The Treasury Nightmare :the Government’s Accounts Are Heading into Dangerous Territory.

Listener: 21 March, 2009.

Keywords: Macroeconomics & Money;

Until recently, government revenue was in the happy position of being a little more than government expenses. But, unfortunately, the forecast is ominous.

The Treasury is picking that government expenses will continue growing after 2008, broadly following the trend of the past few years, but thinks the revenue (mainly from taxes) will stagnate through to 2011, partly as a result of the recession but also because of the various income tax cuts.

If, as expected, the economy moves out of recession from 2010, the Government’s revenue will remain below its expenses (see graph), and the small surpluses of the past eight years will be replaced by an ongoing structural deficit of about $7 billion a year. The recovery will fail to claw back the revenue losses from the tax cuts.

The Government might be able to borrow $7 billion in a few exceptional years (especially to cover a recession); “might” is the operative word. Borrowing that amount every year will be difficult – probably impossible. The debt servicing will become unmanageable as the Government sees its debt rapidly growing and its net worth diminishing.

It’s the Treasury nightmare. It has happened before – in the 1970s. The gap was largely covered by double-digit inflation, which acted like a tax on those who held fixed-interest deposits and the like. Whether we have that option in today’s globalised world with its fluid financial markets is not obvious. But even if it were feasible, inflation is not a strategy that has much to commend it. The 1970s structural deficit was addressed by the Ruth Richardson measures of 1990 and 1991; their painful memory lingers on.

Of course, we might hope, Micawber–like, that something will turn up. (Optimists have been promising higher productivity growth for almost 50 years.) But that is hardly a prudent strategy, and since the figures are the Treasury’s central forecast (and not its upside or downside scenarios), something might turn down instead. In any case, most religions have the sentiment that God helps those who help themselves.

An obvious solution would be to cancel the upcoming income tax cuts, treating this as a temporary measure to ease us through the recession. But the Government has rejected this option, which is forcing it to consider cutting spending.

A number of commentators have questioned whether spending cuts should occur during the recession. The Government seems to take the view that any savings can be temporarily used for infrastructural investment – bridges here, bypasses there. And as the economy recovers, the excess spending can be turned off, unlike with the spending the Government hopes to cut.

The total amount of spending that needs to be cut – about 10% of total expenses – is daunting. It won’t be resolved by the usual reprioritisation programme in which an incoming government cuts some of the previous government’s spending, and puts in its own favourites instead. Such cuts are marginal anyway.

It won’t be resolved by selling (privatising) public assets. That is just a temporary alternative to borrowing, and there is only a limited amount of family silver that can be sold.

A 10% government expenses cut will almost certainly have to heavily target the big ticket items of education, health and welfare. That will involve cost shifting from the taxpayer to the general public, which means different people will be affected differently. Making us pay for our own health is a tax on the sick. Requiring us to take out private health insurance is a tax by another name.

I can’t see the problem being resolved unless the Government raises taxes directly in due course (a higher rate of GST is an option), or raises them indirectly by cost-shifting measures. But then I am a realist.

Frankly, if the Treasury’s projections are right, then the deficit problem becomes acute in 2011. The 2011 election is likely to be fought between the Micawbers of the right and the Micawbers of the left.
In David Copperfield, Wilkins Micawber spent time in a debtors’ prison, and ended up emigrating to Australia.

He also said: “Annual income twenty pounds, annual expenditure nineteen nineteen six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.”