Budget pressures on Australian governments 2014

Unprecedented infrastructure spending by states and territories is largely responsible for a $106 billion decline in their finances since 2006, argues this report. Overview Australian government budgets are under pressure. Without tough decisions, they risk posting deficits of around 4½ per cent of GDP within 10 years. The problems have got worse since our first Budget Pressures report. We would be better off if we faced up to the tough problems sooner rather than later. We now need to find savings and tax increases of $70 billion a year. Over the economic cycle of boom and bust, balanced budgets are much better than the alternative. Persistent government deficits incur interest payments, and limit future borrowings, reducing flexibility in a crisis. They are also unfair: they require future taxpayers to pay for today’s spending. Despite relatively favourable economic conditions, Australian governments will post a collective deficit of between 2-3 per cent of GDP this year, and will remain in deficit by 1 per cent of GDP in 2017. Long-term spending has increased. The biggest driver was the sustained increase in health spending. Over the past decade health expenditure rose by over $40 billion in real terms. The ageing population was not the prime cause. Rather, people of any age saw doctors more often, had more tests and operations and took more prescription drugs. Similarly, Age Pension costs grew much faster than GDP, not because of population ageing, but with policy decisions to increase benefits and widen eligibility. New analysis in this edition of Budget Pressures shows that budget sustainability is also threatened by infrastructure spending. After a threefold increase in capital spending over the last 10 years, states are paying 3 per cent more of their revenues in interest and depreciation. Capital recycling and public private partnerships may improve credit ratings, but ultimately future recurrent budgets must still pay for the cost of past infrastructure. Continued trends in health and Age Pension costs are likely to drag future budgets backwards by 2 per cent of GDP by 2023. Future budgets will also be strained by promises of substantial new spending on the National Disability Insurance Scheme, schools, and defence, costing an extra 1 per cent of GDP. In addition, prices of Australia’s minerals are likely to decline, dragging budgets another ½ percent of GDP into the red. What can responsible leaders do to bring Australia’s budgets under control? First, they must explain the size and importance of the problem. Second, they must design a package of measures that share the burden of reform fairly across the community. As we showed in our Balancing Budgets report, the most promising reforms include lifting the age of access to Age Pension and superannuation, tightening the Age Pension assets test, paying less for pharmaceuticals with expired patents and asking students to pay a greater share of their tertiary education. However, given the size of the problem, budgets can only be balanced by looking at both expenditure and revenue. The highest priority tax increases should be the withdrawal of poorly targeted tax concessions, particularly superannuation for the wealthy, capital gains discounts, and negative gearing. Sustainable budgets require governments to make tough choices. They are politically difficult, but vital to Australia’s prosperity.