National Observer No. 73 - Winter 2007

 

Mr Costello's repeated budget failure

by John Stone

National Observer
(Council for the National Interest, Melbourne),
No. 73, Winter 2007

As this article is being written, our politicians are gearing up for a federal election, which could even be held in late August or 1 September, before publication. Most commentators, however, seem to think an October-November date most likely - a view reinforced by the current doleful prospect for the Coalition parties in the opinion polls.

This article makes no attempt to canvass reasons for that opinion poll performance. Two major areas of government failure, however, stand out. First is the general area of immigration and citizenship policies,(1) where its sins of both omission and commission have offended those chiefly responsible for electing it (in 2001 particularly). The other area where its failures are now costing it dearly is that of fiscal policy-cum-tax reform, to which this article is directed.

In what follows I first sketch the government's budgetary performance generally over its 11 years existence. In doing so I remark on what can now only be called the deliberately misleading nature of the Commonwealth's financial accounts. Next I examine the persistently woeful record of the Treasurer, Mr Peter Costello, and his department over recent years in forecasting budgetary revenues. Suspicion is growing that this record, given its one-way nature, can no longer be regarded as just bad luck.

Given the large budget surpluses recorded, year by year, in the Commonwealth's accounts, I ask what rationale there can now be for accumulating them. These surpluses have led, in turn, to the creation of that fiscal monstrosity, the Future Fund and, recently, the Higher Education Endowment Fund, which have distorted the Commonwealth's accounts even further. Finally, I note that the result of this fiscal record has been that, for at least four years now, the opportunity for genuine tax reform (as distinct from ad hoc fiddling at the edges of our current moribund personal income tax system) has been neglected.

THE GOVERNMENT'S BUDGETARY RECORD

The Howard Government's budgetary record can be divided into three periods, namely:

* The initial years (1996-97 through 1999-00) dealing with the $10.1 billion "Beazley black hole" deficit bequeathed to it in March, 1996 by the outgoing Keating Government. Also relevant was the $96 billion pile of Commonwealth debt, $69 billion of it deriving from that government's previous five successive years of deficit budgeting.

* The period (2000-01 through 2002-03) covering the introduction of the Goods and Services Tax (GST), including the resulting shock to economic activity and recovery therefrom. This was when the Commonwealth first began to present its false and misleading budgetary accounts.

* The period from 2003-04 to date, featuring incompetent (to use no harsher term) revenue forecasting. Combined with a lack of focus upon what should constitute personal responsibility and a private enterprise economy, this has led to an increasingly desperate search for means to cover up the consequences. Those cover-ups have led, in turn, to rendering the Commonwealth's accounts even more misleading. Meanwhile, unprecedented opportunities for genuine reform of the personal income tax (and associated corporations tax) system have gone begging.

The record for those four initial years, while hardly stellar, was none the less broadly commendable. The 1996-97 Budget, in particular, while failing to attack the Keating Government's swollen expenditures nearly hard enough, could still have been described (and was)(2) as "a good start". Failure to follow through 12 months later, and budgetary spending laxity more generally, were the most obvious subsequent demerits. Nevertheless, by June 2000, the Budget showed a $13.1 billion underlying cash surplus, while Commonwealth net debt had been cut to $54 billion (from 18.5 per cent of Gross Domestic Product to 8.3 per cent). So far, not so bad.

FALSE AND MISLEADING

The second budgetary period (2000-01 through 2002-03) centres around the Prime Minister's unwise decision in 1997 to introduce a centrally controlled broad-based indirect tax (the GST). After having caused the government almost to lose office in October 1998, this decision took effect from 1 July 2000. Its disastrous electoral consequences apart, the GST produced a huge rise in Commonwealth spending, a significant one-off rise in prices, a sharp temporary decline in economic activity (notably dwelling construction), and a consequent marked budgetary deterioration, moving temporarily back into deficit.

From a longer-run viewpoint, the government's decision to deny that the GST is a Commonwealth tax, and to portray it instead as being merely a tax collected on behalf of the States by the Commonwealth acting as their agent, was an act of palpable dishonesty.(3) To have this dishonesty repeated, year by year, in statements not merely by the Treasurer but also by his department(4) (which I once had the honour to head) is, I readily admit, personally painful to me.

A whole article could be written about this deceitful presentation of the Commonwealth's accounts. The Commonwealth Statistician, having retained sufficient statutory independence to take a truthful view, correctly treats GST receipts as Commonwealth revenue, and their disbursement to the States (after deducting a charge for costs of collection and administration) as Commonwealth expenditure, namely payments to the States.(5) The Auditor-General, similarly, who also retains sufficient statutory independence to allow him to tell the truth about this accounting scam, regularly qualifies the government's annual accounts in respect of it, beginning with the accounts for 2000-01.(6)

If the Treasurer were running a major Australian company, and presenting false accounts qualified by its auditors in this manner, he would risk being charged in the civil courts by the Australian Securities and Investment Commission for deceitful and misleading conduct. His company's shares would be marked down accordingly in the market, and he would be forced to mend his ways. But because Mr Costello seems to feel that he can do as he likes, and that in this falsehood he is above the accepted community standards of truthful behaviour,(7) he persists in it.

I have devoted some time to this episode, because it is the fiscal sleight of hand involved that underpins the government's perennial untruthful claims to have cut our taxes. True, it says, we introduced a GST, but we abolished the former wholesale sales tax that it replaced, and cut personal income tax and corporation tax (as well as forcing the States to remove some of their minor taxes). The result, it claims, has been lower taxation overall.

When such budgetary boasting is challenged, the Treasurer seeks to deny the record. Yet given a moment's thought, any teenager would grasp the obvious truth. If you raise Commonwealth spending significantly - to "compensate" all pensioners, family benefit recipients, unemployment benefit recipients, first home buyers, elderly savers, Old Uncle Tom Cobbley and all for the loss of their purchasing power resulting from the one-off GST-induced rise in prices - you will have to raise your tax gathering equally significantly. In the 2000-01 Budget, huge ongoing additions to expenditure were made on these "GST compensation" grounds. Other things being equal, therefore, Commonwealth taxation necessarily had to rise commensurately. (The small decrease in State taxes did little to offset that).

The Commonwealth's accounts purport to show that in 2000-01 its taxation receipts fell by 2.2 percentage points of GDP (from 23.5 per cent to 21.3 per cent).(8) In truth, in that year its taxation receipts (including the GST) rose by 1.6 percentage points, from 23.5 per cent of GDP to 25.1 per cent. Whereas in 1996-97 (the Coalition's first full year in office), Commonwealth tax receipts were 22.8 per cent of GDP, in 2006-07 they are estimated to have been 24.9 per cent (GST inclusive).

When therefore the Treasurer now says that "the government's medium-term fiscal strategy has a number of supplementary objectives, including ... not increasing the overall tax burden from 1996-97 levels", what he is in fact promising is not to increase the tax burden as now falsely presented from 1996-97 levels. In reality, Commonwealth taxes are already roughly two per cent of GDP higher than 1996-97 levels.

FALSE FORECASTING ALSO?

Commencing with 2003-04, the Budget papers began to incorporate serious errors in forecasting the outlook for non-rural commodity prices, and hence in forecasting the outlook for profits, and corporation tax payments, by Australia's mining companies.

The Budget papers do not contain forecasts for non-rural commodity prices as such, but a good approximation to the degree of error involved can be had from their forecasts for Australia's terms of trade.(9) Whereas the 2003-04 and 2004-05 Budgets forecast increases in our terms of trade for those years of 1.75 per cent and 4.5 per cent respectively, the actual outcomes were increases of 7 per cent and 10 per cent.

In the 2005-06 Budget it seemed that the lesson of these errors had perhaps been learned, with a forecast terms of trade improvement of 12.(25) per cent which turned out to have been only (sic.) 10.9 per cent. Not a bit of it, however; the 2006-07 Budget forecast no change in the terms of trade for that year, whereas the most recent Budget now estimates them to have improved by 6 per cent. That Budget forecast a decline of 1.5 per cent in our terms of trade for 2007-08. Despite some softness in some non-rural commodity prices in the past few months, this forecast could once again be exceeded.

The striking feature of this forecasting record is that, with the minor exception of 2005-06, it has been consistently one-way. That is, the forecasts have consistently under-estimated, by large margins, the terms of trade (read, mineral export prices) improvement, and hence consistently under-estimated, by large margins, the prospective growth in corporation tax payments by our mining companies.(10) Year after year, the Commonwealth's accounts have recorded surpluses far exceeding those initially forecast - despite, every year, further large spending decisions after the Budget has been brought down. So in recent years the Pelion of these greater-than-forecast surpluses has been piled upon the Ossa of the excessive surpluses budgeted for in the first place.

SURPLUSES TO BURN

The numbers involved are not trivial. The 2003-04 Budget estimated an underlying cash surplus for that year of $2.2 billion. Over the next 12 months the government took policy decisions estimated to cost $5.3 billion during 2003-04. Nevertheless, the 2004-05 Budget still put the 200304 surplus at $4.6 billion. When final figures became available, that had risen to $8.0 billion. In other words, the surplus outcome was $5.8 billion greater than originally estimated, despite subsequent policy decisions costing $5.3 billion. This implies an original forecasting error of $11.1 billion.

The years 2004-05 and 2005-06 displayed very similar patterns. In 2004-05, an original Budget estimate of a $2.4 billion underlying cash surplus became, in the outcome, a surplus of $13.6 billion, despite policy decisions meanwhile costing $2.5 billion. So we had a surplus $11.2 billion greater than originally estimated, and (after allowance for those extra policy decision costs), an original forecasting error of $13.7 billion.

In 2005-06 an original Budget surplus estimate of $8.9 billion became (despite subsequent policy decisions costing $7.0 billion) a final surplus outcome of $15.8 billion, implying an original forecasting error of $13.9 billion.

As for 2006-07, we do not yet have a final outcome figure.(11) Between the original Budget estimate of a $10.8 billion surplus and the revised estimate of $13.6 billion in the 2007-08 Budget papers, new policy decisions costing $6.3 billion were taken. So the forecasting error will have been $9.1 billion plus what will probably again be the upward revision of that $13.6 billion estimate.

With these forecasting errors persistently in the one direction, there is growing suspicion within the community that there is something rotten in the state of Denmark. Can it be, people are asking, that the Treasurer, knowing that even bigger forecast surpluses would produce irresistible pressure for the personal income tax rate scale reforms that he seems determined not to give us, is instructing his department to produce these latter-day "rubbery figures"? Is the Prime Minister, whose own spending proclivities are seemingly boundless, supporting this approach to budgeting because he always likes to have (our) money up his sleeve? We do not know the answers to these questions, but it is increasingly clear that some answers are needed.

As the heading above, "Surpluses to Burn", indicates, these huge and unbudgeted-for cash inflows have induced in Canberra an attitude of almost totally unrestrained spending profligacy. Space precludes pursuing the point, but these days barely a week goes by without some new announcement whereby the Howard Government tells us how generous it will be with our money.

BUDGETING TO NO PURPOSE

As noted earlier, when the Howard Government was first elected, it was entirely appropriate that it should aim first to bring the budgetary position back from the chronic deficit in which the Keating/Beazley duo had left it. It was also entirely appropriate, in those early years, to aim for budget surpluses to apply to winding back the Commonwealth debt level.(12)

It is a matter of opinion as to when this debt repayment objective should have been moderated or abandoned. By the beginning of the government's third budgetary period (2003-04 onwards), Commonwealth net debt had already declined to only 3.9 per cent of GDP, and was clearly destined to disappear entirely in the very short-term. Even then, moderation of the policy would have been appropriate. That did not happen.

Two years later, the 2005-06 Budget made it clear that in that year the Commonwealth's remaining debt would be paid off entirely and that it would begin to accumulate net financial assets. Yet still the surpluses available in the years beyond not only remained considerable, but were in fact sharply increasing (from 0.3 per cent of GDP in 2004-05 to 1.0 per cent in 2005-06). It is no accident, therefore, that in that Budget the government announced its intention to create the Future Fund:(13)

"With net debt dramatically reduced by this Government through continued surpluses and the use of assets sale proceeds to retire debt, the Government has made a further commitment to long-term fiscal sustainability by establishing a Future Fund to meet its unfunded superannuation liabilities, which currently amount to $91 billion. ... Funding superannuation now will reduce future pressures on the budget at a time when the Government will need to face the spending challenges of an ageing population."

In two earlier articles(14) I have discussed the rationale (or rather, lack of it) of this decision. It boils down to saying that the Treasurer, confronted with the huge surpluses resulting from his own previous budgetary aimlessness, resorted to "conjuring up a newly-devised Future Fund into which the remaining embarrassing surpluses might be stuffed, ostensibly to deal with a suddenly recognized problem which has existed long before this government took office and which, for the past nine years, it has studiously managed to ignore".(15)

There would be no merit in going over all that previous ground. However, the Future Fund's establishment has rendered the Commonwealth's accounts even more misleading. Because the Fund has been set up "off budget",(16) its earnings do not appear in the Commonwealth's budgetary accounts. When it was first established, this was more a question of principle rather than of practical effect, but growth in the Fund's size has meant that in 2007-08 its earnings are already estimated to be $3.0 billion.(17) Not only, therefore, is the Treasurer stuffing away his continuing excessive surpluses in the Future Fund, but he is also now effectively concealing from us the size of those surpluses. In 2007-08, for example, the true estimated underlying cash surplus is not the $10.6 billion figure shown in the Budget papers, but $13.6 billion.(18)

In its most recent Budget the government has gone a step further. In addition to the Future Fund, we now have a new receptacle (the so-called Higher Education Endowment Fund) into which the Treasurer's huge surpluses can be stuffed. This "perpetual" fund has been established "with an initial investment of $5 billion from the 200607 surplus". Note that word "initial". Needless to say, this exercise in reactive policy-making was greeted with cynical delight by assorted denizens of what used to be called our centres of higher learning - most of whom will never dream of voting for the government bestowing it upon them.

TAX REFORM: OPPORTUNITIES GONE BEGGING

As noted earlier, by the 2003-04 Budget the Commonwealth's net debt had already declined to negligible proportions. How much of the surpluses accruing since then has actually been used to benefit taxpayers? How large are the opportunities that have gone begging?

In 2002-03 the personal income tax rate scale comprised marginal tax rates of 17/30/42/47 per cent,(19) with corresponding taxable income thresholds at which those rates began to operate of $6,000/$20,000/$50,000/ $60,000. Five annual Budgets later, we now have in 2007-08 a largely unaltered rate scale (15/30/40/45) with corresponding taxable income thresholds of $6,000/$30,000/$75,000/ $150,000.(20) Taxpayers are doubtless glad to have those increases in their marginal tax rate thresholds. Also, the change from a 17 per cent rate cutting in at $20,000, to a 15 per cent rate cutting in at $30,000, can be seen as a genuine reform. By lessening the disincentives against job-seeking by people - particularly many part-time workers - having taxable incomes less than $30,000, it is a useful step in the right direction. For the rest, however, these changes have been meagre in terms of the opportunities the Treasurer has had to do more. They have also left the structure of our personal income tax system almost untouched.

Many things could be done to reform our personal income tax system. The major ones, however, are straightforward:

* Compress the current four-rate21 structure to a two-rate one (at current rates, that is, a 15/30 structure).

* Move progressively over time to drive down those two rates (including also the 30 per cent corporate tax rate) proportionally further - for example, to 14/28, 13/26, 12.5/25 and so on.

* Abolish the remnant capital gains tax which, even at a 50 per cent discounted rate for assets held for more than 12 months, is a serious disincentive to risk-taking.

* Strengthen, in doing so, the anti-avoidance provisions of the Income Tax Assessment Act to give the Commissioner greater powers to strike down "schemes" that seek to present income as capital gains.

For present purposes I leave aside the last two proposals, concentrating simply on those involving the rate scale.

Australia finds itself today in a highly competitive world. We have many great natural advantages. We also have some man-made ones: the quality of our constitutional arrangements, the structure of our democratic participatory system, the rule of law and so on which, despite the legitimate criticisms that can be made of them, are still of relatively high quality among the nations of the world.

Where we are clearly labouring under a disadvantage is in the structure of our system of personal taxes. For talented (and hence highly paid) people throughout the world, including those many talented Australians who now exercise their talents overseas in more taxation-friendly countries, the thought of having to hand over 46.5 per cent of every dollar of one's income above $150,000 is simply not acceptable. We have no lack of untalented, or modestly talented, people clamouring to come to our shores, whether legally or illegally, yet the people from whose presence we could most benefit are strongly deterred from coming (or returning) here.(22)

In my previous article on these topics(23) I noted that, in his then last three Budgets, the Treasurer had boasted of having "given" us tax cuts totalling (over the respective four-year forward estimates period in each case) $14.7 billion, $21.7 billion and $36.7 billion, respectively. But, I asked, what if we focus instead on the surpluses still left in the Treasurer's coffers after those tax measures? On that basis, the Treasurer "gave" back to us only 55 per cent, 39 per cent and 45 per cent of the amounts that he could have, but for his no longer necessary budget surpluses and his Heath Robinsonian Future Fund device.

In these respects, Mr Costello's 2007-08 Budget is worse. It provides personal income tax cuts totalling $31.5 billion over the four years 200708 to 2010-11, chiefly by raising the 30 per cent rate threshold from $25,000 to $30,000. As noted earlier, there is a genuine reform element involved in that. By contrast, however, the rate scales once again remain unchanged. A small bone has been thrown to taxpayers in the higher income brackets by increasing thresholds for the 42 and 45 per cent rates by $5,000 (to $80,000) and $30,000 (to $180,000), respectively. Even this small bone's availability is delayed until 1 July 2008. On the major reform issue, there has again been no progress whatsoever.

As to the magnitudes, the 2007-08 tax cuts are estimated to cost $31.5 billion over the four-year forward estimates period. The underlying cash surpluses currently estimated for those four years total $49.6 billion,(24) so that once again Mr Costello has delivered tax cuts (including an element of tax reform on this occasion) amounting to only 39 per cent of the scope available to him. Even this figuring takes no account of the high likelihood that, when the year is over, we shall find that the scope - the size of those underlying surpluses - has increased still further.

CONCLUSION

What if, from (say) 2003-04 onwards, the Howard Government had actually set out to reform our personal income tax (and associated corporate tax) system? What if it had actually sat down and framed a strategy - not something that could be achieved overnight, but something to which it could genuinely claim to be progressively working over a period of (say) three, or even five, years?

Had such a course been taken, Australians today could be enjoying a personal income tax system with a top marginal rate no higher (and almost certainly less) than 30 per cent, equating the corporate tax rate and hence removing the basis for much of our huge tax-avoidance industry. We could also have abolished the anti-risk-taking capital gains tax entirely, thereby becoming one of the very few Western countries whose taxation system featured that internationally attractive aspect. The behavioural effects of such developments would already be producing a major virtuous response by way of increased economic activity and increased tax revenue flowing from that. I could go on, but you get the picture.

None of this has happened, and the failure of purpose and imagination involved on the part of the Treasurer, and the government as a whole, speaks volumes.

 

 

ENDNOTES:

(1). See, on those matters, my earlier articles in National Observer, namely "Solutions to the Muslim Problem in Australia" (No. 66, Spring 2005) and "The Unmentionable Problem of Australian Citizenship" (No. 70, Spring 2006).

(2). John Stone, "Job well done, but there's more hard medicine to come", Australian Financial Review, 21 August, 1996. See also John Stone, "Budget was good, but it's only the beginning", Australian Financial Review, 29 August 1996.

(3). I believe I was the first commentator to point out this dishonesty publicly, in an article entitled "Skullduggery" in the Adelaide Review (July 1999) describing the so-called "agency arrangements" as "this transparent little lie". Later articles in that journal, entitled "Whose Revenues" (May 2000) and "Budget Rectitude" (June, 2000) pursued the matter further, but without effect.

(4). Including in the Pre-Election Economic and Fiscal Outlook (PEFO) documents produced under the Charter of Budget Honesty Act 1998. That Act requires that, within 10 days of the issue of writs for a federal general election, the Secretary to the Treasury and the Secretary to the Department of Finance must produce, under their personal authority, a document updating the last issued economic and financial outlook (in, for example, the Budget papers). (It was the September 1998 PEFO, prior to the 3 October election, that first alerted me to the accounting skullduggery afoot). The Treasurer's falsehood has thus resulted in corresponding falsehoods having to be uttered (short of resignation) by two otherwise highly respected public servants.

(5). For a full discussion of the reasons for the Statistician's decisions on the matter, see Accruals-based Government Finance Statistics 2000 (Catalogue No. 5517.0), Information Paper published by the Australian Bureau of Statistics on 13 March 2000.

(6). For example, in his Audits of the Financial Statements of Australian Government Entities for the Period Ended 30 June 2004, the Auditor-General says (para. 2.21) that "the GST should be recognised as revenue of the Australian Government in the CFS [Commonwealth Financial Statements]. The CFS audit opinion includes a qualification in relation to the understatement of taxation revenue caused by the omission of GST from the CFS". Similarly, he notes that the payment of the GST proceeds to the States should be included as Commonwealth expenditure.

(7). This, incidentally, from the man who during the "McLachlan declaration" incident last year told us that, as a boy, he had been taught by his parents always to tell the truth (unlike, he insinuated, his colleague the Prime Minister). See, on all that, John Stone, "Mr Costello's Wasted Opportunities", National Observer, No. 69, Winter 2006, pp. 32-34.

(8). Budget Strategy and Outlook 2007-08, Budget Paper No 1, Statement 13, Table 2, page 13-6.

(9). The terms of trade are the ratio of prices received for our exports to the prices paid for our imports. Exports include rural exports, manufactures and services as well as non-rural commodity exports, all of whose prices (as well as those for imports) can also vary. Nevertheless, in the recent "commodities boom" years it has been the prices for non-rural commodity exports that have chiefly influenced the very favourable movement in Australia's terms of trade.

(10). It is a considerable exaggeration to say, as the Leader of the Opposition does, that Australia's prosperity today is solely the adventitious product of the minerals export boom. Nevertheless, it is true that a great many other Australian businesses which depend, to a greater or less degree, on supplying goods and services to the miners (and their employees), have also been enjoying higher profits, and paying higher taxes as a consequence.

(11). Note that 35 years ago the Budget outcome was customarily both known and published by the Treasury within a few days of the end of the financial year. Today, with the aid of powerful computers, a largely worthless accrual accounting system, and a joint Treasury/Finance responsibility, the government struggles (although not, I think, very hard) to publish the figure three months later.

(12). Whether it was appropriate to aim at paying off that debt entirely is more arguable, but for purposes of this discussion I leave that question aside.

(13). Budget Strategy and Outlook 2005-06, Budget Paper No.1, Statement 1, p.1-15.

(14). John Stone, "The Future of Mr Peter Costello", National Observer, No. 65, Winter 2005; and "Mr Peter Costello's Wasted Opportunities", loc. cit.

(15). "The Future of Mr Peter Costello", op. cit., p. 49.

(16). In the United States, a main charge against those responsible for the Enron scandal some years ago was that the true state of that company's affairs had been concealed by setting up associated entities "off balance sheet". No doubt if Mr Costello were confronted with such reprehensible behaviour from an Australian public company, he would be loud in his condemnations.

(17). Budget Strategy and Outlook 2007-08, Budget Paper No.1, Statement 13, Table 1, p.13-5.

(18). Ibid. Footnote (b) to that Table states: "For the purposes of consistent comparison with years prior to 2005-06, Future Fund earnings should be added back to the underlying cash balance."

(19). In fact, 18.5/31.5/43.5/48.5 per cent after taking the 1.5 per cent Medicare levy into account.

(20). From 1 July 2008, the 40 and 45 per cent thresholds will increase to $80,000 and $180,000, respectively.

(21). Five-rate if you include the zero rate for taxable incomes less than $6,000.

(22). There are now special tax arrangements to make it easier for foreign business executives to take jobs in Australia for some years. This underlines the ludicrous nature of a system that forces us to make such complex special arrangements to undo (in part) the consequences of its deficiencies.

(23). "Mr Peter Costello's Wasted Opportunities", loc. cit., pp. 23-24.

(24). $61.3 billion if estimated earnings of the Future Fund are included, as they should be.

ABOUT THE AUTHOR:

John Stone is a former Secretary of the Australian Treasury and Senator, and is the Honorary Secretary of The Samuel Griffith Society.

 

National Observer No. 73 - Winter 2007