There is a lot of doubt as to whether the Gillard Government will be able to deliver a budget surplus in 2012/13 as promised.
The problem is that government is spending too much and expected revenues will not be as high as initially forecast.
When government needs to balance the books (i.e. run a modest surplus), but cannot raise more revenue, the only solution is to cut spending. Or, renege on the budget surplus promise.
Each of those choices is politically tough. The beneficiaries of government spending are usually well-organised and vocal. Seemingly, however, the promise of a budget surplus has few friends, and many are now suggesting that the Government quietly shelve that promise.
Many economists are making the argument that a budget surplus in 2012/13 isn't really economically important; it is just the politics that dictates the need for a surplus. The fact of the matter is that budgets matter, and politics matters too.
To his credit, Wayne Swan has resisted that sort of argument. While I doubt that he will actually deliver a budget surplus at least Swan has some understanding of the need for fiscal prudence.
Government spending is ultimately financed through taxation. I am going to ignore financing through inflation -- that is unsustainable and dishonest. Taxation can be deferred through bond issues, but bonds should be repaid, with interest. Public debt is deferred taxation.
Now there are always very compelling reasons for government to spend more money. Lobbying government to increase expenditure is a very lucrative industry in itself. But we have to trade off the benefits of additional government spending (which actually decline very quickly) against the costs of additional taxation (which rise very quickly).
As government spending increases so private activity is crowded out making the economy more reliant on government. But like any other organisation there are limits to what government can do well. As government expands it increasingly undertakes activities that it isn't very good at, and inefficiencies grow. Combine that with an increasing tax cost and it quickly becomes clear that government spending should be constrained.
Australians have an intuitive understanding of the costs of budget deficits -- every month (except January) the RBA interest rate announcement is widely covered in the news. Loose fiscal policy, sooner or later, results in high interest rates -- at least, higher than they otherwise would be.
Providing a coherent and credible path back to surplus was a clear message from ratings agencies that enabled Australia to maintain its AAA credit rating after the 2008 stimulus package.
All up this sort of argument suggests that budgets should be smaller rather than larger and balanced rather than unbalanced. It is fully consistent with Kevin Rudd's argument that, ''This reckless spending must stop''.
The problem is that government can be fiscally irresponsible for a long time. Much longer than individual households or firms. As Adam Smith said, ''There is a lot of ruin in a nation''. Just look at the Europeans, and the Americans. Fiscal irresponsibility has taken a long time to manifest itself in crisis, but the day of reckoning has arrived.
Taxation and government spending in a democracy are ultimately decided at the ballot box. It is here that many economists make a fundamental error. James Buchanan, the 1987 Nobel laureate, has argued many economists propose policy as if they were advising God, or at least an omnipotent and benevolent dictator. Economists very often overlook the fact that governments have to govern with the consent of the governed. The bottom line is that there is no economic policy that isn't political.
The electorate has good reason to demand fiscal prudence, after all the costs of imprudence are very high. So when the electorate decides that it prefers low levels of public debt to high levels of public debt that means that government needs to deliver within a tight budget constraint, or convince the electorate otherwise.
Government also needs to convince the electorate (not to mention the international bond markets) that the public sector is being well-managed. Expectations play a very important role in economic decision making and confidence is an important component of a healthy growing economy. One easily observed measure of government performance is the budget balance. It isn't the only measure and shouldn't be a mechanical measure but nonetheless is an important measure.
A government that cannot balance a budget is not doing a good job. That must undermine confidence in the economy and it also means that government is imposing huge costs on the economy and future generations. Of course, just as there are always ''good reasons'' why government should spend more, so too there are always ''good reasons'' why the budget should be balanced sometime in the future, but not just yet.
A government that gets into the habit of not managing its finances ends up imposing huge costs on the economy -- and the electorate knows that. That is why the Australian electorate has a low tolerance for debt and deficits.
So yes, honouring the promise to deliver a budget surplus is political, but it is good economics too.
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