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Howard’s end: how the Coalition’s last budget created the ground for the current deficits

The good times are over. That’s the message both parties are sending out ahead of the budget and September’s election. Shadow treasurer Joe Hockey promises major cuts to spending and welfare if the coalition…

What sort of economic legacy did the long-serving Howard-Costello prime minister-treasurer double act really leave? AAP/Alan Porritt

The good times are over. That’s the message both parties are sending out ahead of the budget and September’s election.

Shadow treasurer Joe Hockey promises major cuts to spending and welfare if the coalition is elected while the government, having been forced to walk away from its budget surplus promise, is now cutting previously guaranteed benefits like increases in family benefit payments.

The focus on these sorts of welfare cuts begins the dismantling of policies that were central to John Howard and Peter Costello’s budgets, especially the pair’s final big-spending 2007 budget which bestowed generous tax concessions - in areas such as superannuation - and transferred income to families that came to be dubbed “middle class welfare”.

In my comment piece on last year’s federal budget for The Conversation I began with the proposition that “good policy should be free of surprises”.

Although governments need to pay for additional expenditure promises – like Gonski and the NDIS in this case – there is also the need to address the underlying structural problem of reducing existing expenditure when revenues fall.

All this is at a time when the carbon tax, the mining tax – and just about every tax – is not raising the expected revenue, and Treasury’s forecasting performance is not looking good.

The point is that fiscal policy should be made in the context of a long-term vision for the economy. This includes getting everyone who wants to into work, providing the public infrastructure needed to increase productivity, the right mix of private and government provision of health and education; and reform of the regulatory environment. We should see clear lines being drawn between the major parties with regard to their philosophy. However, in recent decades we haven’t seen much of this.

Under John Howard, the Liberal-National Party coalition government sought to position itself as good economic managers in contrast to Labor. It recorded budget surpluses after 1997-98 in every year except one (2001-02), with surpluses reaching around 1% of GDP during its fourth term. The record economic growth led to huge windfalls in receipts from company income tax.

Falls in unemployment, jobs growth and wages growth greatly increased personal income tax receipts. While government expenditure as a proportion of GDP was fairly stable, albeit rising slightly, this has to be seen in the context of a switch from public provision of services to private provision. Consequently, there was less provision of government services but increasing government expenditure.

In the 2004-05 federal budget, treasurer Peter Costello announced the baby bonus, a lump sum payment of A$3000 to parents receivable after the birth of each child. It has risen from A$3000 since commencement on July 1, 2004 to A$4000 in 2005 and to A$5000 on July 1, 2008, and is indexed to inflation. Wayne Swan subsequently reduced the baby bonus to A$5000 from September 1, 2012 and to A$3000 for second and subsequent children from mid-2013.

In the same budget there were other significant increases in benefits to families with children as well as tax cuts for all Australians. As more than one commentator pointed out, there was an incredible degree of giving with one hand and taking away with the other, with inevitable administrative cost and waste.

The biggest single item of government expenditure is on social welfare. The majority of the recipients are middle income households due to the generosity of family payments. In 2007, even families with A$100,000 in income were eligible for child support. In effect, what the Howard government built up is a system of massive transfers from middle income taxpayers back to middle income consumers. It might well have been more efficient to let these middle class households keep the money instead of paying extra tax.

In 2007, during the election campaign, further planned personal income tax cuts of A$34 billion over five years were promised by both the Howard government and matched by the ALP, with the ALP firmly in its policy-copying “me too” election mode. The result of policy-matching meant that the Howard Government effectively locked in the next government to their tax reforms, including raising tax thresholds and reducing the top tax rate of 45 cents per dollar (ultimately lowered to 40 cents per dollar).

Significant changes were also made to superannuation policy in 2007. The majority of workers could now withdraw their superannuation tax free after upon reaching the age of 60. Most self-employed can claim their superannuation contributions as a tax deduction. In addition, semi-retired people can continue to work part-time, and use part of their tax-free superannuation to top up their pay.

Despite the relatively generous tax treatment of capital gains, the new superannuation tax treatment led to the selling off of some assets, particularly rental housing, as people sought to take advantage of the opportunity to add funds to their superannuation accounts and claim them back later tax-free.

People were allowed to transfer up to A$1 million into their superannuation accounts before June 30, 2007, after which an annual maximum of A$150,000 of after-tax contributions could be made. The effect of this change in the rules was enormous. In the June quarter of 2007, A$22.4 billion was transferred to superannuation accounts by individuals. This compares with A$7.4 billion in the June quarter of 2006. June 2007 was the first time in Australia that member contributions exceeded employer contributions.

Treasurer Wayne Swan will deliver what is likely to be the Gillard government’s last budget in difficult economic circumstances. AAP/Dean Lewins

There was criticism of the tax and spend policies of the Howard government: much of it focused on the apparent generosity of the taxation cuts and income transfers to families. The policy was also seen to be in contrast to the generally accepted role of fiscal policy to dampen spending in times of economic boom. Giving tax cuts in 2007 and beyond coincided with a time when consumer spending was considered to be running too high.

The biggest criticism of the Howard government’s generous spending was its concentration on consumption rather on improving the supply-side of the economy.

Productivity growth had slowed considerably during the fourth term of the Howard government. Many areas of Australia’s infrastructure were showing signs of much-needed reform to enable the continuation of productivity growth and economic prosperity. Rail and road transport, ports, broadband speed, water and energy emerged as needing quite urgent reform. It has to be said, however, that the ability of the federal government to address infrastructure problems was hindered by the lack of a working relationship with state governments.

It is ironic that the big spending of the Howard government didn’t save it from losing the 2007 election to another supposed fiscal conservative, Kevin Rudd. Indeed, it could well have been that his fiscal profligacy played a part in Howard’s election loss as voters lost faith in his economic credentials.

The Gillard government is now living with the legacy of two previous prime ministers but her own government’s economic management has played the major part in her inevitable election loss. Next week’s budget will do little to repair her reputation with voters and, in their current mood, is likely to damage it further.