Fact check: Did the Government inherit the 'worst set of accounts' in history?

Extract from ABC Fact check

Updated yesterday at 4:59pm

 

Photo: Julie Bishop wrong on the history of Australia's financial accounts (AAP: Mal Fairclough)

Governments have long blamed their predecessors for the state of affairs they inherit, but Liberal Deputy Leader Julie Bishop says the challenge left for Treasurer Joe Hockey set a record.

On March 16 she told ABC Radio's AM program that "all areas of the budget have to be considered for savings because we inherited the largest deficits in Australia's history from Labor".

• The claim: Deputy Liberal Leader Julie Bishop says the Abbott Government inherited the worst set of financial accounts in Australia's history.
• The verdict: Large borrowings to finance Australia's participation in World War I and World War II and the impact of the Great Depression led to much higher deficits and levels of debt than any government has experienced since. The Howard Government also inherited more gross and net debt and a higher budget deficit relative to GDP than the Abbott Government. Ms Bishop is wrong.

Ms Bishop has made several similar statements recently. In a Network Ten interview on February 10, she said: "We can't solve all the problems of the budget debt and deficit, the massive unprecedented size of it that we inherited from Labor - because it was the worst set of financial accounts inherited by any incoming government in Australia's history."
She told AM the same day: "We did have an enormous challenge given that we inherited the very worst set of financial accounts in Australia's political history... We sought to get a budget that was fair but recognised the fact that we had enormous debt and deficit to manage."
ABC Fact Check investigates whether the current government's financial inheritance stacks up as the worst in Australia's history. Given Ms Bishop's repeated references to debt and deficit in this context, Fact Check will use those yardsticks.

Comparing deficits and debt over time

When considering the state of finances passed from one administration to the next, the time of year of the handover is relevant.
For example, Robert Menzies in 1949, Gough Whitlam in 1972 and Kevin Rudd in 2007 all came to office in December, whereas Bob Hawke in 1983 and John Howard in 1996 were both sworn in during March. To compare budget figures consistently, Fact Check has used data from the last financial year before a change of government.
In the case of Tony Abbott, who took office in September 2013, only three months had elapsed since the end of the financial year.
The budget papers show that Mr Abbott inherited a $19 billion deficit and net debt of $153 billion when he took office in September 2013. By comparison, his predecessor Mr Rudd inherited a surplus of $17 billion and net assets of $29 billion, and before him Mr Howard inherited a deficit of $14 billion and net debt of $83 billion.
So the legacy to Mr Abbott looks high, but economists contacted by Fact Check warned that these actual dollar amounts cannot sustain long-term comparisons.

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Sydney University economist Michael Rafferty said comparing those figures is a "problem" due to inflation.
"The value of money in different time periods is different and a dollar today may be worth less than a dollar ten or twenty years ago," Dr Rafferty said.
"If I told you that the average mortgage in 1990 was $200,000, today that figure might be more like $380,000 to $400,000. So nominally, mortgage debt today is nearly double the 1990 figure. But of course incomes have grown in the last 25 years, so if household income has doubled over that time, the amounts are in proportion."
Jeff Borland from the University of Melbourne told Fact Check that using dollar amounts confounds two possible reasons for increasing debt - price inflation making the number bigger or governments borrowing more to fund their activities.
"For example, in 1990 the government might have needed to borrow money to build a bridge. Suppose at the time it costs $10 million. Then 20 years later it needs to build the same bridge again, but because of inflation it now costs $15 million. In both cases the government is borrowing to do exactly the same thing – but because of price inflation it looks like it is borrowing more."

Using GDP to measure debt and deficit

To give a reliable indication of the financial accounts of government over time, dollar amounts of debt and deficit need to be compared as a percentage of gross domestic product.
David Richardson, a senior research fellow at the Australia Institute, told Fact Check that the increasing size of the economy, as well as inflation, makes dollar amounts of debt and deficit unreliable over time.
"Looking at the figures without looking at gross domestic product tells you nothing," Mr Richardson said. "If you go back 40 years, everything you want to measure is going to be roughly 30 times bigger now than it was then," he said.
Shane Oliver, chief economist at insurer AMP Capital, said debt especially needs to be expressed relative to the size of the economy because "that provides a guide to the country's ability to service it".

If you go back 40 years, everything you want to measure is going to be roughly 30 times bigger now than it was then.

David Richardson, The Australia Institute

The debt referred to in this instance is government public debt, which has been examined by Fact Check previously. Public debt can be measured as either gross or net amounts, but economists approached by Fact Check agreed that net debt is the better indicator as it allows for "debt-related assets" of the government to be offset against borrowings.
"Much like a household - if it has a $100,000 mortgage but $100,000 on deposit at the bank giving net debt of zero, then that is far more reflective of its true debt position than the gross number of $100,000," Dr Oliver said.
In a 2008 paper on the history of government debt in Australia, three economists from the federal Treasury wrote: "Net debt is the most commonly quoted and well-known measure of a government's financial strength. One of the reasons is that it is part of everyday life for businesses and households.
"Another reason is that, historically, it was the only available stock measure for governments who were recording financial information in a cash-based accounting system. Finally, it is a measure that is internationally comparable, given most OECD countries report on it."

The historical records

Data relating to federal deficits, net debt and gross debt is recorded in the 2014-15 budget papers, going back to 1970-71.
Finding consistent sets of figures before 1970 is more difficult.
The Reserve Bank of Australia published a paper in 1997 containing statistics from 1949-50, and experts contacted by Fact Check said two historical texts are commonly used for comparisons stretching back to Federation in 1901.
They are: Commonwealth Government Finances 1901-82: A Handy Compendium, by Alan Barnard, and Australians: Historical Statistics, edited by Wray Vamplew.
It is worth noting that in its early years, the Commonwealth was debt free and ran budget surpluses.
The Australian Office of Financial Management, which manages the government debt portfolio, said in its 2003-04 annual report: "For the first 10 years following Federation, the Commonwealth did not have any public debt as budget revenues exceeded outlays.
"The first Commonwealth debt was taken over from South Australia on January 1, 1911 as a consequence of the transfer to the Commonwealth of the Northern Territory and the Port Augusta to Oodnadatta railway... The first public bond issue in Australia was made in 1915 as part of financing the war effort."

State debt and federal debt

A complicating factor with the data in the budget papers is that the debt figures, both net and gross, include Commonwealth bonds issued on behalf of state and territories.
Including state debt leads to a number of anomalies and can make federal government debt appear larger.
Dr Rafferty says although including debt incurred on behalf of the states would represent the "legal position" - that is, it is formally a federal debt - the figure excluding state borrowings "is more meaningful in practice".
Professor Borland similarly says it is "safest" to consider only federal debt as "you only want to count debt that the federal government is directly responsible for repaying".
Fact Check was unable to locate any source of net debt incurred by the Commonwealth alone.
In relation to gross debt, the AOFM has published a table for 1983 to 2004 and another for 2004 to 2013, both of which show the dollar value of gross debt incurred by the Commonwealth alone, and by the Commonwealth on its own behalf and on behalf of the states.
The AOFM explains on its website that until July 1990, the Commonwealth borrowed on behalf of the state and territory governments, which "are responsible for meeting all obligations as to interest and principal on the Commonwealth government securities on allocation to them".
The two sets of records from the AOFM show that this distinction became progressively less relevant after 1990 and is now immaterial.

Tracking the deficit

The 45 years of historical data in the budget papers shows that when the Coalition won the 2013 election, the deficit was 1.2 per cent of GDP.
His predecessor Mr Rudd inherited a surplus but Mr Howard received a deficit amounting to 2.9 per cent of GDP, more than twice the size of the deficit left for Mr Abbott.
Ashley Owen, from funds management company Philo Capital Advisers, was recently commissioned by financial advisory firm Centric Wealth to put the current budget into historical context. His research shows that when compared with governments coming to office at times such as the Great Depression or the world wars, the Abbott Government inherited a small budget deficit.
For example, John Curtin's incoming Labor government in 1941 inherited a country in the middle of a war and a deficit of around 10 per cent of GDP.

Infographic: Source: Ashley Owen, Philo Capital Advisers (ABC Fact Check)

Sydney University's Dr Rafferty told Fact Check that budgets are "in part reflections of spending and taxing decisions made several elections ago" and of the state of the economy.
"The budget position the [Abbott Government] inherited was in part the accumulation of taxing and spending decisions made by several governments - Labor and Liberal," he said.
Jeff Borland, a professor of economics at the University of Melbourne specialising in economic history, said it is more important to look at what happens during the term of government rather than what is inherited.
"In 1929, Bruce gave Scullin an economy about to go through a depression," Professor Borland said. "Managing the depression was one of the hardest jobs any government had to face," Professor Borland said.
Labor prime minister James Scullin took office on October 22, 1929. Just a week later the US stock market crashed, sparking the start of the Great Depression.
Professor Borland said the Abbott Government is facing difficulty. But he told Fact Check: "I don't think it's true it's the worst in history."

Tracking the debt

The historical data in the budget papers shows that Tony Abbott inherited net debt standing at 10 per cent of GDP.
This is not the highest proportion recorded in this data set that covers the past 45 years.
In the last full financial year of Paul Keating's government, 1994-95, net debt was 16.8 per cent of GDP, which was inherited by Mr Howard when he took office in March 1996.
Of the leaders of other incoming administrations since 1971, Mr Hawke inherited much lower net debt of 3.4 per cent and the others - Mr Whitlam, Mr Fraser and Mr Rudd - all inherited positive net assets.

Infographic: Source: 2014-15 Budget papers (ABC Fact Check)

Turning to gross debt figures as a proportion of GDP, the budget papers show that Mr Abbott's inheritance was 16.9 per cent. Again, this number is lower than the ratio left for Mr Howard of 21.3 per cent.
In December 2013, Canberra's parliamentary library published research on Australia's gross and net debt position since 1971.
Alan Payne wrote: "In gross and net terms the Rudd/Gillard/Rudd Labor government recorded the second largest debt position of all previous governments over the reporting period with only the Hawke/Keating Labor government experiencing a higher debt position."
Philip Soos from Deakin University has researched government debt since Federation and has looked at debt incurred by the Commonwealth in isolation from the states and territories.
For example in 1971-72, the last full financial year before Mr Whitlam succeeded William McMahon, the budget papers - which has only combined Commonwealth and state debt - show gross debt at 25.8 per cent of GDP. Mr Soos tells Fact Check that when state and territory borrowing is excluded, the ratio is only 8.5 per cent.
However this does not mean that on this measure Mr Abbott inherited a record amount of gross debt. On Mr Soos's numbers Mr Howard inherited gross debt of 20 per cent of GDP.
Going back further towards federation, Mr Soos said incoming governments during the Great Depression and after World War II also "inherited far larger amounts of public debt from the previous administration" than Mr Abbott inherited from Mr Rudd.
Mr Menzies, for example, inherited 71 per cent gross debt when he took office in 1949 in the aftermath of the war - four times the gross debt ratio of 16.9 per cent left to Mr Abbott.
Mr Owen has also looked at gross debt over long periods of time without, as Mr Soos did, excluding state borrowings, and came to a similar conclusion.
Since Federation, "the main debt build-ups were caused by the massive deficit spending efforts in the two world wars," he wrote in his paper for Centric Wealth.
His research shows a number of times when gross debt relative to GDP was higher than the proportion inherited by Mr Abbott. For example, when Mr Scullin handed over to United Australia Party leader Joseph Lyons in 1932, gross debt was above 50 per cent. "Between 1929 and 1932 the level of debt was actually reduced by 15 per cent but nominal GDP contracted by a staggering 31 per cent (half of which was due to a real GDP contraction and the other half was through price deflation)," Mr Owen wrote.

 

Infographic: Source: Ashley Owen, Philo Capital Advisers (ABC Fact Check)

This historical trend is also illustrated in the 2008 paper by three Treasury economists. It says:
"During the First World War, gross Australian government debt increased from around 2.2 per cent of GDP to around 50 per cent of GDP... Gross Australian government debt increased from around 40 per cent of GDP in 1939 to around 120 per cent of GDP in 1945. [It] was progressively reduced after the Second World War and largely eliminated by the beginning of the 1970s."
The Australia Institute's Mr Richardson agreed. He told Fact Check: "All outgoing governments until about 40 years ago left outstanding government debt much larger as a share of GDP than the present government inherited."

The verdict

Using Ms Bishop's yardsticks of deficit and debt, and examining them relative to GDP to enable long-term comparisons, it is clear that the Abbott government did not inherit the worst set of financial accounts in Australia's history.
Large borrowings to finance Australia's participation in World War I and World War II and the impact of the Great Depression led to much higher deficits and levels of debt than any government has experienced since.
In more recent times, Mr Howard inherited more gross and net debt and a higher budget deficit relative to GDP than Mr Abbott.

Ms Bishop is wrong.