– Realistic growth estimates required for governments to plan for budget balance –
A report released today by the Bankwest Curtin Economics Centre (BCEC) found that government debt in Australia is unlikely to reduce in the next five years because of unrealistic estimates of output and revenue growth.
Beyond the Bottom Line: Government Debt in Australia is the third report in the BCEC’s ‘Focus on the States’ series. It examines the highly topical issue of government debt in Australia, including commentary on the nation’s current debt position, how state and territories compare, whether Australia currently has a debt problem and how debt should be managed over the economic cycle.
Using the latest Australian National Accounts data and Federal and State Budget papers, the report shows that total public debt in Australia has risen to a 15 year high of 18.6 per cent of Gross Domestic Product (GDP). This equates to a net value of $283 billion.
Professor Alan Duncan, BCEC Director, said the current level of public debt in Australia was not unprecedented, however the rapid pace at which debt had accumulated post-Global Financial Crisis (GFC) and the unlikely reduction in debt over the forward estimates, was concerning.
“In light of Treasurer Scott Morrison’s claim that Australia has a spending problem, not a revenue problem, the report looks at whether the responsibility for rising debt lies more on the revenue or expenditure side,” Professor Duncan said.
“We find that revenue and spending should both bear some responsibility for Australia’s growing levels of debt.
“Government spending has been regularly underestimated by at least one per cent of GDP in pretty much every budget since the end of the GFC, with actual spending now hitting 26 per cent of GDP.”
The report highlights that tax revenues have failed to rise above 23.5 per cent of GDP at any point since the GFC, yet the forward estimates in successive Federal budgets consistently target revenues of 25 per cent of GDP.
“Tax revenues at 25 per cent of GDP is simply unrealistic as a target unless significant increases in taxation are being planned,” Professor Duncan said.
“With lower growth prospects and budget forecasts, which history says are unrealistic, important decisions need to be made both on the revenue and spending side to have any chance of hitting the target of budget surplus by 2018-19.
“Revenues at 23.5 per cent of GDP and spending at 26 per cent of GDP is not a recipe for budget balance.
“Simply to commit to spending controls alone, given Australia’s current economic climate, is unlikely to deliver the path to surplus.
“Government spending should be adjusted to accommodate a slowing economy, but this won’t be enough on its own to balance the books at Federal level.
“Reform options will have to be considered to return the economy to surplus and drive down government debt,” Professor Duncan said.
The report found that revenue and spending measures should both be considered in the 2015 Mid-Year Financial Outlook (due to be released in December), however any reforms brought in to increase revenue streams, need to be carefully judged both from the likely impact on growth and also from the distributional side.
The 2015-16 Federal budget specifically commits the government to achieve budget surpluses, on average, over the course of the economic cycle by paying down debt and ensuring that new spending measures are more than offset by reductions in spending elsewhere in the budget.
“The most challenging conditions faced by governments at all levels are caused by a trifecta of sharply declining revenues, large budget deficits and high levels of debt,” Professor Duncan said.
“The prospects for high and rising debt are likely to increase without tighter controls on borrowing and greater accountability for the government’s commitment to balance the budget over the course of the economic cycle.”
BCEC research indicates that the Australian economy has undergone a structural change through the course of the GFC, with output growth dropping by at least 0.5 percentage points from 3.25 per cent to 2.75 per cent.
“The traditionally held notion of a long-term real GDP growth rate of 3.25 per cent or more is no longer defensible. Our findings indicate that the current trend growth rate for the Australian economy is between 2.5 to 2.75 per cent,” Professor Duncan said.
“This revision to trend growth is important given the assertion in the 2015 Federal budget that the Australian economy will return to surplus within the next five years.”
The Commonwealth government spent around $14.5bn in 2014-15 on public debt interest payments, equivalent to around 0.9 per cent of GDP. However, debt interest payments are nowhere near the high water mark of 1.7 per cent of GDP (equivalent to 7.1 per cent of total revenue). This reflects the fact that the government pays significantly lower rates of interest on its debt now compared with the
1990’s.
The report cautions against governments accumulating significantly larger debt, even though the current interest rate of 2.7 per cent on Treasury bonds is relatively cheap. To do so, opens up risks should economic conditions deteriorate sharply or should interest rates rise from their current levels.
“Loading up further on debt potentially erodes Australia’s defences against adverse economic shocks,” Professor Duncan said.
The Golden Rule is a device that has been invoked at various times in jurisdictions around the world as a guiding principle for the management of public finances. The basic premise of the Golden Rule is that the government budget, net of investment, should balance over the course of the economic cycle.
“It is hard to escape the conclusion that Australia has departed from the fiscal disciplines of a balanced budget over the course of the economic cycle,” Professor Duncan said.
“More prescriptive debt stabilisation mechanisms, such as the ‘debt brake’ introduced in Switzerland in 2003, could serve as a means for Australia to bring about greater control of government debt.
“In our view, it is worth considering whether a more prescriptive fiscal framework would deliver more control.
“Debt brake mechanisms force governments to be more disciplined and save during the good times, and not to give in to the temptation to increase spending to match revenues over the course of an economic upturn,” Professor Duncan said.
The BCEC report found overall public sector debt held by Australia’s states and territories has increased over the past decade. In 2013-14 public sector debt for all states and territories combined totalled $111bn, equivalent to 7.3 per cent of GDP.
Western Australia has seen a large increase in net debt relative to state revenue, more than doubling from 25 to 67.9 per cent in the ten years to 2014-15. This has seen Western Australia move from third to second place when ranked on the level of net debt.
Queensland increased its public debt by 90.3 percentage points relative to state revenue between 2004-05 and 2014-15. Victoria is now ranked first in terms of overall public non-financial sector net debt, which constitutes 68.4 per cent of revenue.
“Public debt payments relative to state revenue and output have increased for all states and territories since the GFC, with the exception of Tasmania. Queensland and the Northern Territory currently have the highest public debt payments relative to total income”, Professor Duncan said.
“However, the current position of states and territories is not the worst it has been, with expenditure on public debt at the end of the 1990s typically higher than those we observe today.”
Spending on public debt interest in Western Australia started from a relatively low point, but has increased from 0.37 to 2 per cent of state revenue between 2007-08 and 2014-15.
Key findings and additional information are attached below.
Notes to editor:
The Bankwest Curtin Economics Centre is an independent economic and social research organisation located within Curtin Business School at Curtin University. The Centre was established in 2012 with support from Bankwest (a division of Commonwealth Bank of Australia) and Curtin University.
Selected charts from the report are provided with this release. Hi-resolution versions of all tables and charts in the report are available on request.
Key Findings:
Concepts of Public Debt
- Defining and conceptualising public debt is important in order to measure adequately the extent and consequences of public indebtedness, its drivers, and potential policy responses.
- Public indebtedness can be assessed in a number of ways: by type of financial instrument; level and institutional sector of government; and as a share of national income, GDP or government revenue.
- At its most basic, public debt consists of all liabilities that require payment or payments of interest or principal by the government to its creditors.
- Since the Global Financial Crisis, there has been a greater focus on public debt and the adequacy of current debt management controls.
- The International Monetary Fund (IMF) recommends that general government gross debt be adopted globally as a headline indicator of a country’s fiscal position.
Government Debt and the Business Cycle
- Any discussion of government debt and Australia’s fiscal position must be considered relative to the business cycle.
- A rising level of debt should be expected at certain points in the business cycle and may be desirable, particularly in economic downturns.
- The Structural Budget Balance (SBB) adjusts actual and forecast figures for the underlying cash balance to account for variations in key cyclical drivers.
- Using the SBB, a structural deficit indicates that the Federal budget balance is below expectations given the point in the economic cycle.
- Trend growth has declined since the start of the Millennium and is currently estimated at around 2.5 to 2.75 per cent.
- The Australian economy remains below trend even with this downward adjustment to trend real growth.
- Progress towards a surplus by 2019-20 is predicated on average annual growth of 3.5 per cent over the next five years, yet only five of the last 30 quarterly measures of GDP growth from June 2008 have exceeded three per cent.
Australia’s current debt position
- Today’s public debt represents the accumulation of consecutive budget deficits post-GFC at both Federal and State levels.
- Total Australian public sector debt (at all levels of government) has climbed to a 15-year high of 18.6 per cent of GDP and 46.8 per cent of total revenue.
- Net general government debt as a share of GDP currently sits at around 12.5 per cent and has climbed rapidly from a low of -3.8 per cent in 2007-08.
- The 2014-15 value of Commonwealth general government net debt has been finalised at almost $239 billion.
- Government net debt as a share of revenue has seen the most rapid increase since the GFC, jumping from -15.2 per cent in 2007-08 to 63.1 per cent in the 2014-15 final budget figures.
- Both Commonwealth and State debt positions have deteriorated post-GFC.
- Public non-financial corporations constitute a greater share of net debt at the State level compared with the Commonwealth, with the share having increased gradually over time.
- General government sector debt at both State and Commonwealth levels has increased the fastest in the last ten years.
- From 2004-05 to 2013-14, State general government net debt increased from 13 to 16 per cent as a share of revenue.
- At the Commonwealth level, general government debt has increased by 14 times the amount ten years ago from 3.6 to 52.1 per cent of revenue.
Debt Servicing – Commonwealth
- The Commonwealth government spent around $14.5bn in 2014-15 on public debt interest payments, equivalent to around 0.9 per cent of GDP.
- Public debt interest payments, although rising, are nowhere near the 1996-97 high water mark of 7.1 per cent of total revenue (1.7 per cent of GDP).
- Measured as a share of GDP, the 2014-15 stock of public debt in Australia is worth 86 per cent of debt in 1996-97, yet 2014-15 debt interest payments are only 41 per cent of the 1996-97 payments.
- This reflects the fact that the government pays significantly lower rates of interest on its debt now than in the 1990’s.
Is it an Expenditure or Revenue problem?
- Government revenue streams can be highly responsive to changes in the economy, but spending is typically more entrenched and harder to adjust quickly.
- Spending cuts are not always desirable in response to an economic downturn.
- The Commonwealth government received revenues of $378.3 billion in the 2014-15 financial year – equivalent to 23.5 per cent of national output.
- There has been a decreasing reliance on individual income tax as a source of revenue, shifting from around 14 per cent of GDP to 11 per cent in 2014-15.
- GST revenue increased from 2 to just over 4 per cent of GDP at the time of the ANTS package, easing to a current share of 3.4 per cent of GDP.
- Company tax revenues increased from 4.5 to 7.2 per cent of GDP during the period of economic growth between 2001-02 and 2007-08.
- Company tax revenues have fallen since 2007-08 – apart from a short recovery in 2009-10 – and currently stand at 4.1 per cent of GDP. Commonwealth government spending totalled nearly $418 billion in 2014-15, or 26 per cent of GDP – this translates to around $46,000 per household or $17,622 for every Australian resident.
- The combination of social security and health spending comprises more than half of all spending.
- Social security spending has decreased over the last 15 years from 38 to 35 per cent of GDP, while health spending has increased.
Predicting the future
- One of the difficulties faced by successive governments in setting fiscal policy has been to predict accurately future revenue and expenditure.
- Tax receipts were consistently underestimated prior to the GFC and consistently over-estimated post-GFC.
- Despite a long-term revenue trend of 23.5 per cent of GDP – and only two periods prior to the GFC where revenues were significantly atypical – consecutive budget projections of future revenues continue to reach for an above-trend target of around 25 per cent of GDP.
How do the States fare?
- Public non-financial corporations play a much larger role at State than Commonwealth level, and are responsible for more net debt given States’ borrowing to fund significant capital works investment.
- Overall public sector debt held by Australia’s states and territories has increased over the past decade.
- In 2013-14 public sector debt for all states and territories combined totalled $111bn – or 7.3 per cent of GDP.
- Queensland’s public non-financial sector net debt increased by 90.3 percentage points, from -25.2 to 65.1 per cent of revenue in the ten years to 2014-15.
- Western Australia has seen a large increase in net debt relative to state revenue, more than doubling from 25.0 to 67.9 per cent in the ten years to 2014-15. This has seen WA move from third to second place in the ranking of net debt.
- Victoria’s net debt has increased from 12.1 to 68.4 per cent in the last ten years and is currently ranked first.
- South Australia increased its public debt from 15.5 to 61.9 of state revenue between 2004-05 and 2014-15.
- Public debt payments relative to state revenue and output have increased for all states and territories since the GFC, with the exception of Tasmania.
- The current position of states and territories is not the worst it has been, with expenditure on public debt at the end of the 1990s typically higher than those we observe today.
- Victoria and Queensland have experienced considerable growth in public debt transactions relative to state output since the GFC.
- Queensland and the Northern Territory currently have the highest public debt payments relative to total income.
- Spending on public debt interest in Western Australia started from a relatively low point, but has increased from 0.37 to 2 per cent of state revenue between 2007-08 and 2014-15.
- New South Wales has seen spending on debt servicing increase over time relative to revenue; however, this trend started well before the GFC and remains flat compared to other states and territories.
International Comparisons
- Australia has consistently ranked low by international standards in terms of gross debt levels relative to national output, with the IMF estimating gross debt-to-GDP at just over 30 per cent.
- This compares starkly with the United Kingdom, where gross debt-to-GDP stands at more than 90 per cent.
- Almost all OECD countries have experienced an increase in public debt relative to national output since the GFC, with Switzerland being an exception.
- The margin between gross and net debt in Australia has fluctuated between 10 and 20 percentage points over the past 25 years, increasing over the GFC, but tapering off since.
The Golden Rule
- The basic premise of the Golden Rule is that the government budget (net of investment) should balance over the course of the economic cycle.
- Governments should borrow only to invest – up to a prudent level – and should not use debt to fund recurrent spending commitments.
- A budget deficit is acceptable at low points in the economic cycle, and indeed may be necessary to support recovery.
- The quid pro quo, however, is for governments to target budget surpluses when the economy is operating above trend, and for these to be used to balance the budget over the full cycle.
- In Australia, the prescriptions in the Charter of Budget Honesty Act 1998 lays out a number of principals for sound fiscal management, including commitments aimed at: maintaining Commonwealth general government debt at prudent levels; moderating cyclical fluctuations in economic activity; and managing risks arising from excessive debt.
- While Treasury forecasts a return to structural balance by 2018-19, the IMF figures predict a reversal from 2015-16 to reach a structural deficit of nearly 2 per cent by 2018-19.
- Looking at the public finance outcomes over the course of the post-GFC cycle from June 2011 to March 2014, it is hard to escape the conclusion that Australia has departed to a greater degree from the fiscal framework provisions of a balanced budget.
Fiscal Policy Biases and Solutions
- Without measures in place to hold governments to account on their public financial management, the fiscal disciplines required by those governments are likely to be more loosely adhered to.
- A number of countries have embarked upon prescriptive fiscal strategies, often enshrined in a range of accords, formal agreements and legislative measures.
- Switzerland introduced a debt brake mechanism in 2003 that places a ceiling on government spending so that it does not exceed structural revenue.
- Debt brake mechanisms enforce fiscal disciplines during periods of relatively high economic growth.
- BCEC modelling of a prospective debt brake mechanism for Australia simulates the potential impact of a debt brake for Australia starting the debt brake regime at three points – 2002, 2008 and 2011.
- Indicative simulations show that a debt brake for Australia from 2002 would have restricted spending during the growth period from 2002 to 2007 and kept the deficit closer to balance over the more challenging economic period from 2008.
- According to BCEC simulations, a debt brake would have limited the 2014-15 Federal budget deficit to around $17bn – a reduction of more than 50 per cent on the actual deficit.
- Simulating debt brakes is limited by the difficulty in predicting the effects of spending restrictions on economic performance, demand or revenues.
