Tax hike needed to rein in deficit, bankers warn

With inflation looming banking and economic luminaries are warning we need deep structural reforms to lift growth to tackle our debt mountain.

David Murray has warned on debt. Picture: AAP

Australia is staring down the barrel of tax hikes and deep structural reforms to rein in its ballooning debt, according to the nation’s business and policymaking leaders.

Net debt is forecast to hit $1 trillion within four years, representing more than 40 per cent of the nation’s economic output.

Former Commonwealth Bank chief executive and head of the 2014 financial system inquiry David Murray predicted “much, much higher” economic risk if the country failed to pursue a bracing reform agenda to lift growth and erode debt.

“That’s because we can’t really guarantee strong economic growth and low interest rates — we’ve already seen inflation start to increase in the US,” Mr Murray said.

“That high inflation will be much worse for us without the benefit of structural reforms if governments and central banks are behind the curve.

“So it’s getting more and more urgent to sort out the debt issue because the time frames are very long by any standard.”

Former Reserve Bank governor Bernie Fraser said the sheer size of the debt and budget emphasised the scale of the measures that had to be implemented.

He said tax increases, or at the very least abandonment of the $17bn stage 3 tax cuts in 2024-25, were “unavoidable and inevitable”.

“The debt is going to be a real problem; it’s locked in and will have to be faced up to at some point,” Mr Fraser said.

“It can’t be addressed through endless quantitative easing or credit creation by the Reserve Bank.”

According to the budget papers, the deficit will blow out to $161bn this financial year — which was a $52.7bn improvement on recent expectations.

The deficit will further narrow to $106.6bn in the 2021-22 financial year, and then to $57bn in 2024-25 over the forward estimates.

The bad news is that, even after a decade, the deficit will still be equal to 1.3 per cent of GDP in 2031-32, so the level of debt will continue to escalate.

Gross debt is forecast to peak at $1.2 trillion, equal to 50 per cent of GDP, by 2024-25, or $980.6bn in net debt.

The argument from debt fetishists is that interest rates have never been lower, making debt servicing costs extremely favourable.

In the period from March last year to May this year, the Australian Office of Financial Management issued $282bn in treasury bonds, with a weighted average yield of only 0.88 per cent.

The budget papers say that, based on current yields, an extra $1.6 trillion in debt would be needed in order for interest payments to reach their peak of 2 per cent of GDP in the 1990s recession, or an extra $251bn to reach 1 per cent of GDP.

But even with near-zero interest rates, the total interest bill on government debt in 2021-22 is forecast to be an eye-popping $17.3bn.

For context, that almost matches the $17.7bn cost of reforming the aged care system over the forward estimates.

Josh Frydenberg addressed the debt conundrum in his budget speech, saying net debt was low as a share of the economy by international standards — about half that of Britain and the US and less than one-third of Japan.

However, there is less margin for error, because any undershooting in annual GDP growth could see the Australian number ratchet up.

“We are better placed than nearly any other country to meet the economic challenges that lie ahead,” the Treasurer said.

Former BHP chairman and National Australia Bank chief executive Don Argus, a renowned debt hawk, said the world was currently “awash with debt”, as countries experimented with Modern Monetary Theory to lift growth rates and resolve their fiscal challenges.

“They’ve done the right thing in pursuing growth because you don’t want to have people on the streets, but Japan went down that route and came in and out of recession for 30 years,” Mr Argus said.

In the current environment, he said, a 1 per cent increase in interest rates would cause an awful lot of pain, both for the government and the consumer.

Mr Murray said the budget response was the right prescription for the impact of the pandemic.

The challenge now was to sort out other pressing issues, such as “rigidity” in the industrial relations system, inflated energy prices and an inefficient corporate tax system.

“Without fixing one or all of those challenges, it’s very hard to imagine a serious increase in the proportion of investment to GDP in the long term,” he said.

Former Reserve Bank director Warwick McKibbin said rising interest rates would put Australia in a vulnerable economic position, because a lot of the spending in the budget relied on temporary revenue from the mining boom.

“Lessons should have been learnt from the 2000s,” Professor McKibbin said.

“But what we’re seeing now is a temporary stimulus in demand and a permanent reduction in supply until COVID washes through.

“Some prices will go up a lot, and the question is how central banks are going to respond.

“We need a clear view from the Reserve Bank on that.”