RDP 2011-07: Australia's Prosperous 2000s: Housing and the Mining Boom 6. Fiscal Policy
December 2011
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One of the most striking differences between macroeconomic policy in Australia and that in most other developed economies is the way in which fiscal policy has been conducted over the past couple of decades.[14] In the 11 years to 2007/08, the Australian Government ran budget surpluses on 10 occasions, and by 2005/06, the Government had no net debt (Figure 12).[15] In contrast, most countries in the OECD have consistently run budget deficits, with the aggregate debt-to-GDP ratio showing little change over the two decades to 2007, before increasing sharply during the financial crisis (Figure 13).
It is difficult to pinpoint the reasons why fiscal policy in Australia has been conducted so differently to that in many other countries. The strong terms of trade has certainly helped, although the commitment to sound fiscal policy predates, by quite a few years, the big run-up in the terms of trade. Perhaps its origins lie in the debates in the 1980s and early 1990s about the current account deficit. These debates were associated with a sense of national economic insecurity regarding the consequences of high and persistent trade deficits. In the national soul searching that went on at the time, an increase in public sector savings was widely regarded as the most effective way of ‘improving’ the current account deficit. This view coincided with some dissatisfaction with the effects of the stimulatory fiscal policy in the early 1990s.
In retrospect, it is somewhat ironic that when public savings did increase in the mid 1990s there was not a reduction in the average current account deficit. Yet the public commitment to sound fiscal policy that emerged during those years has been highly persistent. Both major political parties have committed to maintain a balanced budget over a run of years, and there is broad public support for this approach.
Against this backdrop, three fiscal issues have attracted considerable attention at various points over the decade: (i) the role that fiscal policy can play as a countercyclical tool; (ii) the appropriate use of the revenue from the resources boom; and (iii) the role of public debt in financing public sector infrastructure.
For some years up until the crisis, the conventional wisdom was that fiscal policy's role as a countercyclical tool was limited to allowing the automatic stabilisers to work. Using discretionary fiscal policy was seen as too difficult from both a political and implementation perspective. The financial crisis in 2008 changed this, with many countries implementing large fiscal stimuli, under the imprimatur of the IMF and the G-20. The stimulus in Australia – equivalent to around 6 per cent of GDP – was one of the largest in the world. It was also the largest discretionary easing of fiscal policy in at least two decades.
One reason that Australia was able to implement such a large stimulus was that public finances were in sound shape prior to the crisis; unlike in many other countries, the fiscal response was not constrained by concerns about medium-term fiscal sustainability. Whether this episode marks a return to more activist fiscal policy though remains to be seen. In many respects the circumstances that led to the stimulus were highly unusual: a crisis in the global financial system, a very large increase in uncertainty and risk aversion, and a collapse in international trade. These events were easily identified and were not the result of domestic factors, thus overcoming some of the hurdles that can limit the fiscal response to a deterioration in economic activity.
A second issue has been how the proceeds of the resources boom should be used. In the period from 2004 to 2008, the strong growth in nominal income generated strong growth in tax receipts. This growth in revenue was used to fund significant cuts in income tax and increase transfer payments to the household sector, as well as to build up assets in a number of funds. While estimates of the structural budget position during this period are very sensitive to assumptions about the ongoing level of the terms of trade, most estimates suggest a deterioration during the latter part of this period, although the actual surplus remained around 1½ per cent of GDP.
During this period there was some debate as to whether the fiscal proceeds from the strong economy should have been used in other ways. A similar debate has resurfaced over the past year or so when considering how the proceeds of the current resources boom should be dealt with if the boom continues. One perspective has been that some of the proceeds should be allowed to accumulate in a fund to support future spending. The argument here is that, given the uncertainty about the longevity of the resources boom, it might be prudent to increase public-sector saving to smooth public expenditure and support the economy if the boom were to unexpectedly end.[16] A related argument is that saving the proceeds could take some of the pressure off aggregate demand. On the other hand, one counterargument is the boom is expected to be highly persistent and thus accumulating revenue in a fund would be an inappropriate transfer from current taxpayers to future taxpayers. Another argument has been that using growth in revenue to fund tax cuts would help improve the incentives for work and promote growth in the economy.
A third issue has been the role of the public sector in infrastructure provision. From the mid 1980s until around the mid 2000s there was a steady decline in public investment relative to GDP, largely due to declining investment by state governments. A number of these governments have limited the borrowing that they have been prepared to undertake for public infrastructure, partly due to concerns that increased borrowing could jeopardise their high credit ratings. While this approach has ensured that state government finances have remained generally sound, its critics argue that it has led to projects not being undertaken that have social rates of return considerably higher than the cost of borrowing.[17] The aversion to debt also saw strong growth in public-private partnerships as a way of funding infrastructure, with mixed results. An issue over the coming decade is likely to be how to fund public-sector infrastructure and the appropriate size of public-sector balance sheets.