Should we still run a surplus in 2012-2013? The case for a balanced budget

Julia Gillard’s government needs to keep its promise to deliver a surplus. AAP

In late 2008 the federal government was under some considerable pressure to abandon any plans of delivering a budget surplus in that year.

I wrote an op-ed for the Australian Financial Review arguing that while budget deficits could occur after the fact, the government should never plan for a deficit.

Fast forward nearly three years and again the government is under some pressure to abandon plans to produce a budget surplus.

Stimulus policy’s poor record

Lord Keynes famously said that when the facts changed he changed his mind, what did others do? Well, the bottom line is that the facts have not changed – government spending has a poor track record of stimulating the economy.

So I’m still of the opinion that if the government were to adopt an active policy towards stimulating the economy, spending should not be that policy.

There are a lot things happening in the world economy. But I want to concentrate on the domestic scene. The economy faces the very real risk of stagflation – the combination of high inflation and stagnant economic growth.

Low levels of economic growth often manifests as rising unemployment.

Inflation is already above the Reserve Bank’s 2 – 3% target band while unemployment is above the 4.5 – 5% estimate for the non-accelerating inflation rate of unemployment.

In early September we’ll discover if Australia has experienced two consecutive quarters of negative growth. I suspect not, but I doubt growth has been very strong.

In short, those economists who believe that government spending can stimulate the economy have cause to advocate yet more debt and deficit.

Spending equals redistribution, not creation

But they overlook the costs of that intervention. Government cannot create wealth by spending, it can only redistribute wealth.

Even then it is a negative sum game because of the transactions costs of government intervention and deadweight losses of taxation.

What few people appreciate is that government can crowd out private behaviour even when the economy is not at full employment. Deficits and debt financing cause crowding out.

James M Buchanan, the 1986 economics Laureate, has argued that because public debt is simply postponed taxation, and because opportunity costs are subjective, the burden of public debt is borne by future generations.

This manifests itself in a smaller capital stock in future relative to a larger consumption in the present. Quite simply we are sponging off future generations.

Making future generations pay

Do future generations really want to pay, again, for us to spend yet more money on one-size-fit-all school halls and pink batts? Certainly they would have no interest in yet more tattoos, or plasma televisions.

Of course future generations would benefit, as would we, if we could get the economy working well again. It isn’t as if the determinants of good policy are somehow secret.

It is well known that productivity growth is the long-term driver of economic prosperity. There are some things that government can do to promote productivity growth. Cut taxes for a start.

Taxes on business are a huge burden on the economy – even the Henry Review recognised the high deadweight cost of corporate taxation, estimated to be 40c in the dollar. Payroll taxes were 41c in the dollar.

Cutting taxes, spending

Cutting taxes, of course, increases the deficit everything else being equal. So the next thing to do is to cut spending.

Many economists are surprised to discover this strategy has a good track record. It worked in the 1930s for Australia and the UK, again in the 1980s in the UK and the late 1990s in Australia.

At the time economists were outraged and signed petitions against spending cuts. Over 100 Australian economists signed a petition against the 1996 Howard-Costello budget cuts.

That episode was so embarrassing that it is now impossible to find a list of signatories.

Red tape

The simple fact of the matter is that there is a lot of waste in government.

The real problem of government isn’t just that it is often wasteful, but that it involves a people do stuff – fill out reports, submit to inspections, comply with regulation, and the like.

Grattan Institute’s Saul Eslake has made a convincing argument that a lot national security and corporate governance activity simply results in productivity-stifling regulation.

So reducing the scale and scope of government has massive flow-on effects.

In addition, however, government should actively seek out opportunities to reduce the regulatory burden on business in particular and society in general.

More tax, regulation

Of course, the government plans to do none of those things. Right now it is proposing more taxation and more government regulation.

The carbon tax will have undesirable consequences. Poverty traps increase at low levels of income and again at the $68,000 - $80,000 income range.

Single earning more than $50,000 are worse off.

The proposed mining tax disadvantages smaller Australian based miners relative to larger multinational corporations.

In addition to purely economic issues, there are political economy issues. This government is well into its second term of office and has never yet produced a budget surplus. For all the excuses, the Budget Papers reveal that spending decisions have been the cause of consistent and persistent deficits.

Fiscal responsibility?

To his credit Mr Swan talks a good talk about the need for fiscal responsibility but is yet to actually deliver on that front. He has long promised that the budget would return to surplus.

Last year he told the Seven Network’s Sunrise co-host David Koch that come hell or high water, next year’s budget would be in surplus.

This is a self-imposed constraint. Governments have extraordinary fiscal powers and few constraints on spending the public purse.

This is why the ability to demonstrate self-control is important – it is the lack of self-control that is troubling both Europe and the US. In the absence of self-constraint there is little to stop government from pursuing a policy of tax and spend.

Being held to account

One way to convince the public that they can be trusted with the public purse is to commit to self-control and then to deliver.

Being held to account for broken fiscal promises is an important governance mechanism.

The argument for balanced budgets relies on the fact that outside of its core competencies government isn’t very good at adding value.

By contrast core competencies in the private sector are diverse and those who fail to add value are quickly replaced by those who can.