Till debt us do part: Why Frydenberg opted for big deficits

In his first budget speech as treasurer in May 2014, Joe Hockey mentioned government debt on five separate occasions.

The size of the deficit facing him and the new Abbott government got four mentions, as did the term repair.

Treasurer Josh Frydenberg’s 2021 budget has the fewest references to debt and deficit of any Coalition treasurer since the 2013 election.Credit:Alex Ellinghausen

“Doing nothing is not an option. The days of borrow and spend must come to an end,” he declared.

“There is no easy way to repair the budget.”

In his first budget as treasurer in 2016, Scott Morrison ditched the term repair, debt got mentioned once – but deficit was uttered five times.

Morrison was at pains to argue the government was committed to its fiscal strategy, with windfall gains pumped back into the budget and new spending offset with cuts elsewhere.

“Any increases in tax revenue as a result of measures contained in the budget have been re-invested back into lower taxes, not towards fuelling unsustainable higher spending,” he said.

“Our new spending commitments have been more than offset by our disciplined restraint and better targeting of spending in other areas.”

In Josh Frydenberg’s first budget speech in April 2019, repair was again missing. Debt got mentioned five times while deficit got one call-out. More important were the six mentions of looming surpluses.

“Tonight I announce that the budget is back in the black and Australia is back on track,” he said as the Liberal Party started selling “back in black” souvenir coffee mugs.

The Back in Black mug was offered by the Liberal Party following the 2019 budget. Since then, the budget has gone into record levels of debt and deficit.

How the times have changed since that pre-pandemic, pre-election pronouncement was evident in Frydenberg’s budget speech this week.

Budget debt and deficit were mentioned just four times – the smallest number of utterances since the Coalition took office in 2013. Budget repair has disappeared from the Liberal Party’s lexicon.

The words of Frydenberg reinforced the budget’s number, highlight just how much the Coalition’s fiscal policy has been up-ended by both the pandemic and by the realisation that before the world knew about COVID-19 the Australian economy was struggling.

By any measure, the debt and deficit numbers contained in the budget are unparalleled outside of war-time.

After a deficit of $85.3 billion in 2019-20, this financial year the deficit will hit a new record of $161 billion. Next year, a shortfall of $106.6 billion, then $99.3 billion, then $79.5 billion and then $57 billion in 2024-25. It’s not a sea of red – it’s an ocean.

Back in Hockey’s 2014 budget, much was made of the deficits run by the Rudd and Gillard governments.

Responding to the global financial crisis, Labor ran cumulative deficits of $239.7 billion over 6 years.

Based on Frydenberg’s numbers this week, the Coalition is on track for cumulative deficits of $588.7 billion over 6 years, after accumulating $121.5 billion in deficits between 2014-15 and 2018-19.

Hockey talked of gross debt heading towards $667 billion early in the 2020s. Frydenberg was not so upfront, only referencing net debt by 2024-25.

The reason the current treasurer did not follow his predecessor’s precedent is obvious. JobKeeper alone cost the budget $90 billion. But new spending was unveiled this week, including $17.7 billion on aged care, $1.7 billion on childcare, $2.3 billion to deal with mental health issues raised in a recent Productivity Commission report, $1.1 billion on women’s safety and $1.3 billion towards the nation’s key spy agencies.

Gross debt is on track for $1.6 trillion early next decade, and to keep growing.

Macroeconomics chief economist Stephen Anthony, a former official with the federal Treasury and Finance Department, says by any measure Australia’s debt levels are likely to climb at an extraordinary rate.

He warns that the nation’s finances were now precarious, with long term fiscal and economic ramifications.

“Big public debt equals tax hikes,” he says.

“One more dollar of tax raised means one less dollar invested in the productive private sector, with the deadweight efficiency costs and administrative burdens of taxes on top of that.

“When governments borrow, and credit markets are tight, they put upward pressure on interest rates and crowd out pro-growth private activities.”

Frydenberg and the rest of the government point out Australia’s debt levels are modest by international standards. In the US it reached 108 per cent in Donald Trump’s last year (and will climb under Joe Biden’s stimulus measures), in Britain it is 100 per cent while in Japan it is 266 per cent.

Government debt as a share of GDP is on its way to its highest level since King George VI – here with his family and British Prime Minister Winston Churchill – was alive.Credit:AP

Anthony also cautions that our total debt level is much higher. Public debt, including unfunded superannuation liabilities and state government debt, takes our total public debt to around 77 per cent of GDP.

And then there are the nation’s households who are among the most indebted in the developed world. Household debt is 180 per cent of household disposable income.

It’s not just the debt quantum.

Back in 2019, Frydenberg made much of the benefit that came from paying off government debt.

He noted the interest bill on government bonds was $18 billion.

“This is money that could have built 500 schools or a world-class hospital in each state and territory,” he thundered.

“We are reducing the debt and this interest bill.”

Interest is now expected to reach $20 billion annually, and that depends on global interest rates remaining at historically low levels for years.

Based on Frydenberg’s own rhetoric, that’s a lot of schools and even more world-class hospitals, forgone because of the interest bill.

None of this got a mention in a 40-minute budget speech that managed to lock in an extra $96 billion in new spending.

All of this debt, all of these deficits, and the change in the language of the government is being driven by three linked issues.

The first is the most obvious. The pandemic recession, the deepest downturn since the early years of the Great Depression, knocked a huge hole in the budget.

Tax revenues alone are $169 billion lower over the three years between 2020-21 and 2022-23 than Frydenberg had been expecting when he delivered his first budget back in 2019.

Spending over that same period has exploded, up $240.6 billion over what was forecasted. That includes some economy-saving policy measures such as JobKeeper and the poverty-busting coronavirus supplement.

The second change is a major re-thinking of government fiscal policy.

Ever since coming to office, the Coalition has had a fiscal repair strategy. Its stated aim was to deliver budget surpluses worth at least 1 per cent of GDP.

That would be achieved by offsetting any spending measures with cuts in other areas, banking any windfall tax revenues delivered by the economy (such as record-high iron ore prices) and by putting in place savings that built over time.

That policy has been completely junked.

It’s not even called a “budget repair strategy” – now, the government is committed to a “medium-term fiscal strategy”.

That strategy has no promise to deliver a surplus. Instead the aim is to “target a budget balance” over the economic cycle. This will be achieved by controlling spending and revenue growth through “policies that drive earnings and economic growth”.

The government will use its own balance sheet to “support productivity-enhancing investments that build a stronger economy, support private investment and create jobs”.

It’s a motherhood statement that connects directly to the third change in government thinking.

That change has been driven by a reappraisal of the pre-pandemic economy.

Often forgotten is that two months after Frydenberg declared the budget back in black, the Reserve Bank started cutting official interest rates from a then-record low of 1.5 per cent.

The bank would eventually get rates down to a pre-pandemic low of 0.75 per cent while also urging governments to increase spending on infrastructure to help get the economy running faster.

The government tried to argue that monetary and fiscal policy were working in the same direction. The evidence clearly showed they weren’t.

Treasury, and the government, have undergone a near Damascene conversion in recognising that unemployment needs to be much lower if wages are to start growing at a healthy clip.

The stated aim is to drive the jobless rate below 5 per cent, probably towards 4.5 per cent.

But the budget also shows that even if this is achieved, real wages are forecast to be flat over the next three years.

HSBC chief economist Paul Bloxham noted that on the economic fundamentals, Australia was behind its international counterparts.

“Australia’s economy starts this upswing with wages growth and underlying inflation at all-time lows and well below the central bank’s target,” he said.

“Inflation is also a lot further below target than in comparable countries, such as the US, Canada, Britain and New Zealand.”

All of the debt and string of deficits are being sold as a necessary and prudent response to the coronavirus pandemic. Out of the pandemic, spending is focused on getting the economy growing faster.

“The best way to deliver higher wages over time is to build a stronger and more productive economy and drive unemployment down,” Frydenberg told the National Press Club this week.

But even the budget forecasts suggest this is easier said than done.

After all the extra spending, the economy is expected to expand by a strong 4.25 per cent in 2021-22 before slowing to 2.5 per cent the following year and then 2.25 per cent in 2023-24.

The absence of a productivity dividend from the changes and spending outlined in the budget is evident by the absence of real wages growth.

EY chief economist Jo Masters says the spending in areas such as aged care and childcare would deliver benefits.

EY chief economist Jo Masters says there is little in the way of productivity improvement in the budget.Credit:Jessica Hromas

But there was no real productivity dividend from all the cash and proposals, with issues around tax completely missing from the budget.

“You can’t call this budget a game-changer in terms of productivity. If you want to pay off the debt then you’re going to have to look at real reforms,” she says.

Soaring iron ore prices have papered over some of the structural problems now evident in the budget and the economy. If China was to stop hoovering up every ounce of iron ore it can find (or Brazil was able to get its production back to normal levels), that fiscal bonus would quickly disappear.

It’s one of the reasons that ratings agency S&P Global was less than enthusiastic in its appraisal of the overall budget.

“The fiscal recovery outlined in Australia’s budget is occurring as we expected, but downside risks remain, underpinning our negative outlook on Australia,” S&P director Anthony Walker noted.

The government has made much of the world’s three major ratings agencies maintaining triple A ratings for Australia through the pandemic. There is a real risk S&P could downgrade Australia as early as September.

Such a downgrade would have almost no impact on the cost of Australia’s debt. But it would cause more consternation within a Coalition which for years has used debt and deficit as a cudgel to bash the Labor party.

And that’s before the next election which is due by May.

There is about $10 billion worth of policies yet to be revealed that are tucked away in this budget. They are likely to be released in the run-up to polling day, whenever that may be.

There is also a major outstanding issue around tax that has to be resolved by the major parties.

A one-year extension of the low and middle-income tax offset was dressed up by the Treasurer as a tax cut. Without the extension, more than 10 million people would have suffered a drop in their after-tax incomes next financial year.

But without further extensions, or a change to the government’s tax plan, these 10 million people face a reduction in their after-tax incomes from 2022-23.

Both parties know the issue exists and despite protests from Frydenberg that the offset will not be extended, no one inside the government or opposition believe that position can be maintained through the coming election campaign.

An election lies ahead with the need to find more money for tax cuts and other sweeteners to attract voters.

It appears the chances of a budget speech any time soon mentioning surplus or falling debt are increasingly remote.

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