The long-term politics of budget deficits

As a childless person on an above-average income – ie, the principal victim class of the tax-welfare system – I am pleased with the Coalition’s stance on massive budget deficits. I’ll be paying for it in the long run (and consistent with the permanent income hypothesis, I am increasing my savings to maintain stable long-term living standards).

But personal interests aside, I am interested in the long-term politics of this. The most detailed polling on this to date (pdf), though based on an online panel, finds majority public support for the government: 51% supporting Rudd’s approach, 33% Turnbull’s, and 16% undecided.

However, the latest package of handouts hasn’t changed confidence in Australia’s capacity to withstand the GFC, which has been hovering around 60% since October last year. Nor has it changed approval of the government’s performance since November last year. (The Opposition’s disapproval has substantively increased, from 35% to 44%).

The Pollytics blog is convinced that this is a disaster for the Coalition. Maybe. But less that twelve months ago the public was also buying the then media-macroeconomic wisdom that we needed a contractionary fiscal policy, of which the Coalition was sensibly (even more so in retrospect) sceptical.

The medium term politics depend on how Australia’s performance in the GFC is judged, and what effect is attributed to the handouts. The longer-term politics depend on attitudes to public debt and tax. If my theories are right, the underlying tax and spend public opinion dynamic should be turning back towards lower taxes. The Coalition’s current stance, along with their historic advantages as the more-favoured party on tax, could help them take advantage of any swing back towards preferring lower tax.

22 thoughts on “The long-term politics of budget deficits

  1. Andrew:
    What’s your stance on current-account deficits? Is a continual current account deficit of say 5% of GDP more sustainable than a budget deficit of 3% for the same period of time?

    If you have a current account surplus that outweighs a budget deficit, and you have growth so the new cash in the economy from the current account surplus is taxed NEXT year, then you can almost do this forever, and only be “one-or-two years behind”.


  2. I hope you are right — I tend to think people are still in the “everything is free even if it is borrowed” mentality which has built up over many years. It will be interesting to see what might change that. Unfortunately, looking at today’s paper where someone was suggesting that we pay a mere 14% income tax for our medical expenses, we’re obviously not even close. It starts reminding me of that scene from Hitchhiker’s where you end up paying more tax than money you earn.


  3. Dave – You can have a current account deficit and a budget deficit for as long as people will keep lending to you. There is a large literature on current account deficits which range from saying it does not matter much to it matters a lot; I don’t have the expertise to offer a confident view.

    Conrad – It was only last November that most people in a Newspoll were concerned about the budget going into deficit. I think this is probably the underlying ‘common sense’ opinion, but the public mood does seem to quite susceptible to the macro conventional wisdom as reported in the media.


  4. Conrad

    I think the point is that you are already very close to paying 14% of your income in income tax for the current health care system – assuming that you are an “average taxpayer”.

    I think that there are some relatively minor increases envisaged, but certainly not that everyone’s tax should rise by 14 percentage points of their income.

    The report as I understand it is simply suggesting that the real cost of the current system should be made obvious to everyone, so that they realise that the Medicare levy actually only pays for a small proportion of their public health care expenses.


  5. Looks like Turnbull’s trying to gain credibility through taking principled, Liberal (they lost all their credibility with countless middle class welfare measures over the course of this decade) stances on these matters instead of just popularity by managing the daily media cycle like Rudd. I really hope it pays off for him.


  6. So much of this argument is predicated on the widely accepted but unproven assumption that the Government has a budgetary constraint that is comparable to a household budget. Once this assumption falls, so much of the debate about deficits and stimulus spending is left without substance. I suggest you have a read of the papers of the Center of Full Employment and Equity and just to give a sample of their reasoning, try reading section 4.2 of this paper:


  7. Andrew, are you possibly missing something?

    The current controversial issue between the Coalition and the Government is that, AT THIS POINT IN THE ECONOMIC CYCLE, one side favors big debt and the other does not. This is a counter-cyclical phenomenon.

    Now if the economy does recover, and the public mood changes with it (with relatively lower taxes preferred to more expenditure) guess what Rudd will do? He too will join the lower tax queue?


  8. Fred – Indeed, it is already clear that Rudd will shamelessly rewrite his (and our) history when needed. However, he will pretty easily be painted as the person responsible for our poor budgetary situation.

    Contra my thesis, Labor was in power for most of the previous low tax opinion cycle, though I would only ever claim that these things are pluses or minuses all other things being equal.

    However, two of the three times they came to power (1972 and 2007) we were at high points in the pro-tax and spend cycle, which is consistent with my thesis.


  9. Rudd will be easily painted “as the person responsible for our poor budgetary position”.

    Not necessarily so.

    If he can show that his plan has partly succeeded, and that Australia will share with most other countries in the world (including Germany) a willingness to run deficits, his strategy may prove a winner.

    Rudd will thereby alleviate the inevitable depression associated with the current decline in private borrowing. Later on, in reverse, he can run surpluses (including relative tax concessions and restrain expenditure) as soon as private borrowing picks up. Remember Rudd only needs to achieve a balance over the entire economic cycle.

    Most critics (minus the libertarians) will applaud. Turnbull can easily counter that either way he is a loser. But it is a feasible risk for Rudd to take.


  10. Maybe I lack imagination, but as another childless person on an above-average income, I am struggling to think of too many ways in which my taxes are likely to increase in the future. Raising marginal tax rates or reducing income tax thresholds would be quite unpopular. A possible candidate is removing the private health insurance rebate, but even that is not a huge benefit in the scheme of things. Going back to higher taxes on super contributions is another option, but I never really expected the current wildly advantageous arrangements would last forever. They could end negative gearing of course, and Henry seems minded to, but it’s a big step with a housing shortage.
    So perhaps the options involve taxing low and middle income earners more? I wouldn’t mind seeing a higher GST, so that low earners finally paid something. Or they could reduce various family benefits and payments. I live in hope…


  11. Rajat – Tax rates may not increase, but our old friend bracket creep will do its work. On the other hand, people like us are shielded from expenditure constraint, since we get virtually nothing from the feds anyway.


  12. Bracket creep is not much of an issue above $75K, especially with the range of tax concessions currently available for super and negative gearing that we childless ones can afford to adopt. On super, I meant to say that they might reintroduce taxes on payouts, not contributions. That is a risk, but they would have to make some attempt to grandfather the tax-free status of existing balances or else there will be riots on the streets.


  13. I still think that there will be bracket creep – especially if the various policy measures turn out to be inflationary – just that I personally won’t lose out too much over that. It will be the poor sods currently on $60-75K. But yes, they might cut some spending/benefits, etc. Increasing the Medicare levy seems to be another favourite option (Keating did it a few times) and is a real pain for higher income-earners.


  14. ungulate – I’ve read section 4.2 of the paper and the Government Budget Constraint assumption hasn’t fallen. It still stands.


  15. “since we get virtually nothing from the feds anyway.”

    Apart from the Defence Forces, the Federal Courts, the Federal police, financing most of the health system, aged care (you’ll need it one day), the universities (your employer) …


  16. The ADF has not had to defend Australia for more than 60 years, and I am not too worried about my interests in defence. Some court spending may indirectly benefit me. My salary funded by international students; feds won’t even pay for what they require unis to deliver. Aged care – I’m betting I’ll either be dead already or have enough money to pay my own way (better dead than a retirement home). Heath spending the only direct benefit, probably $500-$1,000 a year, mostly to help me subsidise the elderly via my private health insurance, but I could do without it.


  17. “The ADF has not had to defend Australia for more than 60 years”

    Depends on what you mean by defend Australia. In some people’s estimation, they are defending Australia right now in Iraq and Afghanistan.

    “Aged care – I’m betting I’ll either be dead already or have enough money to pay my own way (better dead than a retirement home)”

    Planning on killing yourself if you get diagnosed with Alzheimer’s?


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