The response to the 2005-06 federal budget illustrated the extent to which economists are stuck in policies of the Keating era.
The dominant critique of the budget was that its centrepiece, the tax cut and tax-threshold increase, was irresponsible in the extreme; that they would add demand pressure to an already supply-constrained economy and thereby force the Reserve Bank of Australia to increase interest rates; that they would give permanent tax cuts with temporary revenue, thereby putting pressure on future budgets; and that they failed to save for the future demands of an ageing population.
This is unreconstructed Keynesian economics, much beloved by Keating, which was based on the belief that governments can and need to use fiscal policy as an active tool to micro-manage the pace of the economy. It also assumes that government should and can be responsible for increasing savings and for funding us in our old age.
Even a cursory look back over data from the Keating years shows the flaws of this approach. The growth path of the economy matched that of a roller-coaster. Fiscal policy accentuated the volatility of the economy. Admittedly they were exciting times for economists, particularly those with the task of predicting the pace of the economy, but investors and savers do not want excitement or volatility.
The simple fact is: governments do not save, only people do. Governments spend. Governments take funds via taxation from people. The act of extracting money through taxation, particularly in Australia with its high rates of tax on savings, diminishes savings. It encourages immediate consumption rather than savings.
As for coping with an ageing population, the government's main role must be to ensure that its many programs from welfare to industrial relations to taxation, do not inhibit people from taking care of themselves.
Treasurer Peter Costello from his first budget rejected the Keating approach and adopted a stance of fiscal stability biased towards savings. The states have done the same, at least up to this year. That is, since Keating, governments have maintained small, stable budget surpluses with surpluses and the proceeds of asset sales used to reduce debt. Money left over after a surplus is achieved has been used to fund tax cuts and/ or additional spending. This stance has added to the stability of the economy and has allowed governments to reduce net debt by $136 billion, thereby improving their ability to meet the demands of an ageing population.
The 2005-06 federal budget continued the Costello steady-as-you-go fiscal stance even during a period of plenty. The budget forecasts a large boost in revenue of about $65 billion over the 2004-2008 period, generated by economic growth, particularly in the mining sector. It allocates nearly 40 per cent of this windfall to savings in the form of the Future Fund to repay its debt to public servants, and eliminating the superannuation surcharge. It allocates about 30 per cent of the additional revenue to spending, most notably on its welfare-to-work program. And it allocates another one third or about $19 billion (excluding superannuation tax cuts) to reduce across the board the burden of income tax.
Many economists argued against tax cuts, claiming that the boost in tax revenue is temporary. This is highly speculative and improbable. The increase in tax revenue is being driven in the main by the rise in demand from China and there is no reason to expect this to be a temporary phenomenon.
They criticised the tax cuts as dangerously expansionary, despite the economy clearly slowing and larger budget surpluses now forecast for the next four years.
They criticised the budget as undermining savings by giving funds back rather than retaining them with government. The idea that nearly the full $65 billion should be stacked away in a leaky government vault to pay for the retirement of baby boomers is absurd and inequitable.
Costello has done the right thing. He has shifted the focus of fiscal policy from the short term to the long term and shifted the focus of government spending, from enabling the government to help people to enabling individuals to take care for themselves.
The change in fiscal stance has been one of the seminal reforms of recent years and a major reason for the Australian economy's continuing success. It has helped place us in a better position to address the future than just about any comparable country.
It's time economic commentators got real.
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