. The latter need to acquire money before they can spend it, the former doesn't as they are the ones who issue the currency.

      Regardless, the government needs to spend more money when the economy is in decline in order to increase demand and thereby stimulate the economy.

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    2. ian cheong

      logged in via email @acm.org

      In reply to Toby Paltridge

      Spending as a strategy is good if you a Keynsian. But printing money still increases inflation. Who said Keynes is still right in the global economy?

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    3. William Raper

      Retired

      In reply to ian cheong

      Ian, you ask
      "If tax revenue of down because the economy is down, why does the government need to spend more money."

      In simple financial terms, there is a cost to government for unemployment benefits and loss of income tax, to say nothing of personal family and a multitude of other indirect issues. Thus a political choice is required.

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    4. Ted Stead

      Consultant

      In reply to ian cheong

      Ian, define "printing money". Actual physical currency is a tiny proportion of all money in existence.

      All money creation would have the possibility of causing inflation, but would only be caused when we reach the limit of real resources (i.e. full employment and/or physical resources). Government-created money is a tiny amount compared to the money created endogenously by the banks, and yet that private money creation doesn't get people complaining about the massive asset price inflation…

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    5. Jerry Cornelius

      logged in via email @hotmail.com

      In reply to ian cheong

      Ian, you said:

      'But printing money still increases inflation.'

      This is false. If it were true, explain Japan.

      Inflation arises if aggregate demand continues to rise after the economy reaches its capacity to produce real goods and services. We are not in sight of that position with an official unemployment rate around 5% and general labour under utilization running at 12%.

      You are labouring under the illusion that the Federal budget is constrained the same way a household budget is. It's not. That's not opinion, it's fact. It's been that way since the US abandoned the gold standard.

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    6. Jerry Cornelius

      logged in via email @hotmail.com

      In reply to ian cheong

      The government is not in caretaker mode.

      They are not in care taker mode until the PM recommends to the GG that she dissolve parliament. Until then the Government is the Government and Her Majesty's loyal Opposition are the Opposition.

      Get it straight and don't repeat the uneducated drivel propagated by our MSM.

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    7. Jerry Cornelius

      logged in via email @hotmail.com

      In reply to ian cheong

      On a more sensible note, you said the following:

      'If tax revenue of down because the economy is down, why does the government need to spend more money. If any household or declining business or receiver wanted to spend more money to get out of debt, they would be considered grossly irresponsible.'

      Firstly, government outlays increase automatically during a downturn. As the private sector comes off the boil and people are laid off, the government automatically ends up paying more in unemployment…

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  18. John Armour

    logged in via email @bigpond.com

    Ahh, the "Structural Deficit"...who knows what that means ?

    The article certainly didn't try to explain, except to leave us with the distinct impression that it's a "Bad Thing".

    Economists and the MSM have taught us that ordinary deficits are pretty scary but lest we get too complacent (with only x weeks to the election) we're learning there's something even worse.

    The better-informed citizenry would probably guess that the structural deficit is the one with the cyclical components (like…

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  19. John Armour

    logged in via email @bigpond.com

    Professor Freebairn:

    "Governments at all levels and of all colours must involve themselves and the public in a serious policy discussion of how to turn around the trend to rising and unsustainable budget deficits."

    To paraphrase Oscar Wilde, one would have to be a rather obtuse individual to read Professor Freebairn's appeal, and not fall about laughing.

    It seems there are now at least 4 commenters here who would be struggling to say upright.

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