Saturday, May 17, 2008

Saturday Forum: The Budget that didn't hurt

All throughout the bureaucracy at the end of this week they are asking the one question: how many tough ideas were bowled all the way to the up to the Prime Minister’s office in the lead-up to the Budget and then knocked back?

There must have been many.

As early as last November just before the election Kevin Rudd warned us that his first Budget would be tough.

“When I talk about a razor gang, I'm dead serious,” he told the National Press Club.

“It's probably not the right town or a popular place to talk about it here in Canberra. But I have lived in Canberra, Therese and I have lived in Canberra and it just strikes me as passing strange that the Coalition Government, which supposedly belongs to the conservative side of politics, has not systematically applied the meat-axe to its own administrative bloating"...

In January the Finance Minister Lindsay Tanner put flesh on the meat-axe metaphor, warning that he was going to slash spending by an extra $3 billion to $4 billion - perhaps more - in the months ahead.

“It's a big task. We have set the bar high, and there will be pain,” he declared, noting that “there inevitably will be pain when you cut spending, but it is critical that we get inflation back in check.”

The Prime Minister agreed, observing that “nothing happens in politics for free and there will be pain on the way through, I accept that”.

The Treasurer said the three of them would “take the axe to the reckless spending spree that the Liberal Party went on for the last three years”.

And then the language softened.

By the final week Lindsay Tanner was cautioning that “we do not believe that there will be substantial pain, or really major pain for any significant groups of people but inevitably when you make spending cuts, that means that there has to be pain.”

Mr Tanner was right. There wasn’t substantial pain, or even really major pain for any significant group of people.

The promised axe was replace with a scalpel. After taking new spending into account the net savings appeared to amount to $2 billion - not the $3 billion to $4 billion plus promised.

That figure is widely believed to be not enough to put significant downward pressure on inflation.

“The budget won't add to upward pressure, but nor can it really be said that it exerts maximum downwards pressure,” said the ANZ Bank's chief economist Saul Eslake.
The Canberra based consultancy EconTech told its clients on Friday that it had been surprised by just how little net spending had been cut.

On its estimate the net savings were $0.9 billion – “close to zero” - and as a result the budget would have a “broadly neutral effect on the economy”.

What happened along the way? Someone got cold feet.

There is no doubt that all sorts of extremely worthwhile savings measures were considered by the departments of Treasury and Finance and by their Ministers.

There were leaks. The Australian Conservation Foundation is certain that Swan and Tanner were very seriously considering its proposal to remove the special Fringe Benefits Tax position enjoyed by workers who use salary sacrifice to get their employers to buy them cars.

The concession is on track to cost $2 billion a year, and because it gets bigger the more kilometres people drive is thought to create as much extra greenhouse pollution as a medium-sized coal-fired power plant.

Someone stymied it at close to the last moment.

Melbourne’s Herald Sun reported just before the budget that the Prime Minister has personally intervened to overturn a cut that would have cost nursing homes $100 million.

It’s possible that he or his department intervened to overturn many of the cuts proposed by Finance and Treasury.

They may have overturned enough of them to neuter the downward pressure the budget was going to exert on interest rates.

Wayne Swan promised it, back in March, telling the ABC’s Tony Jones “the most important thing we have to do is put maximum downward pressure on inflation so we can put maximum downward pressure on interest rates”.

But Tuesday night when he read the Budget speech there was no talk about putting downward pressure on interest rates.

The “most important thing” was missing.

If Kevin Rudd or his department did overturn proposed savings measure after proposed savings measure in the final weeks of the budget process he is following a model set by Malcolm Fraser as Prime Minister in the late 1970s and early 1980s.

Fraser’s ineffectual Treasurer John Howard put to Fraser tough proposal after tough proposal that had been developed in the Treasury and had them knocked back.

Malcolm Fraser wanted to be liked.

So too it seems does Kevin Rudd. It was apparent well before the budget. When it was discovered that the Coalition hadn’t budgeted to pay the seniors and carers bonuses in the future and that Kevin Rudd was under no obligation to do so he stepped in and guaranteed that they would be safe.

The Budget was shaping up to be a test of whether he would ever be prepared to take unpopular decisions.

He appears to have failed it. And the implications are severe.

No particularly unpopular decisions are expected in the next budget. It will be delivered while the tax and benefits inquiry chaired by the Treasury Secretary Ken Henry is still sitting.

Those decisions will be put off.

The inquiry will report at the end of next year.

By then Australia will gearing up for the next election and the odds of unpopular decisions being announced are small.

This budget, as with all post-election budgets delivered by incoming governments, is the one in which the tough decisions were most likely to be taken.

For people concerned about getting the tax system right the omens don’t look good.

Removing the special tax treatment for salary-sacrificed cars was a no-brainer. There were no valid arguments against it.

As it happens, the Australian car industry was better placed than usual this year to absorb the impact of the change. The Mitsubishi plant had just closed.

Even measures that wouldn’t have hurt the Australian industry at all, such as applying the same import duty to four-wheel drives as to other cars, were seen as too hard.

The argument isn’t too hard to follow.

Ordinary cars face a 10 per cent import duty. Gas-guzzling four wheel drives built to lower safety standards only face a 5 per cent duty, apparently because they were once predominantly used by farmers.

Only a government really frightened of offending the urban professionals who are shifting to four wheel drives at a frightening rate (sales are up 16 per cent in the last year) would allow the rort to stand.

Instead the government upped a motor vehicle tax that would hurt very few people and is itself a standout example of bad tax design.

The extra tax on luxury cars costing in excess of $57,123 has a basis in history, not in logic. By rights it should have vanished when the flat 10 per cent Goods and Services Tax replaced the previous multi-rate wholesale sales taxes.

It remained in order for the Coalition government to avoid the bad publicity that would have come from slashing the price of the cars bought by the very well off. It is a historical analogy, one that on tax design grounds should have been allowed to wither rather than made worse.

It is easy to believe that the government upped the luxury car tax in order to distract attention from its failure to correct the Fringe Benefit Tax anomaly enjoyed by cars and the special treatment enjoyed by four wheel drives.

It is easy to believe that it is a mark of cowardice.

Asked yesterday what measures the government should have taken but didn’t, one very senior ex-Treasury bureaucrat said: “Just open the Tax Expenditure Statement. You’ll find 60 billion of them.”

Produced by the Treasury at the start of every year the Tax Expenditure Statement is a list of the all of the ‘spending’ programs that are delivered in the form of tax concessions.

Worth $51 billion this year, they are set to climb to more than $61 billion over the next two years.

More than half of that total relates to the extremely generous treatment handed out to superannuation (now extended by labor to first home savers, no matter how rich).

Disappointingly for those who care about good administration, Ken Henry’s inquiry has been directed not to touch tax-free superannuation payments for the over 60s. it has also been told not to extend the Goods and Services Tax and not to recommend against future cuts in the top tax rate.

The caution apparent in the Budget and beyond might be appropriate if the Australian economy was on an even keel.

No-one, certainly not the Treasury, would argue that that is the case.

In its words in the budget papers, “powerful countervailing forces are confronting the Australian economy”.

If the forecasts were delivered with less certainty than usual.

If things do turn out as the budget documents suggest everything will be okay. Our economic growth will slow despite an almost unprecedented boom in our terms of trade, and there won’t be a need for another interest rate rise.

But there are a lot of ‘ifs’ in those qualifications.

The terms of trade is a measure of the prices we get for the things we sell overseas as a proportion of the prices we pay for the things we import from overseas.

In the four years since the minerals boom started they have soared 40 per cent – faster than those of any other country.

The budget papers say that in this year alone – 2008 - they are on track to soar another 20 per cent, which because of compounding will mean they have soared 70 per cent in five years.

Foreign income is set to flood into Australia in a way it has never has before.

In the face of that flood all the new government has done is to have held its financial position fairly steady.

That caution demonstrates considerable faith that more restraint won’t be needed in order to avoid another round of interest rate rises.

The grounds for that faith are far from clear.

If circumstances do conspire to give us another round of interest rate rises, they will correctly be said to have been the fault of Wayne Swan and Kevin Rudd.

Or perhaps just Kevin Rudd.

The government had a once-in-a-parliament opportunity to build up Australia’s defences against a renewed wave of inflation and interest rate hikes.

This week someone chose not to take it.