These reforms could help retire budget debt

Treasurer Josh Frydenberg will deliver the budget on Tuesday. Picture: Gary Ramage

The key to assessing the long-term sustainability of the federal budget is to compare the projected path of interest rates and gross domestic product.

Most experts just “set and forget” this gap, assuming that nominal interest rates remain below GDP growth rates.

But in the real world this is a very risky approach. It also runs contrary to a global interest rate environment that appears to have reached a 1970s-like inflection point with surging inflation, especially in the US.

A rerun of patterns of the 1980s to 2010s would diminish Australia’s fiscal prospects and reduce the options we have to manage a future crisis. When running a big debt stock there is a fine line between a cosy Goldilocks cottage and a Roach Motel, a lesson many in government may soon learn.

Australia’s total public sector financial liabilities (commonwealth and state) including unfunded superannuation debt are likely to exceed 75 per cent of GDP by 2025-26. This builds on our internationally high household indebtedness, which is more than 100 per cent of GDP.

Our analysis says a plausible and sustained increase in the cost of borrowing faced purely by the commonwealth during the next five to six years will almost double the debt-to-GDP ratio to more than 55 per cent by the early 2040s.

To us it seems that policymakers, credit ratings agencies and even some economists are blind to these debt risks and are still living in the era of “lower for longer”. Australia followed the US and other developed economies through the pandemic by expanding its central government balance sheet via co-ordinated monetary and fiscal expansion in the face of a zero cash rate floor.

This pushed up asset prices, accumulated large fiscal debts and eventually will feed back into higher “main street” prices.

This looks like modern monetary theory by stealth. The argument is you never have to “pay back the debt” so obviously money is free. We suspect double-digit inflation in the US from the second half of this year will test this understanding.

We project Canberra’s structural budget deficit averaging more than 3 per cent of GDP over the next decade, which reflects an imbalance between receipts and payments, pointing to a build-up in debt across the medium term.

Unfortunately, instead of banking windfalls from higher export prices since late 2020, Josh Frydenberg has continued to spend the proceeds on economic recovery.

This is after having showered stimulus on many Australian businesses that actually benefited from the downturn. Now the commonwealth budget position is extremely vulnerable to further fiscal slippage, especially given the exaggerated sense of capacity to pump prime to maintain Goldilocks conditions.

Meanwhile, Australian governments continue to defer hard decisions about economic reforms that actually might raise trend GDP growth rates across time. This forecast debt build-up leaves little scope for funding major structural spending fixes.

Nor does it provide any buffer against other national emergencies and global risks. We should take remedial action now to guard against the uncertain but possible prospect of a loss of policy flexibility in the future.

What is really generating and expanding the structural deficits are the leaky buckets, a set of interrelated entitlement programs across aged care, social security, disability care, housing and health. The holes get bigger every year. Together and acting in tandem with state government programs, they generate a downward spiral of welfare reliance rather than self-provision.

Then there are the defence and energy-climate spending pressures, which are more about the tendency to buy a policy fix before we have an optimising policy program bedded down.

Recent examples are the decade spent dithering over the $200bn Future Submarine program and the $10bn Snowy 2.0 white elephant.

One innovative way to deal with the budget’s leaky buckets is to better assist ageing and disabled Australians to achieve right-sized housing, care and income support with far less public subsidy. Our idea is to allow the full value of the sale proceeds of the family home (say up to $2m) to be excluded from the means test for the homeowner couple for life. The sale proceeds would be available to fund any right-sized accommodation (private dwelling, at a retirement village or aged-care facility).

Any remaining proceeds should then be allocated to a special-purpose retirement living superannuation account and invested in a 30:70 mix of income-producing equities and bonds.

In 2021-22 the government will spend up to $40bn subsidising superannuation, while never lowering Age Pension eligibility and costs.

Nor does it ensure that current and future retirees can purchase a cost-effective annuity that can offer them an adequate and reliable income stream for life.

The easiest way to fix these issues is to establish a single national public default scheme – a future fund of retirement income – that could use its balance sheet to efficiently convert lump sums to annuities, avoiding duplication, and permitting the investing of retirement dollars in ways that better match overall system asset and liability structures and so raising overall risk-adjusted returns.

The focus of tax reform should be on economic rents and base broadening, replacing inefficient imposts such as company taxes and stamp duties with more efficient ones such as the corporate cashflow tax (allows immediate deduction of all capital expenditures, denies deductions of interest payments, and compensates negative cashflows at the same rate and time as it taxes positive cashflows) and land taxes.

While every galah in the pet shop talks big on the productivity agenda, there is no real desire to undertake the hard reforms or club busting in business via competition policy.

That means reforming closed shops such as gigantic tech companies that refuse to pay tax in Australia. Then there are the medical professions, especially the specialist guilds (surely the most powerful trade unions in the nation), with their interminable waiting lists.

Australia faces simultaneous risks in the international economic and security environment and fundamental fissures in the federal budget. This is certainly not the time to embrace a “free money” big debt policy, which is the Roach Motel that will leave us less scope to manage the major challenges ahead.

We need to set all our policy levers on maximising living standards and opportunities for current and future generations, just as our forebears did for us.

Vision and leadership have been lacking as politicians have been too happy to kick the structural reform can down the road. We hope the federal Treasurer will confound expectations by announcing on Tuesday real reforms that assist in minimising the structural pressures on the budget.

Stephen Anthony is chief economist at Macroeconomics Advisory and a former Treasury official. Macroeconomics’ budget preview is released on Thursday at macroeconomics.com.au