Expenditure cuts more likely to cut Australian debt than tax rises

In BICSI Bytes by info@bicsi.com.au

According to a recent KPMG Economics study, reductions in Australian government expenditure would be more likely to succeed in reducing budget deficits and government debt in Australia than tax increases.

Australia’s net debt is currently estimated to be 23.6% of GDP, or A$380 billion. But the IMF has shown that, by adding the value of unfunded superannuation and pension liabilities of government workers, that debt increases by nearly $470 billion and becomes 49.5% – equal to $33,500 for every Australian.

Commenting on this statistic, KPMG Chief Economist, Brendan Rynne said: “While Australia currently enjoys a below average debt-to-GDP ratio relative to other AAA-rating countries, we are heading towards an above-average position by 2018. If it became AA in a few years – as our current trajectory indicates – yields to investors on Australian government bonds would increase by around 0.28% and the extra interest on that would be $1.06 billion per annum. So we do need to get on top of our debts, and the earlier the better.”

In its April 2016 paper, entitled ‘Solving the Structural Deficit’, KPMG identified a range of measures aimed at reducing net government expenditure in four key areas of:

  • Health and aged care;
  • Welfare;
  • Superannuation and aged pension; and
  • Education.

These potential reform measures – which also included an explicit recognition that the base rate for Newstart increase from $250 to $300 per week – generated around $12.0 billion in savings.

The analysis contained in the report shows the least distortionary impact to Australia’s economy of achieving a 5% net debt reduction by 2020 is to reduce Government expenditure by between 2.5% and 3.0% per annum, or between $10.8 billion and $13.0 billion for FY17.

Rynne continued: “In April, we showed that such a quantum reduction is achievable even without putting at risk the social safety net we want our community to continue to be covered by. Now we have shown the most cost-effective way to do it.”

KPMG carried out modelling involving five simulations where Australia’s debt-to-GDP ratio was targeted to achieve a reduction of 5% over the current trajectory between 2016-2020:

  • Reduce government consumption only;
  • Cut government spending and increase corporate and household tax rates so that spending cuts contribute 85% and tax hikes 15% to the reduction program;
  • Increase both corporate tax and household tax but in their current ratios of Australia’s tax base (33% and 67%):
  • Increase household taxes only; and
  • Cut government expenditure and increase corporate and household tax rates so that both actions contribute 50/50 to debt reduction.

The analysis showed that the negative effects on the Australian economy over the next five years were minimised when government cuts were the sole mechanism used. The economic effects became positive after 12 years through the adoption of this policy. The second least distorting policy option was where government spending cuts contributed 85% of the fiscal consolidation.

The results showed that the greater the reliance on increased tax receipts, the worse the economic effects – with a 0.25% reduction in GDP over the next five years. The most negative effect was the scenario where government and corporate taxes were raised with no corresponding cut in government expenditure.

Rynne concluded: “Numerous international studies have shown that fiscal consolidation programs based on expenditure cuts have tended to be more effective than tax-based actions. We wanted to look at this in the real-world current situation that faces Australia. Our analysis has shown that the least-worst way of reversing the current debt trajectory is for the new government to focus on restraining public expenditure, as difficult politically as this may be. The current faint ringing from distant alarm bells will steadily become louder by 2018 if no action is taken.”