Inside Story

Big cuts and little cuts

It’s not so much the size of government spending that counts – it’s the quality, writes Brian Toohey

Brian Toohey 2 March 2010 2062 words

Andrew Jeffrey

FOLLOWING the brief excitement of the global financial crisis, Australian politics is back in a familiar groove. A Labor government is trying to demonstrate its commitment to fiscal discipline by imposing yet another “efficiency dividend” on the public service. The latest example to attract the public limelight was a plan to close the National Archives offices in Adelaide, Hobart and Darwin, saving $1.4 million a year out of annual government spending of around $345 billion. Faced with public opposition, the government last week decided to retain an archival presence in each city, but co-locate them with the offices of similar bodies such as state public records. It isn’t clear how much, if anything, will now be saved.

Meanwhile, the Coalition is lambasting Labor for its alleged addiction to “big spending” and “spiralling debt,” while blocking its attempt to save money by means testing the rebate on private (or, more accurately, semi-private) health insurance. Never mind that John Howard’s Coalition government was no slouch on the spending front (see Treasury’s Economic Round Up, Summer 2008). Likewise, since becoming Coalition leader in December, Tony Abbott has announced over $6 billion in spending initiatives without accompanying funding measures.

Kevin Rudd’s government undoubtedly shovelled money out the door in an effort to stop Australia suffering a deep recession during the global financial crisis. And there are grounds for disagreeing with the size and composition of this spending: the $16.2 billion for school buildings was partly wasted by spending too much too quickly, at least half the $2.5 billion allocated on home insulation could have been more fruitfully diverted to renewable energy projects, and so on. But without some sort of stimulus program there is little doubt that many more businesses would have gone broke and unemployment would have been much worse.

In any event, the Rudd government is committed to returning the budget to surplus, as it should be. But politicians on all sides seem far more comfortable trotting out well-worn lines about government debt and deficits than addressing what should be done to prevent a repeat of the wild financial excesses that almost triggered a collapse as bad as the Great Depression of the 1930s. The debate is little better in the northern hemisphere, where investment banks kept afloat by hundreds of billions of taxpayer funds now denounce any attempt to curtail their future behaviour. Instead, they demand that governments cut the spending that helps the victims of their excesses. Even more brazenly, some banks that made money by helping the Greek government hide its debt are now trying to profit from speculating on the chances that it will default.

International comparisons suggest that there is no clear relationship between government spending and good economic and social outcomes. Some northern European countries do relatively well, for example, by spending more than Australia. The Treasury head, Ken Henry, acknowledged this point in a speech to the Whitlam Institute in November when he said, “Based on the numerous efforts to estimate, for developed countries, an empirical relationship between size of government and aggregate measures of things relevant to wellbeing, including rates of economic growth, it would be sensible to conclude that the optimal size of government is not a question that can be answered by a technical economic analysis.”

In Australia, the expected peak in government spending of about 28 per cent in 2009–10 is driven mainly by the temporary stimulus package. Subject to some crucial provisos, there is no reason why Australians can’t enjoy good outcomes if the government then re-tunes spending at around the average level since the dismissal of the Whitlam government in 1975 – roughly 25 per cent of gross domestic product.

One proviso is that unswerving attention has to be paid to the quality of the spending. Another is that outlays might have to increase after a few years for the nation to enjoy better health outcomes, unless people are willing to pay a higher proportion of their individual costs. There is also a strong case for enhancing budget transparency by delivering various benefits as direct payments rather than as tax concessions. Because this would shift the fiscal impact of these measures from the revenue side of the budget to the direct expenditure side, outlays and receipts would rise.

ALTHOUGH doable, there should be no mistaking the difficulties and potential pitfalls involved in meeting the constraints the Rudd government has imposed for returning the budget to surplus. One of the government’s key conditions is that the real growth in government spending will be capped at 2 per cent once economic growth returns to 3 per cent; another is that revenue should not exceed its 2007–08 level of 26.1 per cent of GDP. Even if the government doesn’t succumb to Coalition taunts to stick rigidly to the 2 per cent cap, the task will extremely demanding.

The finance minister, Lindsay Tanner, will slog away to produce lots of little cuts like the closing of the National Archives offices. Often the savings will be trivial. Other cuts – like those to the CSIRO, the Australian Bureau of Statistics and the Meteorological Bureau in the 2008–09 budget – will be positively harmful. Because large slabs of the budget are exempt from the cap, the axe will almost certainly fall with disproportionate force on remaining areas, such as spending on education, payments to the states, and investment in productive areas such as transport infrastructure.

Rudd should be reluctant to cut payments to the states, having warned in January that their spending on health had grown by around 11 per cent over each of the last five years compared to increases in their revenues of around 3 to 4 per cent a year. Whether these words are reflected in the 2010–11 budget that Wayne Swan delivers in May is another matter. After all, Rudd has boasted about delivering an “education revolution” but the current budget projections show spending on education will be lucky to increase by more than 1 per cent a year in real terms to 2012–13. Although spending is not the only thing that matters, there is no way this will be enough to fund Rudd’s promise of greatly expanded student places in universities and pre-schools, increased high school retention rates and more resources for disadvantaged schools.

Education minister Julia Gillard’s recent release of the My School website, comparing the results of literacy and numeracy tests, suggests a possible government answer to criticism about funding levels. For well over a hundred years, Australian governments were expected to provide a quality education in a school within reasonable travelling distance of most families. Now Rudd and Gillard are urging parents to choose a school further away by providing the comparative data needed for parents to shift their children to better performing schools (as measured by extraordinarily limited criteria). As Rudd put it with less than felicitous regard for English usage, the data will give parents the option to “walk with their feet” (or tell their children to do so). But choice will offer no remedy when there is only one public school in a regional town, while switching schools within a city can involve additional travelling time and more parental worries about safety.

Many commentators have noted that My School’s comparative information is based on literacy and numeracy tests that don’t measure broader educational standards. The headmaster of St Andrew’s Cathedral School in Sydney, Dr John Collier, has said that the emphasis on partial measures “will encourage schools to teach to the test with endless drills to improve their score… with less time spent teaching the sciences, humanities, or the creative arts.” Although Gillard sometimes acknowledges that there is more to a good education than testing literacy and numeracy, she still insists the results will allow parents to judge how well particular schools are performing in an era in which analytical and creative skills are at a premium.

Others note that class results vary from year to year, partly as a result of changes in students’ intellectual ability, personality traits and home environment. Simply demanding that teachers lift their game can do little to alter these factors. (Nor will it alter the stubborn reality that 20 per cent of schools will always rank in the bottom 20 per cent of tests.) Specialised help for children with learning difficulties usually improves outcomes, but it is a labour-intensive process. Gillard has promised extra funding for disadvantaged schools, but its adequacy is yet to be demonstrated at a time when overall spending on education is being heavily squeezed. On present indications, it looks like a lot of weight will be placed on encouraging parents to berate “bad” teachers, or change schools, as a key part of the “revolution” wrought by the My School site.

The spending cap will also squeeze much-needed investment in infrastructure. The last budget allocated only an extra $8.4 billion for roads, rail, and ports over five, or more, years. Many studies conclude that $50 billion to $100 billion could be justified in the near future. Apparently, nothing more will be made available. The main reason is the government has let itself be intimidated by the opposition’s scare-mongering about public debt.

Many countries have a problem with government debt. Australia is not one of them. Despite large deficits in the wake of the global financial crisis, net government debt in Australia is now expected to peak at just under 10 per cent of GDP compared to an average of 90 per cent for most economically advanced countries. So long as borrowing is used for productive investment in areas such as transport, a responsible economic policy would keep net debt at between 5 and 10 per cent of GDP after the budget is restored to surplus. Instead, the government has tried to negate the opposition’s claims that it mightn’t be able to repay debt by repeating that it will reduce net debt to zero. As the Reserve Bank governor, Glenn Stevens, recently told a parliamentary committee, “There are few things less likely than Australia defaulting on its sovereign debt.”

Having no debt is a bad public policy. Debt is a good way to spread the costs of infrastructure spending on transport facilities, schools, police stations, parks and so on across the generations that will benefit. Debt allowed the NSW government to build the Sydney Harbour Bridge by 1932 rather than wait until well after the second world war when it might have accumulated enough cash. Provided they can handle the repayments, there is nothing wrong with people borrowing to buy a home instead of saving enough to pay entirely in cash. The same applies to well-run businesses, and governments, that borrow for productive investment.

Once the economy is growing at a normal pace, however, the deficit should be reduced to zero. There is ample scope to do so without underfunding areas such as education, scientific research, health, productive infrastructure and a generous social safety net. Not all spending that involves the word “infrastructure,” however, is justified. The Productivity Commission makes a good case that most of the $6 billion allocated to upgrading irrigation infrastructure will be wasted.

Clamping down on upper- and middle-class welfare offers the biggest opportunity to cut the deficit and fund worthwhile spending. There is no excuse, for example, for letting multimillionaire retirees pay only $5.30 for prescription drugs that cost a low-paid member of the workforce $32.90. At least $3 billion could be saved, without hurting the poor, by cutting the cost of the Pharmaceutical Benefits Scheme. The means test for the age pension is extraordinarily loose, letting many people enjoy the benefits of a part pension even though they are much better off financially than a large proportion of the workforce.

And the budgetary costs of tax concessions often tip the whole concept of means testing on its head, with the maximum benefits going to high-income earners. The concessions for superannuation — estimated by Treasury to cost $32 billion by 2012–13 — are a notorious example. The overall cost of what Treasury calls tax expenditures, mainly tax concessions, is expected to rise to over $116 billion by 2012–13. Trimming this figure to under $100 billion would improve equity and the budget bottom line, without the need to savage vital areas of spending. •