In recent elections, cutting government spending has become
a political taboo. Who can forget the Labor Party’s fear inducing “cut to the
bone” slogan? The reality of Australian state and federal governments is that there
is always inefficient and wasteful spending occurring. It is a certainty that
taxation revenue will be squandered because unlike a business or an individual,
there are no market prices or accurate profit and loss statement to tell the
government if resources are being used efficiently. How do we know what a
customs/border security officer is worth? Without market pricing there will be
inefficiencies that are usually ignored because the government of the day will
always prioritise the political solution over the economic solution.
This post will outline wasteful spending and that there is
ample room for reducing government expenditure.
Currently, the federal government is forecast to be in
surplus by 2016. This will not happen simply because recessions or financial
crisis are likely to occur between now and then. The negative impact of such
risks has been ignored when forecasting the budget trajectory.
Recessions are never predicted in advance, which means that
forecasts are always optimistic. This is why I doubt Australia will run a
surplus in the next 10 years. Consider that for most of 2010 and 2011 the
Australian Treasury forecast that they would have a surplus in 2012-13 only to
abandon that prediction at the end of 2012!
It was only a year or two ago, these same mainstream
economists were saying running deficits are okay during “low-growth periods”.
But what if these are the good times and the worst is yet to come? It means
that the deficits will grow and we will enter a debt spiral in which deficits
cannot be contained without political blowback and the debt balloons into the
stratosphere. Eventually, markets lose confidence and interest rates spike as
the threat of default looms. The fallacy that people make when thinking about
debt crises is that the problem does not start when rates spike but in the
years prior when debt accumulates. It is still early days but remedial action
needs to be taken now before the government is left to the mercy of the
markets.
But why cut spending and not increase taxes? The simple
answer is that the economy grows when the private sector is free to invest
capital at high rates of return. A crude example is if a business can invest
and generate 20% ROI, while the government builds a highway that collects tolls
and generates 5% ROI. Then the private business should invest that money
instead of the government taxing or borrowing from the private sector to
deliver lower returns. This is fundamentally why increasing taxes is the worst
way to reduce the deficit. Cutting spending is the best path to balancing the
government budget. There is plenty of waste, fraud, abuse and middle class
welfare which can be eliminated to deliver instant expense reductions:
Political remedies to
cutting spending
Of course the government is constrained politically in cutting government spending because there will be some interest group that will
protest less money flowing their way. The best way to reduce the political
blowback is by reducing spending and reducing taxes simultaneously. For
example, if $1,000 in government expenditure is cut, reduce taxes by $500 and
use the remaining $500 to reduce the deficit. As the deficit is reduced further
the tax reduction can increase to make further cuts more appealing. For
examples if the deficit is relatively small then a $1000 reduction in government
spending can then be used to reduce taxes by $800 and the deficit by $200.
This is why the austerity measures in Europe have been
unpopular and ineffective. The European governments reduced spending and raised
taxes which slowed the economy and resulted in political turbulence. By cutting taxes in tandem with government expenses, the political cost is reduced and the economy benefits.
But where to cut? As you can see from this chart that the major growth in
expenses over the next three years comes from social security welfare, health and education. They are not
in percentage terms but it does show where the budget is bleeding the most in
dollar terms:
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| Source: Budget Paper 1, Statement 6, page 10 |
The table below shows the top 20 expenditures for the
federal government. GST distributions are at
the top with $51bn going to the states, followed by the pension and family tax
benefits. This highlights the burden of the welfare state that will sink the
Australian budget if spending is not reduced or made more efficient:
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