Australian Commentary (35) – Limit Spending or Pay the Price

By Angus Taylor, The Australian, March 02, 2015

Illustration: Eric Lobbecke Source: Supplied

ONE of Einstein’s great insights had nothing to do with physics: “Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.” As we begin to focus on the longer-term future of Australia through the intergenerational report due this week, this truism will pack a big punch. The cumulative impacts of spending growth, interest and debt will be exposed like never before, and the necessary solutions will become clear.

Western countries have for some time locked into spending growth only sustainable with massive tax increases or crippling debt. While catching the disease later than others, Australia is now well on the same trajectory.

A simple spreadsheet tells the story. On recent spending trends we would need to progressively increase tax rates by at least 50 per cent by 2050 to eliminate deficits and stabilise debt. That’s a 50 per cent increase in every tax. Eliminating debt would require more.0000

Let’s do some simple numbers. The Parliamentary Budget office tells us spending was growing at 3.6 per cent (in real terms) a year up until Labor lost government in 2013. Meanwhile, real GDP was growing at closer to 3 per cent, and tax revenue a little slower. That means the deficit is getting $3-4 billion bigger each year, and growing. By 2025 this would add roughly $30bn to our deficit, and many hundreds of billions to our debt.

Given the expected impact of an ageing population on health, welfare and aged care spending, let’s assume those growth rates continue. The results over time are sobering. On very conservative assumptions, the deficit would exceed $200bn (in today’s dollars) by 2050, because of Einstein’s compounding. To just balance the budget (ignoring repayment of debt), federal taxes would have to ratchet gradually from 22.5 per cent of GDP to around 28 per cent of GDP. That means increasing GST rates to about 25 per cent. Alternatively, we could increase marginal tax rates by about 50 per cent. There are other options, but all are drastic. Eliminating debt would require much steeper tax increases.

Of course, such massive tax increases would slow economic growth at a time when we are already facing strong headwinds.

Let’s suppose we see a decrease in growth relative to last decade (say, a conservative 0.5 per cent per year) because of continually rising taxes, falling workforce participation and sluggish productivity gains. The deficit is twice as big, and debt explodes.

To just balance the budget over time, the federal tax take would have to rise from 22.5 per cent of GDP to 34 per cent of GDP by 2050. This is equivalent to tripling GST (a GST rate of 30 per cent), or almost doubling personal income taxes. Alternatively, we could increase all taxes by 50 per cent. Even then debt still explodes to unsustainable levels. No Australian government could expect to survive elections in the face of such tax hikes.

We could, of course, just accumulate debt, Greek-style. What fun. Except that we are already highly vulnerable to a major financial crisis because our household debt levels are higher than most countries in the world. This spending growth raises the stakes to a point where a complete debt meltdown is inevitable, not far down the track.

Labor refuses to engage and instead offers a magic pudding: “faster economic growth!” Of course we should stimulate growth. That’s why we are chasing trade agreements. It’s why we are encouraging better workforce participation for everyone, and why refocusing on productivity in a highly competitive global environment really matters. But with current headwinds, growth can only offer a partial solution at best. There is simply no choice but to arrest growth in government spending.

This doesn’t mean “cuts”. If we can contain real spending growth to a little less than GDP (say 2-2.5 per cent) and avoid a slump in growth, we can slowly eliminate our debt while maintaining our current tax burden.

Is this realistic? Initiatives already implemented by the government take us roughly half way, which should be celebrated. Beyond this, the private sector has successfully pursued productivity gains in excess of what is required for decades now. Productivity gains in the public sector are achievable if there is political will. That’s the big question. Witness the screeching when the government asked the ABC to look for a perfectly reasonable efficiency dividend.

In each major spending area, productivity gains of this order of magnitude are easily achievable with innovations in technology, funding and pricing models and regulatory regimes. Innovation is revolutionising health and education across the world. We can now target welfare spending in ways that we couldn’t dream of 20 years ago. Infrastructure is being financed in new, innovative ways across many countries, increasing productivity in the process.

The biggest hurdle to productivity is public sector union officials, who now control the Labor Party like never before. They provide Labor shoe leather and the money to win elections. Yet the public sector must recognise the future of our nation — indeed our children — depends on innovation in public services to contain spending growth. Unions have acted in the national interest before, and they can do it again.

You don’t need to be Einstein to know that we have a spending growth crisis, and the solutions needn’t frighten us. It’s time to accept the problem and get on with collaboratively identifying and implementing those solutions.

Angus Taylor, Liberal MP for Hume, was a partner at McKinsey and Port Jackson Partners and studied postgraduate economics at Oxford as a Rhodes Scholar

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