Malcolm Turnbull's choice: Debt and deficit, or defeat

Extract from ABC News

Analysis

By business editor Ian Verrender

Updated about an hour ago

Photo: The Government is likely to indulge the public with the Federal Budget. (ABC News: Nick Haggarty)

Talk about fortuitous timing. There's an election looming and a budget situation — long portrayed as a disaster — suddenly on the mend.

But what to do with this sudden bounty? Repair the finances and bolster the balance sheet in case the global economics winds turn nasty? Or give way to temptation and indulge the punters?
No prizes for guessing which way the Government will bend and what's in store in this year's Federal Budget on Tuesday night. For those who appreciate a liberal application of cliches, prepare to be swamped by a watery array of headlines that feature cash, splash and/or shower.
Will it be enough to get the Government across the line, possibly even as soon as later this year?
It didn't work for John Howard in 2007. But having lost 30 Newspolls in a row, the Government doesn't have a great deal else with which to bargain, except for the unusual advantage that Bill Shorten has lost 30 Newspolls in a row as preferred Prime Minister to Malcolm Turnbull.

Hell, I never vote for anybody, I always vote against. — Comedian, WC Fields.

What happened to the debt and deficit disaster?

The Budget ceased being a disaster when it became clear the Coalition could not fix it in the dying days of Tony Abbott's prime ministership.
With debt around 50 per cent higher than the level from when he was elected, Mr Abbott suddenly switched tack in mid-2015, arguing "a ratio of debt to GDP at about 50 or 60 per cent is a pretty good result looking around the world".
As you can see from this graph from investment bank UBS, we're rapidly approaching 50 per cent.

Mr Abbott's austerity plan, instituted shortly after his election in 2013, was a political disaster for two reasons; it broke a raft of promises from just a few months earlier during his election campaign and sheeted most of the pain on those who were less well off.
Not only that, it may not have had too much of an impact on rectifying the deficit given the spending cuts may well have crimped economic growth.

Why has the economy suddenly improved?

It hasn't. Wages growth is still painfully slow, inflation is below trend and economic growth is tepid.
That is why the Reserve Bank has kept interest rates at a record low for so long and has no plans to raise them any time soon.
Instead, several forces largely outside the Federal Government's control have shifted the budget balance. Commodity prices have been stronger than forecast while employment growth has been good. Combined, those two factors have delivered much stronger revenue flows.
More importantly, the heavy losses incurred from our big corporations in the aftermath of the financial crisis finally have washed through the tax system.
It has taken a decade because, just as our banks and property groups began recovering, the resources boom came to a shuddering halt in 2014.
Typically, it takes three to four years for tax revenues to get back to normal because companies can use previous years' losses to reduce tax. Those credits now pretty much are all used up.
As a result, the budget bottom line is much better than forecast even just a few months ago. According to Commonwealth Bank analysis, there appears to have been a $10 billion improvement and a further $27 billion over the next three years even without any government initiatives.

Does that mean our debt will start to fall?

Short answer: No. Even though the deficits are shrinking, they need to be funded. So, as we keep clocking up deficits, our debt continues to rise.

In fact, our total government debt — from federal, state and local governments — is forecast to hit just shy of $1 trillion within the next two years, around 48 per cent of GDP.
While that is relatively tame compared with other developed nations, we face a number of unique challenges our peers do not.
First is our concentrated export sector. We largely rely in one country, China, buying two commodities, iron ore and coal, leaving us horribly exposed. And China has a massive debt problem, with government debt now around 260 per cent of GDP.
That has prompted the Reserve Bank to sound several warnings in the past month, that a sharp slowdown in China, emanating from its debt problems, would be acutely felt here.
The second challenge is that, while our government debt is still relatively manageable, our private sector debt and particularly that of households, is not. It recently shot to $2.466 trillion, almost 200 per cent of disposable income, amongst the highest in the world.

That is another reason the Reserve Bank has its hands tied with interest rates. A sustained rate hike could push large numbers of Australians to the brink and jeopardise the economy's financial stability.
The third problem is that much of our good news on employment has been driven by population growth. It may have boosted the economy and lifted government tax receipts but now governments have to begin building infrastructure to ensure our cities remain liveable. And that costs money.

What's wrong with tax cuts?

One way to help ease the debt burden of our households would be to hand out some tax cuts.
If the Rudd Government experiment of 2008 is any guide — when taxpayers were handed cash to boost consumption during the financial crisis — households split the proceeds between lashing out on extra spending and repaying debt.
The problem with doing that now, however, is that, unlike 2008, we are not facing a crisis, at least not yet. And just when some windfall revenue looks to have provided an opportunity to repairing our national balance sheet, our pollies instead are looking at ways of dispersing it.
Perhaps a more prudent approach would be to sock that extra cash away to bring budget back to balance earlier so we can begin reducing our government debt. That would deliver the Federal Government some much needed ammunition if chill winds begin blowing on the global economic front.
There has been talk that tax cuts in the order of $10 billion may be in the offing on Budget night. That would swallow almost all the turnaround we have seen in recent months.
It is worth remembering that the round of personal income tax cuts before the financial crisis were applauded by all. But when the global economy faltered, our company tax receipts plummeted and capital gains tax dried up just as the last round of income tax cuts took effect.
The deficits and the debt grew, not from irresponsible spending, but from reduced revenue.
Economic logic and elections make for an uneasy mix.