The federal budget is hard to ‘fix’, but here are some solutions

There are some structural issues that need tackling in order reform our budget, but they are surmountable. AAP/Lukas Coch

Why, after decades of relatively good budgetary management in Australia, is the Commonwealth budget so hard to fix? And why don’t many people seem to care?

We have had 24 years of economic growth, yet are now facing our eighth actual deficit in a row, with Budget Papers forecasting another three ahead, and more may come after that.

The combined recent deficits as this budget year rolls out (2015-16) now total a staggering $320 billion (with almost $40 billion still expected in the forward estimates). Moreover, most economic predictions are for much lower economic growth rates well into the future than occurred with the two mining booms of the 2000s to 2012.

Have governments given up on a balanced budget?

While former Labor Treasurer Wayne Swan was ever the muscular “spruiker” of budget surpluses, his promise in May 2010 to do so by 2013 - revised to a small budget surplus of $4 billion by June 2013 in May 2011 - never eventuated.

Following him, Joe Hockey merely spoke of his efforts at reducing the combined deficit from the one left to him by Labor, but sheepishly admitted the Commonwealth would have a projected annual deficit of $7 billion by 2019 under Coalition management. In his 2015 budget speech Hockey claimed the government inherited a running deficit totalling $123 billion by mid-2013 (when it was in fact more like $210 billion) and that he’d would have brought this figure down to $80 billion by 2019.

Both sides of politics have apparently now given up on balancing the budget in the medium term. Labor’s Shadow Treasurer Chris Bowen is now talking of a 10 year fiscal plan to repair the budget and so is not expecting a balance until around 2026! Not only is that date is four parliamentary terms away, it assumes that abstemious governments will actually spend less than they receive in income over all that time – recent track records on both sides suggests this is pure folly.

The Coalition’s new Treasurer Scott Morrison is not setting himself tricky target dates, preferring to accede with the previous Hockey mantra that the Coalition will arrive at a surplus before a Labor government would – a counter-factual we might reflect upon but cannot prove.

The persistent deficit problem is not just down to lower tax returns (the so-called “revenue problem”) because taxes are indeed growing moderately, but perhaps not by as much as Treasury would wish. The problem is largely down to levels of higher spending than we are prepared to pay for (the so-called “expansionary bias”). We seem to be running a structural deficit of around $30 billion per annum, with politicians continuing to spending now and leaving their successors to pay.

The problem of Consolidated Revenue and “magic pudding” thinking

The parlous state of the budget is due to systemic dysfunctionality. We have kept an anachronistic system inherited from the Royal Budget (the King’s Chest) – keeping all resources in one consolidated revenue account while separating expenditures from revenues.

For years, this was seen as a good way of keeping accounts clean and providing flexibility in expenditure terms. But now it is supremely dysfunctional to have one “magic pudding” fund against which all manner of claimants make audacious bids. The way we have allowed federalism to develop further compounds this sloppiness – because federal governments want to spend their huge tax take to gain most exposure, while the mendicant states and territories continue to cry poor and have few other tactics than going “cap in hand” to the Commonwealth for “more funds”.

Our central budget institutions no longer hold the line as guardians of the public purse; they are out-manoeuvred. The year-round budgetary bidding system constantly ratchets up spending levels as agencies ask for more like Oliver Twist. Many of our public policies are irresponsibly demand-driven with few caps, so people enjoy goods or services and the Commonwealth pays the eventual bill.

Some 85% of the federal budget is non-discretionary (entitlements, transfers, ongoing grants) which can’t be trimmed without a major fight in parliament. And we have enshrined a culture of compensation all-round (the “no discrimination” mantra) – and this applies to any changes in either entitlements or taxation levels.

Small fixes that could have big results

This is paralysing our ability to conduct real reform. If nearly 70% of households are likely to be compensated by a rise in the GST from 10% to 15%, then what is the point in raising the consumption tax at all? And if it doesn’t raise much more growth revenues there will be pressure in a few more years to raise it again.

There are some small incremental fixes that are available to redress our budget problems – such as hunting for savings across the portfolios, or reducing the number of bids, or getting agencies to raise some of their own revenues. More serious temporary fixes might include a complete ban on bids for two years making agencies themselves reallocate their resources to areas of most priority (as we did in 1986-87).

We could go further, like Sweden or Korea, and legislate fixed expenditure ceilings up to four years out which are very difficult to change without subsequent parliamentary approval. Such hard ceilings would force federal and state agencies to manage within budgets over the medium term, because there would be little chance of augmentation. So states running hospitals would have to manage within their imposed allocation and not manufacture waiting lists to claim more money from the Canberra pudding.

Canada uses a different prudential system to limit federal spending within the current budget year by initially only allocating some 70% of the budget outlays in the Main Estimates, and then trickling out additional supplementary allocations as and when its revenues are known and received. It prevents agencies’ overspending against revenue that has not yet eventuated (or will never materialise), and allows governments to direct greater spending ‘in-year’ to any pressing priorities.

More ambitious solutions

We might want to extend levies and charges more broadly, imposing costs on direct users rather than generic taxpayers – for roads, health care, GP visits, aged care, vocational education, pharmaceutical drugs, even public transport. Reverse mortgages for elderly home-owners to help pay for government aged pensions is also a proposal being floated around. Another important idea to help manage the provision of public goods or services is to hypothecate funds for dedicated purposes, as most of continental Europe does.

A specific contributory levy, say, for pharmaceuticals would be set and paid into a hypothecated account which could only be used to pay for subsidised prescriptions, and managed actuarially. If people wanted extensive low-cost prescriptions, then the levy would be set to cover that level of spending; if people wanted less subsidised medicine then a lower contribution could be imposed. Hypothecated provision would compartmentalise these items from consolidated revenue, make them self-funding and annually balanced, making the job of funding and managing core government activities so much easier.

More radical measures include a constitutional provision for balanced budgets (no planned deficits allowed to be introduced into the legislature) or a statutory provision for balanced budgets over a three year period (toughening the euphemistic accountancy jargon used in the Charter of Budget Honesty designed to give governments all the wiggle room they need). Some aspects of Singapore’s budget processes are also worth considering.

Each year accurate projections about economic growth are made which determines a fixed formula of revenue income (roughly 17% of GDP); the expected actual revenue figure is directly transposed into a precise aggregate expenditure limit; no more, no less, it has to balance the revenue.

The expenditure budget is then allocated on a stipulated formula basis whereby each major policy sector of public spending receives a prescribed fixed share; there is no bidding or lobbying for more funds, but agencies have relative autonomy to recalibrate their priorities within their spending envelope.

They can shape their spending strategically. But the only avenue through which any budget growth can occur is if the economy as a whole grows; so agencies have enormous incentive to direct their thinking (and the majority of their funding) towards driving economic growth, from within their own budgets or in conjunction with other stakeholders.

Systemic change is needed

Singapore offers a markedly different way of deploying and investing public spending in a developed society; and it is worth remembering that Singapore’s achievements have occurred over the past 40 years of so. Before this it was once one of the destitute basket cases of South-east Asia with very low living standards, but now has a higher standard of living than most of the West and a per-capital income getting close to twice the Australian average.

Proposals to bring about systemic change to the traditional patterns of budgeting will be resisted by the conservative establishment and those that like the present dysfunctional system, or perhaps do well out of it themselves. But the public interest is not served by retaining perverse budgetary practices, or the perverse incentives that riddle the system. It is not served by sticking our heads in the sand in an ostrich-like mindset believing the problems will just go away.

The budget will not correct itself on automatic pilot; and the longer it doesn’t, the more we will pay in interest payments on mounting debt, the more our children will pay in years to come and the less we will have for today’s areas of genuine need.

John will be on hand for an Author Q&A between noon and 1pm AEDT on Wednesday, November 11, 2015. Post your questions in the comments section below.