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1.3 The fiscal strategy and outlook

In recent years, Commonwealth spending has outpaced revenue collections. An underlying budget deficit of $47.0 billion, or 3.0 per cent of GDP, is expected this year. This is the sixth consecutive budget deficit. We have spent beyond our means for too long.

At a time of continuing economic growth and emerging challenges arising from our ageing population, a prudent fiscal strategy requires the delivery of sustained budget surpluses. After years of growth and a sustained period of high terms of trade, Australia’s fiscal position should be much stronger than it is.

A disciplined approach to fiscal policy is essential. Keeping the nation’s finances under control allows a country to set an ambitious course for itself. A strong budgetary position is a pre-requisite for managing the volatility that arises from Australia’s exposure to sudden movements in its terms of trade.

For the past 25 years there has been bipartisan support for fiscal policy guided by established rules and set with an eye to the medium term. This strategy is based on an approach of generating budget surpluses on average over the course of the economic cycle and reducing government debt. However, in recent years, the strategy was discarded.

Now the Abbott Government has stipulated a budget surplus equivalent to 1 per cent of GDP prior to 2023-24. The Commission regards this as a prudent, achievable and sensible goal. The Australian economy has enjoyed this degree of strength in the past. That strength provided us with a buffer against the global financial crisis.

With no further global or domestic shocks, a path to surplus will allow us to pay down our debt and over time eventually build reserves to better meet the next inevitable economic downturn.

Achieving this is a significant challenge given current spending commitments and recognising the recent relative weakness in Commonwealth revenue collections.

This Audit has not considered in detail revenue issues and reform of our complex taxation system, which are more appropriately dealt with in the forthcoming White Paper on Australia’s Taxation System.

To assist in its deliberations, the Commission has prepared two illustrative fiscal scenarios - a ‘Business as Usual’ scenario and a ‘Reform’ scenario.

These scenarios provide high level guidance and should not be perceived as providing detailed projections.

A key assumption underpinning both scenarios is that substantially higher taxes are not used as the principal means of repairing the Budget. Instead taxes are assumed to recover in line with a growing economy to reach a share of GDP in line with historical averages (of 24 per cent of GDP). The tax share is then projected to remain at that level reflecting an assumption that additional tax collected from bracket creep is returned to taxpayers.

If adjustments are not made for bracket creep the Commission estimates that a person earning the average wage and currently facing a marginal tax rate of 32.5 per cent will be taxed at a 37 per cent marginal tax rate by 2023-24. The marginal tax rate for a person on the minimum wage would rise from 19 per cent now to 32.5 per cent well before 2023-24.

Given what we reasonably know about trends in Commonwealth spending, and holding to the cap on tax collections, the ‘Business as Usual’ Scenario would see the Commonwealth’s Budget remain in deficit out to 2023-24 and beyond. If this eventuated Australia’s taxpayers would be exposed to an unprecedented run of 16 consecutive years of deficits, with net debt rising to almost 17 per cent of GDP or $440 billion in today’s terms.

An alternative pathway that achieves a surplus will require a concerted effort to restrain spending with this restraint commencing within the next few years. This pathway would require unprecedented and consistent fiscal discipline and is reflected in the Commission’s ‘Reform’ scenario. It projects a surplus of 1 per cent of GDP by 2023-24.

The Commission is not proposing a programme of austerity. Far from it.

Our recommendations can be implemented incrementally and in a way that does not harm the economy. In fact, taken together they should strengthen the economy.

Doing nothing is not an option. If these policy reforms are not undertaken now the size of the savings task will continue to grow and we will place an unfair burden on our children and their children. If we leave the task the future cost and disruption will be far greater.

By reducing expenditure, as well as red tape and compliance costs, government can make room for the private sector, which in many cases is better placed to deliver services more efficiently.

We must also recognise the primary role that monetary policy plays in keeping the economy strong. The current monetary policy stance will support businesses and the broader economy during this period of transition. Fiscal restraint by the government will help keep interest rates low over this time.