Challenge of prosperity

THE demands of post-stimulus politics now press upon the Rudd government as it confronts an election year with a daunting agenda that spans tax reform, productivity redemption, a fiscal "black hole" and huge structural changes driven by the sustained China boom.

As Reserve Bank governor Glenn Stevens said this week: "The issue before us now is not, in fact, how to get on the road to recovery: we are already on it. The question, rather, is how to make sure that the road to recovery will connect to the road to prosperity."

Australia's resilience in the downturn leaves a conundrum for the Rudd government: its management of the next phase cannot be as successful as its management of the recovery. At this week's recovery conference in Melbourne hosted by The Australian and the Melbourne Institute, economic leaders offered a range of warnings and policy hints about the new cycle. Here is a snapshot.

Treasurer Wayne Swan signalled a 2010 election with tax reform as a frontline issue and vital to Labor's economic credentials. While cautious, he flagged a commitment to tax redistribution, a crackdown on concessional treatment of superannuation for high income earners, the abolition of inefficient state government taxes, a more competitive corporate tax rate, but extracting more tax from the resources sector.

Swan puts a premium on consensus in tax reform. But it is more likely that tax will erupt next year as a policy fracture between Labor and Liberal. Swan expects a 10-year tax reform plan from the Ken Henry tax review, with the government's initial response coming early in 2010. He says a fresh election mandate will probably be required for some tax reforms, opening the prospect of competing long-run tax visions at the 2010 poll. Contemplating the Henry report, Swan said "it may be one of the hardest tasks I face as Treasurer, including the challenge of the past 18 months".

Identifying fairness, simplicity and economic competitiveness as the principles governing Labor's response, Swan pledged to accept "some short-term pain in return for long-term gain".

Yet the bottom line for tax reform is transformed. Rudd announced the review in early 2008, when the budget was in strong surplus. It is now in deep deficit with no fiscal scope for further net cuts in taxation. As Swan said, if the reform is to be revenue neutral then "cutting some taxes logically means raising some others".

He rejects any change to the GST, thus eliminating the natural trade-off: raising GST revenue for the states as a substitute for inefficient state taxes.

The message from Productivity Commission chairman Gary Banks is that the Rudd government should focus on three priorities for productivity that fit its needs of minimising the cost to the budget and getting quick results. As usual, such advice has a nasty political twist.

First, Banks says reduce industry assistance. He warns against excessive help for the car industry, stresses that total federal support for industry runs at $17 billion gross and that much could be withdrawn with a net positive impact on the economy.

Second, he argues the gains from removing anti-competitive regulations and eliminating red tape that are waiting to be made. Yet the risk is that Kevin Rudd moves in the opposite direction by imposing new regulatory burdens in industrial relations, carbon emission reduction and financial markets post-crisis.

The third area Banks identifies is the cult of cure-all in relation to infrastructure. In a blunt warning about the culture beloved by the Rudd government, Banks says infrastructure spending "cannot be a panacea" for either productivity or boosting jobs. Poorly conceived nation-building is a negative. He wants projects properly assessed, efforts to encourage more private infrastructure investment and urges the government to reassess its school building program within its fiscal stimulus strategy.

Banks's conference speech reveals the paradox of the present debate: the Rudd government endlessly talks productivity yet the commission remains concerned about its policies.

Access Economics principal Chris Richardson told the conference he had one key message: economies bounce back but budgets tend to stay sick. Australia had performed superbly but the net impact of the fiscal stimulus and interest rate cuts had equated to a 10 per cent boost to household incomes.

The withdrawal of the stimulus would hurt and by 2012-13 the budget would still face a $16bn deficit. While the official story said the deficit would be repaired by holding spending to 2 per cent in real terms for several years, this task was tougher than appreciated. "What scares me is the political cycle," Richardson said. "Don't let them [the politicians] go to the next election saying this isn't a problem. It is a problem."

Richardson said bridging the gap equated to abolition of family benefits, abolition of health payments to the states or lifting the GST to 14 per cent. "There are no-go areas in the budget. When you strip them away you have about half the budget left -- the required reduction there is one dollar out of each 10 dollars. That's nasty."

In his keynote speech, Stevens offered a number of warnings. Because Australia started the upturn with less spare capacity that in previous cycles, this emphasised the need for supply side and productivity reforms. It was, Stevens said, too early to judge whether Australia should have won a greater inflation dividend from the downturn. But he emphasised the great structural change under way from the China-driven expansion in resources sector investment.

This meant a current-account deficit "considerably larger for some years than the 4 to 5 per cent of gross domestic product we have seen in the generation before that". He expressed confidence this could be managed. But such a current account "will take some explaining, not least to foreign and international organisations" and "our explanation to our own citizens will also be important".

Consider what this means for the Rudd government: it must explain to the public why the economy is becoming more focused on resources at the cost of other industries, more exposed to China's growth and more dependent on foreign capital and equity at higher levels.