This budget won’t fix the problem: but ageing- and productivity-related problems are increasing funding pressures, and the tax system isn’t up to the revenue task.
The biggest challenge Treasurer Jim Chalmers will face in Tuesday’s budget will be to begin the process of putting it on a more sustainable footing. That starts with acknowledging that the budget is in structural deficit.
Funding pressures arising from the ageing of the population and weak productivity growth will continue to bear down on the budget, while the tax system isn’t up to the task of generating the necessary funds.
Don’t expect this budget to fix the structural deficit but it will make a modest downpayment. Further work will be done in next May’s budget and beyond.
The Morrison government assumed the structural deficit would fix itself, its 2022 budget papers stating it “is projected to improve over the medium term” to well below 1 per cent of GDP.
In the lead-up to Tuesday’s budget the Albanese government has announced its intention to rein in the runaway spending on the NDIS. Audacious pork barrelling decisions of the previous government will also be reconsidered, including on projects demanded by Nationals leader, Barnaby Joyce, in exchange for the party’s agreement to the Liberals’ climate change target of net zero emissions by 2050.
Geopolitical tensions are likely to require extra defence spending. But fundamentally, the ageing of the population combined with a slowdown in productivity growth are widening the structural deficit.
Australians are living longer, the sign of a successful economy and society. An increasingly large proportion of the population will be in retirement and aged care. As the report of the royal commission into aged care points out, there were 4.2 working-age people for every Australian aged 65 years or over in 2019 but by 2058 this will have declined to 3.1 workers.
The 1.5 million Australians aged 85 years and over by then will vote, as will their children. They will demand and obtain better aged care.
The Morrison government’s budget forecasts gaily assumed productivity growth will resume over time at its average rate of 1.5 per cent for the 30 years prior to the onset of the COVID-19 pandemic.
It knew this was a fudge. Less than a year earlier, Treasury had included in its intergenerational report, in addition to the 1.5 per cent assumption, an alternative assumption of 1.2 per cent annual productivity growth.
The rosy assumption of 1.5 per cent annual productivity growth includes the stellar productivity growth years of the 1990s associated with the Hawke-Keating reforms that created Australia’s open, competitive economy, which has not seen since.
Using the more realistic annual productivity growth assumption of 1.2 per cent, Treasury’s intergenerational report projects a structural deficit that is 2.2 percentage points of GDP greater than under the base-case assumption of 1.5 per cent annual productivity growth.
But you won’t find any mention of that in the Morrison government’s May 2022 budget.
Acknowledging the existence of the structural deficit is the first step. The next step is to work out what to do about it.
Clearly, an appreciation of the size of the structural deficit was driving Jim Chalmers to question the viability of the legislated Stage 3 tax cuts. Should they be modified to reduce the structural deficit?
It is a reasonable question. But as various think tanks trawled through the distributional effects of the Stage 3 tax cuts, they ignored another question: what would be the consequences of the government breaking its pre-election promise not to alter them?
At the next election, the Coalition’s message to all voters would be that you can’t believe anything a Labor government promises on tax; your taxes will go up under Labor.
A hung parliament would be the likely consequence, with Labor relying on the Greens and Teals to form government. That’s not a winning formula for tackling the structural deficit.
Labor did indicate before the 2022 election that it would move against multinational profit shifting. It can claim a mandate to do so.
And in relation to the Petroleum Resource Rent Tax (PRRT), the Morrison government made some welcome changes to the generous rate at which undeducted exploration and development expenditures could be carried forward to be offset against project revenues.
It did so in response to the recommendations of a review chaired by former senior Treasury official, Mike Callaghan.
But little noticed was a further decision of the Morrison government, also recommended by the Callaghan review, to review the method for pricing gas for PRRT purposes, known as the Residual Pricing Method. That review was suspended by Treasury in 2020 in order to divert its officers to the urgent task of dealing with the economic fallout from COVID-19.
The review should be restarted if Australia is to obtain a reasonable share of the profits being earned on offshore gas developments.
Fixing the structural deficit will require expenditure restraint as well as tax changes. A good starting point is an honest recognition that the structural deficit exists. Tuesday’s budget will do that.