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Thursday, November 03, 2016

Why Turnbull should split the budget in two

Now that Turnbull's in charge we can all relax, right? We can certainly relax about politics. With the country well-run (and likely to be well-run for some time) there's less to worry about. But it would be a huge mistake not to worry at all.

In the aftermath of the mining boom and the real estate boom our living standards are set to flatline. GDP per head actually fell in the June quarter, for the third time since the financial crisis. Without something to pick up from the mining boom and the receding real estate boom, we will come to resemble Japan. For two decades now Japan's been happy enough and rich enough, but no richer. It's learnt to live with zero growth.

Also, >our budget keeps getting worse. Interest payments on debt will cost $11.6 billion this financial year, a sum the government has to borrow to meet because it is spending more than it earns. Unless we find an escape hatch, debt payments will one day cost as much as defence or education - especially when interest rates rise. Our budget will be so weighed down with debt payments there will be no easy way to get back to surplus.

And despite ultra-low interest rates and an army of soon to be freed construction workers we're not building the kind of things we'll need. Abbott boasted that he was overseeing the biggest infrastructure spend in Australian history. He wasn't. His last budget set aside almost nothing new for infrastructure. He wasn't able to actually spend big because he didn't want to push the budget further into deficit and risk Australia's credit rating (as well as his bragging rights for being tougher on the deficit than Labor).

Whatever he tried blew up in his face. When he talked about boosting productivity, unions saw it (often rightly) as an attack on conditions. When he brought in measures to bring down the deficit he was attacked (rightly) for going after the pension and family benefits rather than the tax breaks enjoyed by the wealthy.

And when he did try to spend something on infrastructure he was attacked (rightly) for his curious determination to spend it on roads even where their costs exceeded the likely benefits.

Turnbull has an opportunity to succeed where Abbott could not, and there's no time to lose.

The budget deficit has to be brought down; not necessarily straight away, but the mechanisms have to be put in place straight away so  they are locked in with a guaranteed improvement over time. Abbott's treasurer was on the right track. Hockey's first budget harnessed the power of compound indexation to restrain spending by more and more as each year passed. Pension and disability payments were to climb more slowly in line with prices rather than wages. The Senate opposed the change because it was seen to be unfair. But if he had created a credible sense of urgency about the budget and imposed the same sort of pain on high income superannuants and investors living off lightly taxed capital gains he might have succeeded.

Turnbull is in a position to create a credible sense of urgency. Unless he does, and unless he does it in the December budget update, the deficit will become harder and harder to fix.

He should do it by openly explaining the problem and saying he wants us all to do our bit, no matter how well off. He should wind back super tax concessions so that high earners no longer get the most (as a proportion of their income). And he should wind back the capital gains tax concession so that investment in housing is no longer particularly tax-preferred and negative gearing no longer particularly attractive.

And he should lift the goods and services tax. Victoria's premier Daniel Andrews has opened the door, saying that if a proposed increase is put to the 2016 election and approved, he won't stand in the way.

But fixing the budget won't allow Turnbull to give the economy a boost by investing in infrastructure. Or it wouldn't, without a revolution in the way the budget is put together.

Two weeks ago the government borrowed $4 billion for 3.345 per cent. What was unusual was that that the loan stretched out to 2039 - almost a quarter of a century. Until recently the government had only borrowed for 10 years. It's now tested the market and found that it is able to lock-in extraordinarily low rates for a generation. That's long enough to be able to safely fund the removal of level crossings or the Melbourne Metro, knowing that payments won't rise.

Turnbull would need to be sure that whatever he funded was the best possible value for money. That would mean listening to Infrastructure Australia, something Abbott didn't do when he poured billions into Melbourne's East West Link.

And Turnbull would need to change the very nature of the budget, starting in December. In modern times all spending and income has been lumped together.

Turnbull could separate "recurrent" spending and the income needed to fund it, from "capital" spending and  the borrowing used to fund it. That way, he could borrow big for demonstrably worthwhile projects while at the same time tightening the recurrent budget.

The ratings agencies are likely to buy it. Labor would too, if it had any sense. Turnbull would be treating us like adults and getting us out of a self-imposed bind.

In The Age and Sydney Morning Herald