Budget repair and the size of Australia s government. Melbourne Economic Forum John Daley, Grattan Institute December 2015

Budget repair and the size of Australia s government Melbourne Economic Forum John Daley, Grattan Institute December 2015

Budget repair and the size of Australia s government Attitudes to the best approach to budget repair are influenced by beliefs about the value of small government, and the priority of economic growth. Many believe that Australia has relatively large government, and that the key to budget repair is smaller government that will lead to faster economic growth and a stabilised budget. While there are many reasons to prefer smaller government, particularly promoting the scope for individuals to make choices that shape their own lives, smaller government is unlikely to solve Australia s budgetary problems. Across the OECD, there is no obvious relationship between size of government and size of government deficits. In any case, Australia has relatively small government. Although government expenditure is currently towards the upper limit of historic expenditure, Australian government expenditure is low relative to the OECD. This is so, even if compulsory superannuation contributions are taken into account. Australian governments spend less in most categories. In particular, welfare spending is relatively low due to Australia s highly targeted welfare system. Australian tax rates are also relatively low. Income taxes are not particularly high if one takes into account social security contributions, which have a similar incidence to income taxes. There are likely to be continued pressures to increase the size of government. Around the world, as economies grow, governments are typically spending an increasing proportion of GDP on healthcare. In Australia, increased spending on health over the last 20 years has coincided with materially improved health outcomes. Instead, budget repair will depend on the hard grind of both expenditure reductions and revenue increases. This will include facing up to the difficult politics of unsustainable inter-generational spending and revenue transfers. History suggests that budget repair is more likely to succeed when governments both reduce expenditure and increase revenue; otherwise the politics of budget repair is very difficult to manage. And the sheer scale of the federal deficit means that it is very unlikely that the gap can be bridged purely through even the bravest of expenditure reductions. Indeed the Commonwealth s plan for many years has been to repair its budget primarily through revenue increases delivered through fiscal drag. 2

Budget repair and the size of Australia s government Why does size of government matter? Attitudes to size of government affect priorities Size of government and deficits Is Australian government large? Relative to history Relative to developed countries Is government likely to get bigger? Increasing spend on health as countries get richer Government role in health spending What should Australia do about budget repair? Repair through spending reductions alone is unlikely given the size of the deficit Intergenerational issues are difficult Repair tends to be easier politically with simultaneous spending reductions and revenue increases 3

What is our priority? Budget balancing é Taxes ê Expenditure What do you care about most? Small government ê Taxes ê Expenditure Economic growth (short run) ê Taxes é Expenditure More services that government provides (health) é Taxes é Expenditure Structural deficit won t be solved by economic growth. Politics requires budget repair through both revenue and expenses Companies reluctant to invest while budgets don t balance If government reduces taxes, it will be forced to cut expenditure. Smaller government increases economic growth and reduces budget deficit Increasing economic growth will solve the budget issue Underlying assumptions Increasing health spend as income increases Government better at delivering many health services Source: Chris Richardson for the underlying insight 4

There is no relationship between size of government and fiscal balance Government expend, % of GDP, 2014 Budget deficit, % of GDP, 2014 Norway Poland Luxembourg Switzerland Korea New Zealand Estonia Germany Sweden Denmark Iceland Czech Republic Belgium Canada Finland Australia Greece Italy Netherlands Slovak Republic Austria Hungary France Israel Total OECD Portugal Slovenia Ireland United Kingdom Spain United States Japan 30 50-10 -5 0 5 Note: Data for expenditure for Iceland, Japan, Israel, New Zealand, US, Australia and Switzerland is for 2013 Source: Grattan analysis of OECD 10.7 5.6 5

Budget repair and the size of Australia s government Why does size of government matter? Attitudes to size of government affect priorities Size of government and deficits Is Australian government large? Relative to history Relative to developed countries Is government likely to get bigger? Increasing spend on health as countries get richer Government role in health spending What should Australia do about budget repair? Repair through spending reductions alone is unlikely given the size of the deficit Intergenerational issues are difficult Repair tends to be easier politically with simultaneous spending reductions and revenue increases 6

Commonwealth expenditure is high relative to history; revenue is typical for the last 30 years Commonwealth government expenditure and revenue, % of GDP 27 Expenditure 25 23 21 Revenue 19 17 1970 1975 1980 1985 1990 1995 2000 Financial year ended 2005 2010 2015E Note: figures for 2014-15 and 2015-16 are expected figures. Source: Budget Papers 2014-15 and 2015-16 7

But Australian government expenditure is relatively small, even including super General government expenditure, OECD countries, % of GDP, 2014 Finland France Denmark Belgium Sweden Austria Italy Hungary Slovenia Greece Portugal Netherlands Norway OECD UWA* UK Luxembourg Iceland* Germany Spain Turkey** Japan* Czech Republic Poland OECD WA* Slovak Rep Israel* Aust (inc super)* NZ* Canada Ireland Estonia USA* Australia* Switzerland* South Korea Mexico* 20 30 40 50 60 Note: Data for countries marked with an asterisk are for 2013; Turkey data is for 2012 Source: OECD http://dx.doi.org/10.1787/888933248323. Compulsory super contributions 8

Australian governments spend relatively less on welfare, general government and debt Government expenditure, OECD countries, % of GDP, 2013 General public service Greece Slovenia Finland France Denmark Belgium Sweden Italy Austria Portugal Hungary Netherlands United Kingdom OECD UWA Germany Spain Norway Iceland Luxembourg Japan Czech Republic Poland OECD WA Israel Slovak Republic Australia (inc super) Ireland Estonia United States Australia Latvia Korea Defence Eco affairs Health 0 10 20 30 40 50 60 70 Notes: Other category includes Public order and safety ; Environmental protection ; Housing and community amenities ; and Recreation, culture Edu and religion. Welfare category is referred to in the source data as Social protection. Source: OECD http://dx.doi.org/10.1787/888933248323; Australian super contributions from APRA Welfare Other Compulsory super contributions 9

Tax and transfer are quite progressive in Australia, but gross income is unequal Gini coefficient (higher more unequal), OECD countries, 2012 0.5 0.4 Gross income After tax and transfer 0.3 0.2 0.1 0.0 Slovak Republic Switzerland Czech Republic Denmark Iceland Norway Finland Slovenia Sweden Poland Belgium Austria Netherlands Luxembourg France Germany New Zealand Estonia Italy Australia Spain Greece Ireland Portugal United Kingdom Israel United States Note: Countries with no Gini estimate for gross income or disposable income in 2012 are excluded from the comparison This version corrects an error for Australia in the original version published in December 2015 Source: http://stats.oecd.org/index.aspx?datasetcode=idd 10

Australia has a particularly targeted welfare system Public payments to households as a proportion of population disposable income, mid-2000s Transfers to Transfers to poorest 20% remaining 80% Denmark Sweden Belgium Norway Australia Czech R. OECD-23 Neth. Ireland France Austria Slovak R. Germany Switz. Finland UK NZ Luxem. Italy Canada Poland Japan US Korea 0 5 10 15 20 25 30 35 40 Note: incomes are equivalised Source: Grattan analysis of Whiteford (2010) 11

Australia s welfare system is well targeted Average welfare payments per week by household gross income quintile, $2013-14 400 350 300 250 200 150 100 50 Other Rental assistance Unemployment and study Disability Family Pension 0 1 2 3 4 5 Household (gross) income quintile Notes: Pension includes Age and Veteran s Affairs Pension. Family payments include Family Tax Benefits and Parenting Payments. Source: ABS (2015); Grattan analysis. 12

Australian government revenues are about average if you include super General government revenue, OECD countries, % of GDP, 2014 Denmark Finland Norway France Belgium Sweden Austria Italy Hungary Greece Slovenia Luxembourg Germany Portugal Netherlands OECD UWA* Iceland* Czech Republic NZ* Estonia Slovak Republic United Kingdom Poland Aust (inc super)* Spain OECD WA* Canada Israel* Turkey** Ireland Australia* Japan* Switzerland* Korea United States* Mexico* Compulsory super contributions 20 30 40 50 60 Data for countries marked with an asterisk are for 2013; Turkey data are for 2012 Source: OECD http://dx.doi.org/10.1787/888933248215. 13

Australia is uncommonly reliant on income tax, but much lower social security taxes Tax mix, OECD, % of total taxation, 2012 Income & profits Hungary Slovak Republic Slovenia Czech Republic Brazil Poland Estonia Turkey France Greece Netherlands Mexico Portugal Austria Korea Spain Germany Israel Japan Italy Colombia OECD UWA Finland Sweden Belgium Luxembourg United Kingdom Chile Ireland Iceland Switzerland Canada United States Norway New Zealand Australia Denmark Social security Payroll Property Goods & services Other Source: OECD 0 20 40 60 80 100 14

Australian labour taxes are relatively low if social security contributions are included Taxes on labour costs, OECD countries, % of gross wages, 2014 Belgium Austria Germany Hungary France Italy Finland Czech Republic Sweden Slovenia Portugal Slovak Republic Spain Greece Estonia Turkey Denmark Netherlands Luxembourg Norway Poland Iceland Japan United States Canada United Kingdom Ireland Australia Switzerland Korea Israel Mexico New Zealand Chile Income tax Employee social security Employer social security (inc payroll tax) Compulsory super contributions Source: OECD, Taxing Wages 2015 0 10 20 30 40 50 60 15

Australia s top marginal tax rate is unremarkable, although the threshold is relatively low Top marginal tax rate, percent Portugal Slovenia Belgium Denmark Sweden Finland France Netherlands Ireland Spain Japan Israel Canada Norway UK Germany US Italy Australia Greece Iceland Luxembourg Austria Switzerland Korea Chile Poland Turkey Hungary Slovak Rep NZ Mexico Czech Estonia Top marginal threshold, AWE multiple 0 20 40 60 Source: Treasury, Re:think; Grattan analysis 0 5 10 15 20 16

Budget repair and the size of Australia s government Why does size of government matter? Attitudes to size of government affect priorities Size of government and deficits Is Australian government large? Relative to history Relative to developed countries Is government likely to get bigger? Increasing spend on health as countries get richer Government role in health spending What should Australia do about budget repair? Repair through spending reductions alone is unlikely given the size of the deficit Intergenerational issues are difficult Repair tends to be easier politically with simultaneous spending reductions and revenue increases 17

Government has tended to grow larger across the OECD Government revenue as % of GDP over time 40 35 30 25 OECD average Australia 20 15 10 5 0 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 Source: OECD 18

As all OECD countries got richer, they spent more on health (except Iceland) Health spending and GDP, 2000 to 2012 Health spending as proportion of GDP, % 14 12 10 8 6 4 2 0 Source: OECD Hungary Chile Turkey Germany Iceland 0 10,000 20,000 30,000 40,000 50,000 60,000 70,000 GDP / capita, PPP $51k, 16.4% Australia Switzerland No GDP growth Norway Luxembourg Health growing faster than GDP $91k, 6.6% Health stable relative to GDP 19

As all OECD countries got richer, they spent more on health (except Iceland) Health spending and GDP, 2000 to 2012 Health spending as proportion of GDP, % 14 12 10 8 6 4 2 0 Source: OECD Hungary Chile Turkey Germany Iceland 0 10,000 20,000 30,000 40,000 50,000 60,000 70,000 GDP / capita, PPP $51k, 16.4% Australia Switzerland No GDP growth Norway Luxembourg Health growing faster than GDP $91k, 6.6% Health stable relative to GDP 20

As health spending increased, life expectancy improved Life expectancy at 65 years of age years 90 Expected life quality for 65-year-old years 90 85 80 75 Women Men 85 80 75 Severe or profound core activity limitation Nonsevere disability 70 70 Free of disability 65 1880 1910 1940 1970 2000 Source: Grattan Institute analysis of ABS (2008) cat no 3105.0.65.001 Table 7.6 65 1998 2009 1998 2009 Men Women Source: AIHW (2012), Figure 13 21

As health spending increased, health improved Amenable mortality deaths per 100,000 population 250 Self-reported health status Percentage of population in lowest two categories ( fair or poor ) 20 200 15 150 100 10 Fair 50 5 0 1987 1992 1997 2002 2007 0 2001 2004 2007 2011 Poor Source: AIHW Source: ABS 22

Budget repair and the size of Australia s government Why does size of government matter? Attitudes to size of government affect priorities Size of government and deficits Is Australian government large? Relative to history Relative to developed countries Is government likely to get bigger? Increasing spend on health as countries get richer Government role in health spending What should Australia do about budget repair? Repair through spending reductions alone is unlikely given the size of the deficit Intergenerational issues are difficult Repair tends to be easier politically with simultaneous spending reductions and revenue increases 23

Filling a budget hole of $40b without revenue increases is implausible Budgetary impact of budget choices worth at least $2b/yr 2013 $b per year 0 5 10 15 Age Pension assets test Negative gearing Pharmaceutical spend Pension and super access CGT discount Higher ed subsidies Defence spending Cost effective medicine Super contr concessions Super earn concessions Fuel tax indexation Transport infra costs Industry support School class sizes GST broaden Health rebate Mining royalty CGT owner occ Payroll threshold Fuel tax credit Bracket creep Source: Grattan Institute, Balancing Budgets Positive impacts Negative impacts Revenue Mixed Expenditure 24

Current net transfers to older households are unsustainable Average net benefits per household (government payments, less tax) 2010$ $35,000 $30,000 $25,000 $20,000 $15,000 $10,000 $5,000 $0 -$5,000 -$10,000 -$15,000 1988-89 1993-94 1998-99 2003-04 2009-10 Increase of ~$10k/household $20b/yr budget cost 15-24 25-34 35-44 45-54 55-64 65+ Age of head of household Notes: Net benefits are social assistance benefits in cash plus support in kind (such as health and education), minus income and sales taxes Source: Grattan Institute, The Wealth of Generations, p.22 25

Budget repair mostly relies on organic increases in income taxes Budget balance 2018-19 budget compared to 2014-15 budget, nominal $ billion 10 0-10 -20-41 14 12-10 -7-30 -40-50 Budget deficit 2014-15 -7 Initial deficit growth at nominal GDP 0 Measures in 2015-16 budget 25 Personal income tax growth above GDP Other revenue growth above GDP Spending growth below GDP Other Budget deficit 2018-19 Notes: Budget balance is the underlying cash balance from the 2015-16 Budget. Estimates for spending growth, revenue growth and personal income tax are based on forecast growth in these categories above nominal GDP. Personal income tax includes income and other withholding taxes, superannuation fund taxes and fringe benefits. Initial growth in deficit at nominal GDP shows impact on budget balance if spending and revenue had continued to grow at nominal GDP. Other is a balancing item and includes effects of parameters changes. Source: Commonwealth Budget Papers 2015-16; Grattan Institute, Fiscal challenges for Australia 26