The Treasurer falls short of what Australia needs to sustain growth in the long-term. Moreover, in spite of a somewhat popular view that this was a “labour budget”, the artificial distinction between good and bad debt and several of the provisions around social welfare provide fertile grounds for Australia’s hidden disease, inequality, to blossom.
Overview
The macroeconomic environment faced by the government remains challenging, albeit moderately improving. At a global level, economic growth and trade are picking up. The outlook is however weakened by significant risks, including the emergence of new protectionist sentiments, uncertainties about the policy agenda of some major economies (e.g. the US), persistent fiscal imbalances in a number of advanced economies, and increasing financial and balance-sheet vulnerabilities in emerging countries.
Home front
Domestically, economic growth in the last 12 months has gone down to 1.75% from 2.6% in 2015-16. At the same time, the unemployment rate has remained stable around 5.7% while employment growth has decelerated from 1.9% in 2015-16 to 1% in 2016-17. Nevertheless, the budget incorporates a more positive short and medium term outlook, with growth projected at 3% by 2018-19 and unemployment down to 5.2% in for years. This outlook is indeed also supported by recent data from the International monetary Fund. There is however an interesting aspect: the budget assumes a rapid increase in wage growth, which is expected to raise from its current 2% to an impressive 3.75% in four years. How such wage growth should be achieved is not entirely clear at this stage. The main mechanism would seem to be a trickle down effect: less taxes on business, therefore more jobs and hopefully higher wages. Unfortunately, the economic argument here is not really solid, as lower taxes on business profits do not necessarily result in higher wages.
A Labor budget?
In terms of “fiscal repair”, the Treasurer has indicated that the underlying cash balance will return in surplus in 2020-21. Interestingly, the main driver of this repair is an increase in revenue (from an estimated 24.4% of GDP in 2017-18 to a projected 26% in 2020-21). Expenditure will decrease but by a mere 0.3 percentage points of GDP. This heavy reliance on taxes, combined with the announcement of a levy on banks, has led some commentators to call this budget a “Labor budget”. While I can certainly see some interesting changes in policy direction, I do not fully subscribe to this view, partly because of what this budget does and partly because of it does not do.
What this budget does
In macroeconomic terms the budget 2017-18 budget does two key things.
The first one is to strengthen support to business by reducing corporate taxation. This is achieved primarily by reintroducing the remaining elements of the Ten Year Enterprise Tax Plan. The government argues lower corporate taxes stimulates domestic investment and benefits trickle down to workers with more jobs and higher wages. Unfortunately, this argument is flawed. In Australia, where profits are mostly paid out as divided and domestic investors have access to franking credits, a corporate tax rate is likely to have only a marginal effect on domestic investment and Gross National Income (GNI). For another, given the large share of capital held by foreign investors, the corporate tax cut will initially result in a loss of national income. This also means that, unless we put our faith in the Laffer-curve, other taxes will have to be increased in response to the reduction in corporate taxes, which will then weaken any possible trickle-down effect.
Secondly, with this budget the government commits to delivering $75 billion over ten years to finance infrastructure development. Again, this is hardly a surprise: this government has always maintained that physical infrastructure is a key driver of growth and economic diversification. Or, perhaps more correctly, investment in physical infrastructure is regarded as the best, if not only, way in which government spending can be of support to the long-term transformation of the economy. Practice and empirical evidence however suggest that the link between public investment in infrastructure and growth is not so automatic.
Good and bad debt
What is new is the way in which the government enables this greater infrastructure spending. From now on, the budget will report the net operating balance in addition to the underlying cash balance. The difference is important because the net operating balance distinguishes between capital and current spending, while the cash balance does not. In so doing, the government is (not so implicitly) stating that there are two types of spending, and hence two types of debt: good and bad. The good debt is the one incurred to finance infrastructure and capital assets that boost the economy. The bad debt is the one incurred to finance everyday spending. While the government asserts that this will enhance transparency in budget spending, I cannot but think that most of the welfare system and supply of public goods like education and health are delivered through current spending. Calling (and treating) this spending as bad debt appears very narrow-minded.
What this budget does not do
In a sense, this budget is not ambitious enough in supporting private businesses. Something more and different from a generalised corporate tax cut is needed to fosterinnovation and diversification. Private businesses, particular those of small and medium size, need to be encouraged to undertake new activities, to enter new industries. Financial support should therefore be refocused on those businesses that effectively do something new. At the same time, to avoid subsidizing firms or sectors that would not be economically viable in the long term, support to innovative businesses should be made conditional on clearly specified, transparent performance benchmarks. There is nothing in the budget that operationalises this type of innovation-oriented support to businesses.
The process of innovation comes with a cost, which economists call ‘creative destruction’: as new sectors and industries rise, old ones decline. In these declining sectors, jobs are lost. Active labour market policies (ALMP) are then needed to help those who lose jobs in declining sectors find new jobs in the emerging sectors. The 2017-18 budget includes a number of interventions aimed at making social welfare “stricter” in the attempt to close loopholes and ensure that support goes to those who are in real need and/or effectively willing to find a new job. Yet, a true ALMP approach would require a much deeper set of interventions, including more effective training schemes, temporary employment subsidies, and possibly also temporary public sector employment programmes. Unfortunately, these would be likely regarded as bad debt by the current government.
Rising inequality
Government’s focus on growth comes at the risk of neglecting inequality, which is indeed becoming an issue in Australia. The view underlying the budget (and more generally the entire economic policy of the Coalition) is that once growth happens, all the other pieces will fall into place through trickle down effects. But if this does not happen; that is, if the benefits of growth do not trickle down to the lower end of the income distribution, then inequality increases. Again, practice and empirical evidence suggest that growth alone is a necessary, but not sufficient condition to reduce inequality. And higher inequality is, in the long term, harmful to growth prospects. Therefore, I would have liked to see some specific intervention to ensure that growth is inclusive. Instead, here we have a budget where most of the spending that is indeed instrumental to reducing inequality is classified as ‘bad debt’. Therefore, this spending cannot be financed through borrowing and hence will need to be financed through taxes. In fact, this budget, as noted, does introduce new taxes in an attempt to repair the deficit. Problem is that these taxes seem to be essentially regressive, like the Medicare levy, which means that they tend to increase inequality. That is, most of the everyday spending that is needed to make growth more inclusive has to be financed by taxes which tend to increase inequality. This is a short-circuit that might cost future generations much more than repaying the debt.