Federal budget 2009 – ignorance will drive bad policy

As the Federal budget week approaches the various commentators and interest groups are whipping themselves into a lather about what choices the Government might have or not have. A recurring theme is whether the Government should honour its election commitment in 2007 to cut income taxes from July 2009. The debate is being constructed along the lines of whether the nation can now “afford these cuts” given the “rising debt” and the “shocking state” of the budget deficit. This debate demonstrates perfectly how bad policy can be made when the Government fails to understand its options as a monopoly issuer of a non-convertible currency.

The Government has been trying to massage our expectations in the lead up to the Budget week because their is now an alleged “black hole” in its tax revenue. The Treasurer was talking today about the need to keep promise with the electorate (read: tax cuts for the rich) but at the same time they would be forced “to make unpopular decisions”.

The Government has put out a series of nonsensical statements about this issue over the last week. They are under pressure to increase the unemployment benefit rate (it is abysmally low in Australia) and also to provide a $30 per week pension boost to the old-aged among us who rely on the miserably low Federal pension. The rumours (presumably the Government is putting them out in some misguided attempt to massage the public debate) are that they will increase the pension but by less than the expected $30 increase because they need some “room to increase unemployment benefits”.

What is this room concept? Well for the Government which is stuck in a neo-liberal black hole of macroeconomic ignorance it means that they are worried sick about the size of the budget deficit and so think that robbing Peter to pay Paul is one useful way of showing they are responsible financial managers and “keep the debt blowout under control”.

Room should actually refer to their assessment of whether it is better to have pensioners with less and the unemployed with more nominal spending capacity. Given the state of the business cycle and the parlous situation both groups of income support recipients find themselves in for different reasons, it would be a more reasonable assessment to conclude that both groups should get a hefty rise in weekly income from the Government while the latter plans the introduction of a Job Guarantee. There are no “financial reasons” constraining this choice among any of the choices that government makes on a day to day basis.

In relation to the falling tax revenue, the Federal Treasurer told ABC news today that:

The consequence of that will be hard choices on Budget night … We will have to rearrange our priorities to make sure we can meet our commitments and also at the same time put in a medium-term strategy to make sure we’ve got fiscal sustainability … The Government will take the unpopular decisions in the interests of … supporting jobs, stimulating our economy, putting in place the long term investments for the future so we can maximise opportunities when the world economy recovers

Yesterday, the Prime Minister was also trying to massage the debate. He was quoted in Jacob Saulwick’s SMH article – Swan predicts a revenue collapse of more than $115b – that if the Government hadn’t have gone into debt there “would be a complete slash and burn of government services like not paying people the pension”

The PM was also reported in the Rudd hits back over budget deficit strategy article by News Limited journalists Matthew Franklin and David Uren as saying:

We’ve had a write-down in tax revenues for Australia of $115 billion and, given what’s happened in the global economy more broadly, obviously we think the risks there are on the downside … It means you either engage in temporary deficit and temporary borrowing to make up that shortfall in tax revenues …

So the two senior Government members are spreading a litany of falsehoods about the way their own government finances work and in doing so they are likely to make bad policy choices.

Yes, it is true that the automatic stabilisers are working. Tax revenue falls … sharply … in a recession and the budget deficit automatically increases (or surplus decreases). That is why they are called “stabilisers” – they automatically work to expand aggregate demand when a spending gap increases (and vice versa in a growth period).

But note – the T-word is back. What the Government and its critics have to understand is that the deficit will be permanent unless the Government wants to drive the non-government sector back into dissaving and re-create the conditions for the next financial disaster. Further, these borrowings have nothing to do with making up any shortfall in tax revenues as regular readers of this blog will realise.

The deficit is not being funded by the debt being sold. So there is no concept that any government services would be cut if they didn’t sell the debt. The Government is choosing to sell the debt because it is currently running a money policy where the interest rate target is positive and above the support rate it is paying to commercial banks for overnight reserves. In addition, it has an ideological belief, voluntarily imposed on us, that every dollar that is “net spent” should be matched by a dollar of debt issued to the private markets. Totally voluntarily and totally unnecessary.

More on this soon.

Almost every commentator and rival is arguing that now is not the time to make these tax cuts. The budget is “blowing out”; “the cuts will be permanent and make it impossible to wind back the debt”; “the rich don’t need the money” and on and on.

The Australian’s National affairs editor, Mike Steketee said in his opinion piece – Pledge of the abyss – that

THE budget on Tuesday week is going to be full of bad policy … Because the Government insists on keeping its promises … Keeping promises is not normally bad but it is now, when there has been the biggest change in Australia’s economic circumstances since the Depression … when keeping promises is coming at a high cost to good government. Before the previous election … Labor had other priorities, such as spending money to upgrade education and infrastructure. But it played safe by making the Coalition’s tax policy its own … It neutralised the issue politically and … rationalised that the budget could afford it … Now it can’t.

The national Government can always afford to buy whatever there is for sale. To claim otherwise is a falsehood. There is no financial constraint (afford concept) on national government spending which is not the same thing as saying it should spend infinitely.

Another Australian columnist, their so-called economics commentator Michael Stutchbury was also at it again this week in his Budget in Disrepair article. He came up with this gem of ignorance:

After showering Australians with stimulus cash and promising aged pension increases, Kevin Rudd now warns that tax revenue is collapsing. So Treasury needs to show how much hard yakka is needed to bring the budget back within the nation’s post-boom means. “It needs to scare the pants off people,” says Access Economics’ Chris Richardson:

What exactly will the nation’s real means be? We didn’t get close to reaching full capacity before the recession struck because of the continued and escalating fiscal drag coming from the surpluses. At present, the discretionary on-going components of the fiscal stimulus are rather muted in comparison with the temporary “once off” components. So the automatic stabilisers should resolve most of the current budget deficit increase as growth resumes. Then I am sure there will be a need for a significantly larger deficit than the conservative journalists, consultants would be comfortable with.

As long as the private sector desires to save overall, the government has to be in deficit or production and employment will fall. There is no way around that national income fact. These conservatives just have to get used to it.

As an aside, Richardson is no better. He is a former junior official at the Australian Treasury and now in charge of a conservaitve consulting company who continually makes comments on fiscal matters that reflect his neo-liberal leanings and his misunderstanding of how the monetary system operates.

Statements which are meant to appear prudent such as “balancing the budget over the cycle” are nonsensical if non-government saving is not on average zero over the cycle.

Of-course, we cannot turn this into a News Limited attack despite the concentration of neo-liberal economics commentators that write for them. In today’s Sydney Morning Herald, opinion writer Paul Daley in his article Wayne’s world set to crash claims that the Treasurer is in a tough position:

… Because the fiscal policy he must foreshadow at the forthcoming budget is integral to what is already a very precarious – economically and politically – high-wire act … we are asked to put our faith in an economic principle that is utterly counter-intuitive. We are being urged to spend handouts at a time when our every instinct is to save, and to embrace a global orthodoxy that Australia has no choice but to rack up a massive debt to spend itself out of recession … On the one hand Swan must outline billions of dollars more in deficit-expanding stimulus spending. On the other hand, in order to stem spending elsewhere, he will have to slash and burn programs and say “no” to those who missed out during the boom.

As I have pointed out over and over, there is no need for the Government to go into debt. The RBA could simply announce (as they have done in the US) that they will be the overnight target rate of interest on all bank reserves and hence insulate monetary policy from the “reserve add” coming from fiscal policy. Then the Government would have to admit that the debt build up is totally voluntary and has nothing to do with “funding” its current spending program.

Further, as noted above there is no economic reason for trading off spending programs unless it can be shown that the spending gap is likely to be “over filled”. But, of-course, that is not what the debate is focusing on. Instead the focus is on these spurious concepts such as “afford” and “massive debt” etc.

All of these articles are representative of commentators who pontificate about things and influence their readers’ perspectives without understanding the underlying macroeconomics that they are talking about. I could have cited hundreds in financial columns all around the World.

But The Greens have also shown their ignorance of macroeconomics by buying into this “trade-off” claim. They see a trade-off between their desire to see aged pensioners getting a substantial pension increase (greater than $30 per week) and the Government’s election promise to cut taxes. Green’s leader Bob Brown has called for the planned tax cuts for high income earners to be scrapped. He said (press release) that “Tax cuts to the super rich in the middle of a recession don’t make sense”. When would be a better time Bob? They also want the Government to prioritise increasing welfare payments over tax cuts for the wealthy in the upcoming budget.

So The Greens position is that they want the tax cuts to be scrapped so that the “rich pay for six months paid leave for new parents” and “for increases in both the pension and unemployment benefits”.

Where do you start with logic like that? Scrapping the tax cuts will not fund anything! It will just deprive the high earners of extra disposable income, which may or may not be desirable. More about this point later.

Our august Opposition Leader however said that the Government should honour their election promise and keep the proposed July tax cuts. He is of-course just wedging them and, should be disregarded … almost always.

The overriding point is that the Government can spend what it likes in the upcoming budget. It can have pension increases over $30 per week. It can give tax relief to high income earners. It can start to build the national broadband infrastructure. It can buy a few jets and boats (for what reason we might ask!). It can offer a job at a minimum wage to anyone who wants one.

The correct economic strategy for the budget is to first of all make a reasonable assessment of the current and future spending gap (saving desires of the non-government sector) and aim to fill that over time with net government spending.

In general, it is political choices about how the Government fills the gap that should be the subject of all this public debate. These political decisions become more tricky the closer the government gets to filling the spending gap.

This is because if the Government does boost nominal incomes for pensioners, high income earners, builds a national broadband system and buys a lot of military equipment then the spending gap may soon be “filled”. After that point, any further nominal injection of net financial assets (net government spending) will be unwise because it will drive inflation up. Then tougher political decisions have to be taken. But we are a long way from that I would think.

The debate should not be concentrated on this sideshow of ignorance about “trade-offs” which is based on the erroneous claim that the Government cannot afford to spend on everything because then the deficit will “blow out” and the “debt burden will be horrendous” and all of that nonsense.

Whether we want high income earners to have more disposable income is a political matter. There is nothing intrinsically economic about it unless we are trying to argue that there are not enough real resources to go around. Yes, the high income earners may spend less than 100 per cent of the extra income (that is, they may save some of it) which just means the deficit has to be higher.

It is a pity that we have to put up with all this other rot which parades as informed economic commentary. It is not!

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    7 Responses to Federal budget 2009 – ignorance will drive bad policy

    1. Alan Dunn says:

      Hi Bill,

      Do you think the Government has chosen to not know how a modern money economy operates to simply protect their legitimacy.

      Suppose the government came out and said all our spending is via money creation (which it is) and taxes are simply to create demand for our otherwise worthless high powered money.

      That being so they would have far less scope to erect the “blame it on the unemployed” or “those bludgers” smoke screen to cover their “special deals” with a select few.

      Cheers, Alan.

    2. bill says:

      Dear Alan

      I don’t really know why they don’t seize the opportunities they to create public purpose with the capacity that they have. It is a complex web of constraints that prevent them doing this – their own ideological biases; big business breathing down their neck; ignorance; the domination of a conservative economics that originated in the C19th to combat the growing threat of Marxism, and more.

      But it is true, the smokescreen hides a lot of corruption and nice deals.

      best wishes

    3. Barton says:

      Dear Bill and Alan,
      I concur with you, Bill. I natuarally follow the debate more in the US and the UK, where I live, but I have come to the conclusion that above all, it is just plain, unmitigated ignorance-pure and simple. Thrown into that it is a huge layer of ideological bias framed by utterly false, and fixed, ideas. They can’t even think their way through it, no matter how much evidence there is to the contrary. In the US the debate gets quite hysterical as witnessed by all the conspiracy-based, scare mongering websites and exacerbated by supposed public servants like Congressman Ron Paul, who is an absolue idiot and wants to abolish the Fed and go back to the gold standard. Here in the UK the debate is only slightly more erudite and slightly less hysterical with the press joining enthusiastically in the fray writing articles about the government’s “black hole” and repeatedly asking “where it is all going to come from” and ranting about the debt we are “leaving to our children”. And then of course they rant that no matter what the government does, it can never be as good as the private sector and that government spending almost by definition is like throwing money down a black hole and wasting it. The wall of ignorance and unfortunately arrogance is monumental. It gets very discouraging.
      Keep up the good work Bill!

    4. tricky says:

      Hi bill

      in this piece you state

      “But note – the T-word is back. What the Government and its critics have to understand is that the deficit will be permanent unless the Government wants to drive the non-government sector back into dissaving and re-create the conditions for the next financial disaster”

      i’ve believed for some time that the real elephant in the room has been houshold debt, and the pitifull poor savings rate in recent years where there’s been an unspoken assumption that ‘savers are losers’ becuase of the chips falling on the side of the speculators and those who leveraged in times of crisis – note current low interest rates to the rescue of buy to let property speculators…..this is the moral hazard i believe various govts. have introduced by attempting to remove the downside of excessive levels of debt by trying to minimise the downsides, the counteragument being rising houshold assets [namely housing] being key to prosperity, and the msm missing the point entirely by focusing on govt. deficits and debts instead. which ofcourse smacks more of political point scoring.

      bill, do you think a negative real interest rate has had a negative impact by way of encouraging asset bubbles to blow up ? or do you think houshold debt and changing nature of housholds and a period of low interest rates as justification for asset values outstripping historical averages.

      is there a valid argument for interest control to cool asset bubbles, seeing as regulation of bank lending is anatheama to the administrations who’ve presided over a laissez faire attitude to the financial sector….i know it’s somewhat off-topic, but i’ve been hoping to get your opinions on this, as clearly the reponses we are seeing now are a result of financial fallout which was entirely avoidable.

    5. bill says:

      Dear Tricky

      I share your view about household debt. About 10-12 years ago I started writing a lot about the dangers that were building with the Government running surpluses and the household sector being squeezed into debt. I was laughed at by my professional peers who said “assets are rising faster”. They were at the time but the asset composition was changing – more margin debt, more inner city office and apartment investments, and a housing market that had to crash. It is clear that the accumulation of nominal debt remains but a not insignificant portion of the asset value is gone. The worst of this is manifest in the sub-prime mess and what followed.

      In relation to your question – I think both are correct. It was clear that rates were low. Given the fiscal drag that was rising over the period (budget surpluses) and squeezing private capacity to spend and that real wages were growing much more slowly than productivity (thereby creating a realisation issue for producers who were pocketing record profits) something had to give. Otherwise we would have been in recession at the end of the 1990s. What came along was the massive financial engineering that swamped the budget surplus-squeezed households with purchasing power – debt – and that allowed the economy to continue growing.

      I am not a big fan of monetary policy as a counter-stabilisation measure. It has undesirable properties – very broad impact (so not regionally targetted – for example, while Sydney real estate was booming regional Australia was not and so interest rate rises would possibly hurt the slower moving markets); and somewhat uncertain impact – borrowing costs go up but so does income for those who have assets – so what is the impact on overall spending? The RBA doesn’t really know nor do I. The RBA has to hold interest rates up very high for a protracted period before we see any impacts at all. By the time they see any effect there is considerable damage being done.

      I would set the overnight rate to zero and let investment rates (long end of the yield curve) adjust accordingly then use fiscal policy to counter-stabilise. I would not try to regulate lending – the central bank cannot really control the money supply – it can only make it more expensive to borrow reserves from them. I would force the banks to have realistic levels of deposit insurance and I would prevent some of the anti-competitive mergers that have been occurring. Maybe a specific blog on this topic will emerge.

      best wishes

    6. adam says:

      I don’t think concluding a blog with ‘informed economic commentary’, after premising that ‘the Government can spend what it likes in the upcoming budget’ is appropriate. The debt burden is ‘horrendous’, with so much quantitative easing across the developed world the interest on these debts will cripple the country for years. Funding school infrastructure, first home buyers, pensioners, consumer spending is wasteful spending in this current climate.

    7. bill says:

      Dear Adam

      There is a distinction between the notion that the Government can spend what it likes (given it is not revenue-constrained) and saying that it should spend unlimited amounts. If you read my blogs you will see I am very careful to articulate the quantum that the deficit should capture – exactly the spending gap left by private saving! Otherwise, production, income fall and unemployment rise and the private sector’s capacity to enjoy high living standards in the future is compromised.

      As to the so-called debt burden – what exactly is is for a sovereign government. You and I won’t be bearing the weight. The next generation will be enjoying whatever infrastructure is built with the net spending. The interest on the debt is income for the debt holders so that is good. The government is not revenue-constrained so it can clearly service the debt by simply crediting bank accounts. So what exactly is the problem?

      The central bank sets the short-term interest rate so it could set that at zero (which it should) and reduce the payments anyway if that was the issue.

      The only issue might be that the debt servicing payments plus the rest of the socio-economic program of the government at some future time might stimulate nominal demand such that inflationary pressures may arise. Not likely in the years ahead given the excess capacity in the economy but possible at higher levels of growth. Then the government has some choices to make. It could start to immediately overcome that constraint by eliminating funding to private schools; abandoning the high income welfare benefits which it pays via the superannuation concessions; reduce the massive handouts to private health insurance companies and choices like that. It could also stop issuing any more debt as well. All would be ways to adjust if that unlikely circumstance I pose arises. But I haven’t seen a situation in my experience where that point has been reached.

      I agree though that the composition of the deficit is far from ideal and should have been more concentrated on public sector job creation and longer term infrastructure (including restoring our public schools).

      best wishes

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