Geoffrey Garrett

This week’s Australian Budget was clearly highly political. The question is what its economic impact will be.

My overall assessment is that the Abbott government has burnt too much political capital for too little economic gain.

Tony Abbott is likely to be hoisted on his own petard. He won office by attacking Labor for creating a budget emergency and by focusing on former prime minister Julia Gillard’s broken promises.

But there is no budget emergency and Abbott’s record of broken promises seems broader and more systematic than Gillard’s slippage from a floating to a fixed carbon price.

The combination of broken promises that hurt the Howard battlers will haunt the government. This means very heavy political sledding for Abbott, particularly tough given how poorly his government did in its first six months and his and his party’s attendant slide in the opinion polls.

But irrespective of the fate of the government, the biggest casualty is that no one will have any appetite to take on the fundamental structural issues everyone on both sides of politics knows must be on the agenda.

Increase and broaden the GST. Empower or emasculate the states in health and education. Tighten pensions and tax superannuation. Not to mention the across-the-board deregulation needed to promote innovation, competition and, ultimately, productivity.

This is really what Treasurer Joe Hockey’s consistent narrative on ending the age of entitlement is all about. The Budget was supposed to be the first step, with relatively small (1%) GDP improvement over the four years of the forward estimates, a signal of more to come in the out years, and a provocation to start a mature political discussion of the really big issues.

Instead, the political debate will focus on relatively minor changes in policy inflamed by charges of broken promises.

Doing nothing, we were told, was not an option for Australia. Well, the Budget did something. The problem is that it did too much for electoral comfort but too little for structural economic change.

Take the decision to reverse the Gillard/Rudd commitments on increased funding to the states for healthcare and education.

Hockey has been in your face to the states in the past 24 hours, telling them health and education are their problem and they should raise their own revenues to fund them.

What Hockey seems to be doing is provoking the states, mostly with fellow travelling Centre-Right governments, to build the case for increasing the GST — collected in the states for spending in the states.

But the premiers know this is politically radioactive on multiple dimensions. The much safer path for them is to blame Abbott for insufficient funding from the Commonwealth.

The end result will be lots of political pain all around. Poor delivery of key services at the state level. No fundamental tax reform.

There seem to be only two ways the Budget won’t have this bad outcome.

The better alternative, for everybody, is that the Australian economy bounces back very strongly in the next 18 months. Unfortunately, this seems unlikely given that the US Federal Reserve’s commitment to tapering will push up interest rates around the world, with China’s Xi Jingping doing all he can to resist the temptation of another 2009-like stimulus as 7%, not 12%, becomes the new normal for Chinese growth.

The worse alternative, much worse, is a real economic crisis, like that driven by the last real root and branch reform of the Australian economy — the very tough budgets and radical regulation of Paul Keating’s “banana republic” reformism of the mid 1980s.

Australia is fortunately in a much stronger position today than it was then. The ironic downside to this is that the country just doesn’t see a major problem with how the economy is tracking.

The term “too good a crisis to waste” was gallows humour in many Western countries in the dark days of 2009. But some did use the crisis fundamentally to restructure their economies. There was no crisis in Australia, just an acceleration in the spending that began in the latter Howard years.

Fast forward to today. Hockey and Abbott did more in the Budget than Australia was comfortable with but less than we need. They may end up being political casualties, but in the long run the country will be the real loser.

Professor Geoffrey Garrett is the dean of the Australian School of Business at the University of NSW. This opinion piece has appeared on The Conversation.

Richard Holden

You can’t fault a treasurer for trying to put the best possible spin on Budget numbers — and that’s certainly what Joe Hockey has done.

The most important numbers, of course, are the deficit projections  – A$49.9 billion this year, falling to A$2.8 billion in 2017-18, the final year of the forward estimate period. Quite a hockey-stick.

Looking at the forecast numbers in a chart reveals a nice, smooth, downward, exponential pattern. And that is no accident.

But as always, the future amount of revenue and expenditure that the Budget deficit stems from are uncertain. Revenues largely come from tax receipts and they depend critically on how fast the economy grows. Expenditures are a little more certain, but again depend on factors such as the unemployment and inflation rates.

The Budget estimates assume GDP growth of 2.5% next year, increasing to 3% and then 3.5% over the forward estimates period. And that’s where the rabbit goes into the hat in Hockey’s deficit forecasts.

It would be hard to argue that growth will be much higher than 2.5% next year.

First of all, estimates for the near future are almost always better than those for the medium and long term. Second, there is a pretty strong consensus among economic forecasters that growth won’t be higher than 2.5%. What about the 3.5% GDP growth assumption for 2016-17 and 2017-18?

Well, it could happen. It would be nice if it happened. It would also place Australia among the fastest growing advanced economies in the world. In short, it’s no sure thing.

On the flipside, cost growth is assumed to be relatively contained. Inflation is assumed to be 2.5%, which is not a crazy assumption, but actual inflation could certainly be higher. Since a range of benefits expenditure is linked to the Consumer Price Index, this is an important driver of government expenditures.

The bottom line is that the nice, smooth, exponential decline in forecast deficits comes from just that — forecasts. And while those forecasts do involve a great many detailed categories, they are far less “bottom up” than, say, a household budget.

Assumptions are made on macroeconomic aggregates like GDP growth and inflation, not how much a family’s health insurance or mortgage payments will cost. And while that’s inevitable, it does mean that there is a lot of uncertainty about those future numbers. They could be better, but they could be significantly worse.

Then there’s the claim about debt levels: both what was inherited from the previous government and where it will go in the coming years. Where it will go depends on the actual deficits over the forecast period, so it depends on the factors just mentioned.

As to the line that the current government “inherited $667 billion in debt” — well that’s false. And it’s false for multiple reasons.

The number is a projection for government debt at the end of the decade, it includes a range of actions by the current government (such as paid parental leave, removing the carbon and mining taxes, direct action on climate change, and others), it is not relative to GDP, and most importantly it is a projection about gross debt, not net debt.

Net debt compared to GDP is what matters. Net debt is basically what we owe minus what others owe us. Gross debt is not relevant for our credit rating or ability to service debt.

Indeed, when the government talks to ratings agencies and investors it talks about net debt. International agencies such as the International Monetary Fund and the OECD always focus on net debt — they barely mention gross debt.

Moreover, net debt to GDP is what matters. Telling me that your mortgage is $250,000 is not very informative. If you have annual income of a million a year that’s not very much debt. If you make $70,000 a year it’s a lot.

Our net debt to GDP is about 12%. It’s the third lowest in the OECD, where the average is about 50%. It’s lower than Germany, the UK and the US — and lower by a very wide margin.

It’s tempting to call Hockey’s claim that Australia has a debt crisis “fuzzy arithmetic”. It may be fuzzy, but it’s certainly not arithmetic. It’s just wrong.

So, what does this all mean for the Budget next year? Actually, probably not that much. Many of the cost-saving measures come into place (such as the age pension eligibility age) after the likely life of this parliament, let alone next year. The one thing next year will reveal is how the forecasts are looking. We’ll have a better fix on the magic 3.5% GDP growth number.

We should all hope it pans out. Hockey certainly should. He’s wagered his political credibility on it.

Richard Holden is a professor of economics at the Australian School of Business. A version of this post has appeared on The Conversation.

Geoffrey Garrett

This week’s Australian Budget is only the first act in the big economic drama that will take many years to play out. What kind of country does Australia want to be and what is the role of government in getting there?

Most Australians seem, largely without knowing it, to want to follow the script Germany is writing, growing its way out of post-GFC debt through high value-added exports to China while holding the line on pre-crisis taxing and spending policies.

Though the debt mountain is higher and the fiscal tinkering has been greater, this is also America’s strategy. The US is hoping that breakthrough innovations as different as WhatsApp and shale gas will drive faster growth and smaller deficits.

Prime Minister Tony Abbott apparently thinks Australia should instead emulate Ireland, committing to sustained radical surgery on the budget as a way to wipe the slate clean for an economy that is open for business.

Australia is unlikely ever to play out the Greek tragedy of being forced into painful austerity by a massive vote of no confidence from global financial markets.

Do nothing and Australia might instead risk becoming Japan, slowly sinking into the Pacific; or France and Japan, increasingly meccas for cultural tourism and little else. In these countries, very high standards of living will inevitably erode because of an unwillingness to make the big fiscal changes necessary to jump-start growth. But the decline will be gradual and comfortable, not falling off a cliff.

So what should Australia do? Gallic do-nothing is not an option. Irish austerity runs big risks. The right path for Australia is Germanic. But this means getting serious about creating a platform for sustained growth.

To understand Australia’s predicament, it is necessary to step back from the intense politicking of the past few weeks. The clear reality is that Australia is facing the same challenges as the rest of the West, for essentially the same reasons.

Everyone spent heavily, ensuring the GFC did not metastasise into a second Great Depression. The timing of this stimulus-induced fiscal overhang couldn’t have been worse because baby boomers have started to retire, driving up the cost of healthcare and retirement incomes while shrinking the tax base.

At this point, national trajectories diverge. According to the IMF, on top of more than 20 years of stagnation, Japan is condemned to annual growth rates under 1.5% into the indefinite future. But raising taxes and cutting spending has proved too hard for Japan, resulting in net public debt of more than 140% of GDP by the end of the decade, on IMF projections. Things are not much better in France and Italy, with high and rising public debt and anaemic growth as far as the eye can see.

Australia is much better placed. On current (pre-budget) policy settings, our net public debt by 2019 is expected to be 20% of GDP, with growth above 2.5% a year until then. True, our debt has risen dramatically since the GFC. But we are not Ireland.

The GFC killed the long Irish boom driven by Wall Street-like finance. Economic growth in Ireland plummeted from +5.5% in 2006 to -6.4% in 2009, compared with 2.7% to 1.5% in Australia.

Irish government spending mushroomed from 34% of GDP in 2006 to 65% through massive bank bailouts and aggressive stimulus. This ravaged the Irish public balance sheet. In 2006, Ireland rivalled Australia for the advanced economies with the lowest public debt. By 2010, Irish public debt had risen to 70% of GDP. It is expected to peak at more than 100% of GDP next year, six times Australia’s.

No wonder the Irish government is in its eighth straight year of austerity budgets.

Contrast this Irish carnage with the stability of the German economy. Its public debt rose from 53% to 58% of GDP during the crisis and is projected to decline to 40% by the end of the decade.

Many in Australia deride the US as an economy in decline with a broken political system. True, American debt has close to doubled since 2006, reaching about 80% today. But the cataclysm facing the US was extraordinary, and America’s fiscal position is now improving quickly.

The key to the rosy prospects of Germany – and America – is growth. In Germany’s case, led by exporting high value-added manufactures to China. In America’s, catalysed by energy independence and app-created billionaires.

This is where Australia should go, too, but we need to get much more serious about growth and worry less about the numbers on the budget page.

We talk a good game about life beyond the mining boom and the productivity and creativity of our service sector. But much of our innovation is in raw materials (driving trucks in the Pilbara from Perth desktops). And our cost base (big distances and lots of regulation, not just high wages) hurts competitiveness.

The government must tackle our demographic demons before they become too scary.

Raise the pension age, tax superannuation more, broaden and increase the GST, cut waste in the public service, add more user-pay provisions to health and education. But over time, not budgetary shock therapy.

Focus on growth-enhancing policies. Don’t prop up jobs in declining sectors or try to pick winners in advanced manufacturing. Build a platform for sustainable long-term growth through better infrastructure, more competition and less regulation.

Professor Geoffrey Garrett is dean of the Australian School of Business. He joins The Wharton School of the University of Pennsylvania on July 1. A shorter version of this post has appeared in The Australian Financial Review.

Tim Harcourt

It’s been a super month for government economic statements in Australia with the long awaited Commission of Audit report being released just ahead of the usual federal Budget unveiling.

The content of the commission’s report was as interesting as its timing, though apart from a bit of unexpected policy freelancing on the minimum wage, it mainly stuck to its brief of addressing expenditure cuts and didn’t touch the revenue side of the Budget.

But what was the reason for the Commission of Audit and federal Budget to be timed together? What was the strategy behind it?

Ironically, the commission’s approach reminded me of the old Builders Labourers Federation (BLF) trade union tactics by putting out a radical wish list of expenditure cuts – like a BLF ambit log of claims – so the federal Government could be seen to bring down a moderate Budget by comparison.

It’s almost a bad cop-good cop routine or, if you like, a rope-a-dope strategy – named after Muhammad Ali’s famous upset win over George Foreman for the heavyweight boxing title in Zaire in 1974.

The strategy goes like this: put out a radical Commission of Audit report to get the opponents and the media throwing punches and by the time you bring down the Budget, the sting has come out of them and the Budget looks meek and mild by comparison.

This is how Ali beat Foreman: getting his opponent to swing all his punches and wear him down. Regardless of the individual merits of the Commission of Audit’s recommendations, it created a flurry of activity and had people talking of overall public sector waste, whether it was true or not on an individual agency basis.

The other part of the strategy has been to float the idea of the “debt levy” to beat the “debt crisis”. Again, the federal government wanted to create an atmosphere of a budget emergency or crisis. And used it to justify a 1% debt levy on taxpayers (deemed to be high-income earners) to help get through the temporary emergency.

But the debt levy makes no economic sense and for several reasons.

First, there is no debt crisis. Australia is not Europe (see my blog, My Big Fat Greek Debt, Explained), we are not America or Argentina (see my blog, Don’t Buy from me … Argentina). The net debt to GDP ratio in Australia is only 11% compared to the OECD average of 50%.

Second, it makes sense for governments to carry some debt. Governments provide the community public goods – defence, border protection, hospitals, education, roads, etc, that can’t be provided by individual firms and households alone. That’s government’s job, and whatever politicians might tell you, the federal Budget is not like your family budget.

There are social returns on public investment that the federal government provides and has done right back to the time of governor Lachlan Macquarie (1810-21) and even before that. Provided the government can service the debt, and get return on its investments in infrastructure with a growth strategy and sustainable and growing export income, it’s a rational and sensible thing to do.

Third, you can’t call a debt levy temporary. It’s not. As my Australian School of Business colleague Richard Holden has pointed out, you can have levies for temporary acts of nature such as a flood or bushfire, but not an open-ended one, especially like the one proposed which simply doesn’t raise enough revenue.

Of course, aside from the shortcomings of the debt levy and the Commission of Audit, there are ways in which governments can structurally change the Budget – such as, taking away high-income super concessions (former treasurer Peter Costello’s Willy Wonka golden ticket to high-income baby boomers); eliminating middle-class welfare (private school subsidies, private healthcare rebate); eliminating some government agency duplication (there are some sensible parts of the Commission of Audit); and reform federal-state relations for the 21st century.

But is there an economic crisis? No, there’s not. Australia’s economic fundamentals are still in good shape. If you look at the most important indicator, the labour market, we are still receiving better than expected news on employment.

The government’s own figures show that the total number of jobs in Australia rose by 14,200 in April to a seasonally adjusted 11.5 million. Inflation is low, wage growth is moderate and even interest rates look like being on hold for a while, and there is now almost a concern they may have to trickle up a little later in the year to clamp down on growth.

Is there a budget crisis? No, there’s not, and there’s certainly no debt crisis despite the atmosphere created by the Commission of Audit and talk of a debt levy.

Tim Harcourt is the J.W. Nevile Fellow in economics at the Australian School of Business and author-host of The Airport Economist.

Dale Boccabella

The tax treatment of family trusts (meaning discretionary trusts) regularly attracts the “tax rort” or the “tax minimisation” criticism. Rarely though are the reasons for the criticism articulated; the criticism(s) remain at the general level. This article provides a foundation for the criticisms.

The key reason for their tax unfairness lies in their flexibility and the fact that tax law permits the flexibility to go unchecked. They allow a given level of taxable income to be split across family members, and thereby accessing multiple tax-free thresholds and multiple low rate bands (income splitting). There is generally no limit on the family members that can be beneficiaries to “receive” income. In addition, if there are insufficient beneficiaries to absorb the income into tax brackets below 30%, then the income can be allocated to a company beneficiary where the company tax rate applies. This caps the tax on this income at 30% (so called bucket companies).

The discretionary trust can also vary the income allocations in subsequent years to take account of changed circumstances of beneficiaries (e.g. reduce an adult child’s allocation this year because they have just landed a high-paying job).

Some argue that the partnership and the company vehicle can also achieve income splitting amongst family members. This is correct, to an extent. But, these vehicles do not have the flexibility that is available through the discretionary trust. Where these vehicles attempt to replicate the flexibility of the discretionary trust, there are often rules that impose a tax charge on such attempts, and there are numerous tax integrity rules that may apply. The key point here is that the discretionary trust is not faced with such tax charges and is not faced with such integrity rules.

Some argue that the current position results in the tax liability “following the money”, and that this is an appropriate income tax outcome.

First, the beneficiary being taxed is very often just the legal owner of the money, and he/she has no real right to enjoy that money. That is, the legal criterion of entitlement to attract tax liability is satisfied, but it is made clear by the controller of the trust and its assets that beneficiaries are not to enjoy the money. Evidence of this strategy comes from the fact that the amount of money “loaned back” by “beneficiaries” to their discretionary trust has reached staggering sums. Thus, calling the current position one of tax liability following the money is hardly accurate.

Secondly, and accepting the legal entitlement approach as appropriate for now, the tax law in this area is actually taxing the recipient of a gift. This is what the beneficiary allocated income in a discretionary trust is getting (i.e. money for nothing). Overwhelmingly, elsewhere in the Tax Act, recipients of gifts are not taxed. Yet, for some reason we do this in the case of a discretionary trust. The Tax Act does tax providers of gifts, but not recipients. A strong case can be made that the controller of the assets in the discretionary trust and/or the person who is the source of those assets and the income thereon is making a gift to beneficiaries.

Thirdly, the tax law is failing to tax the income to the people who contributed the wealth that produced the income. Alternatively, for a testamentary trust (a discretionary trust created under the will of a deceased), the tax law fails to tax the person who controls the wealth that produced the income. In short, in numerous parts of the Tax Act, attempts at alienating or diverting income away from oneself, without the transfer of the underlying wealth that creates the income, are not tax effective. Yet, we permit this in the case of the discretionary trust.

In addition to the above, there are many other rules in the Tax Act that are inconsistent with the tax treatment accorded to the discretionary trust.

Looking outside the Tax Act, and especially in legal regimes that are required to deal with the “ownership” of assets and income in a discretionary trust, we see approaches that are quite at odds with the Tax Act. In the Tax Act, the assets of the discretionary trust are treated as being in “suspended ownership”, and the income belongs to the beneficiary to whom it is allocated.

First, under the assets test for the aged pension, assets held in a discretionary trust can be counted as assets of a person under the assets test if: (a) the assets in the trust are “controlled” by the person or (b) the person gifted the assets to the trust. The key point is that a person who has control over assets of a discretionary trust and/or who contributed those assets is effectively being treated as owning the assets and the income thereon for social security purposes.

Secondly, in the marriage breakdown area of family law, the assets of a discretionary trust could be held to be “property of the parties to the marriage”. This will be the case where a person has the capacity to control the income or capital allocations of a discretionary trust so that allocations could be made to the person. This can be the case even where the person is not the trustee of the discretionary trust, provided that he or she is the appointor (or nominator) of the trust and thereby has the power to change the trustee. Even where a party is not a beneficiary but has the capacity to become a beneficiary, and from there obtain an allocation of assets or income, it will be sufficient to make the discretionary trust’s assets property of the parties to the marriage.

These two regimes do not tolerate the “legal niceties” of the discretionary trust and/or the affront to equity that would otherwise arise if left unchecked. However, the most important of these is the social security treatment of discretionary trusts. The social security system is closely related to, or even the other side of, the income tax (i.e. negative income tax). The two systems both deal with economic capacity. Why a different approach should be taken in each system is not clear.

The above is a brief outline of the favourable tax treatment given to the discretionary trust. But even from this, those criticising the tax treatment of discretionary trusts (family trusts) have a very strong foundation for their criticism. The guiding principle should be that similarly placed activities or transactions should be taxed in a similar manner. It is very hard to see how this is occurring in the case of the discretionary trust.

At the very least, the issue requires a close and independent examination. To the author’s surprise, the Henry Review did not do this. The government’s tax white paper on the tax system should not repeat that failure.

Dale Boccabella is an associate professor of taxation law in the School of Taxation & Business Law in the Australian School of Business, The University of New South Wales, Sydney, Australia

James Morley

In the mid 1990s, The Wall Street Journal ran an editorial with the headline “Bankrupt Canada”. Ratings agencies had recently downgraded Canadian government debt and the WSJ editorial pondered whether Canada would need to be rescued by the International Monetary Fund.

Soon afterwards, the Liberal government of the day put Canada’s fiscal house in order with deep spending cuts and more mild tax increases. Less than a decade later, Canada’s triple-A rating was restored and today it remains a top fiscal performer with a public debt-to-GDP ratio under 40%, compared to its peak at 68% in 1996.

Jumping across the Pacific and fast-forwarding in time, it would seem that Australia now faces a similar existential debt crisis to Canada’s in the 1990s, at least according to the Liberal government of the day here.

But Australians could be forgiven for wondering “what crisis?” in light of a triple-A rating on government debt and a public debt-to-GDP ratio under 20%.

Indeed, the IMF’s recent country report for Australia explicitly states, “Australia’s modest public debt gives the authorities scope to delay their planned return to surpluses”. Unlike with the Canadian fiscal crisis in the mid 1990s, no mention has been made of Australia needing to be rescued by the IMF.

So what’s going on with all of this talk of a budget crisis? It appears that Prime Minister Tony Abbott and his Treasurer Joe Hockey are suffering from what Nobel prize winner Paul Krugman calls “VSP syndrome”. This label diagnoses a tendency for “very serious people” in policy circles to burnish their economic credentials by proposing tough policies, even when these policies do more harm than good.

Abbott and Hockey clearly want to demonstrate their economic courage by making big cuts to spending in order to save Australia from a debt crisis. The lack of an actual crisis is only a mild inconvenience in this narrative.

Now, other very serious people are going to read this and assume I’m foolishly ignoring the looming demographic crisis faced by all major industrialised economies, with dependency ratios set to balloon in coming decades and our ability to fund social services at currently promised levels becoming increasingly difficult. But I’m not ignoring these long-term problems. At some point, entitlements will have to be cut back.

However, broad cuts to spending now and a temporary crisis levy are not long-term solutions to a demographic crisis. They are simply a way for a government to achieve a temporary surplus at all costs. The temporary nature of the so-called “crisis levy” is as clear an indication as possible that the government’s proposed policies are not really about long-term solutions.

The unemployment rate in Australia has been slowly rising during the past couple of years. Given stable inflation, this has led the Reserve Bank of Australia to cut interest rates and keep them low. But the RBA is no doubt worried about the influence of low interest rates on house prices. In an ideal world, they would like to raise rates back to a more neutral level.

But we are not in an ideal world. Indeed, a manufactured fiscal crisis that produces big spending cuts and a temporary crisis levy (which, for fun, I will resist calling a “tax”) will put pressure on the RBA to keep interest rates lower for longer as they try to help the Australian economy adjust to the post-mining-boom era.

But this loose monetary policy risks increasing imbalances in the housing market, which could lead to a real bona fide financial crisis in the future when house prices stop increasing and household debt becomes more expensive to service.

The real cost of borrowing is unusually low right now. This won’t last forever. And when it ends, it will lead to a difficult period of adjustment for Australians holding a lot of debt tied to short-term interest rates. But the current low real interest rates provide an opportunity for governments to borrow at long maturities to finance public infrastructure.

So if Abbott and Hockey really want to burnish their economic credentials, they should stop wishing there was a Greek-style fiscal crisis to address and instead act on an unusually good opportunity for long-term investment in infrastructure at low real interest rates.

The stimulative effects of this temporary increase in spending would also allow the RBA to return short-term interest rates to a more neutral level and diminish the risk of a future financial crisis based on a housing bubble.

Alas, however, I fear “crisis envy” will carry the day when Hockey delivers the Budget and we will have yet another example of VSP syndrome to point to. It will be an opportunity lost for both fiscal and monetary policy in Australia.

James Morley is associate dean (research) and a professor of economics at the Australian School of Business. A version of this post appeared on The Conversation.

Richard Holden

In the lead-up to Australia’s federal budget on May 13, there have been the usual test balloons floated by the government. Raise the aged-pension eligibility age? A $6 co-pay for GP visits? Cuts to the ABC? And so on.

But the prize for the most “interesting”— and I mean that in the ancient Chinese curse kind of way — is the idea of a “debt levy”.

It’s a little hard to tell exactly what the idea entails since neither the Treasurer nor the Prime Minister will really talk about it, but it seems to be simple enough. Tax those Australians earning over a certain income level a special “one-off” amount and use the proceeds to pay down government debt.

Just like the flood levy and the East Timor levy, right? Actually, no.

The flood and East Timor levies were one-off responses to unusual budgetary shocks — one a natural disaster and the other a geopolitical necessity. They made sense because they dealt with transient fiscal problems. But structural problems require structural solutions— not one-time levies.

When your local surf club has a fire not covered by insurance, it makes sense, painful though it may be, for the members to kick in for the repairs. When the committee says they need a special levy to pay for recurring expenses like petrol for the inflatable rescue boat, there’s a change of committee at the next annual general meeting.

Labor’s response to the proposed levy is as revealing as it is disconcerting. Shadow treasurer Chris Bowen has barely stopped for air in repeating the line: “But they said they wouldn’t raise taxes.” Really, Mr Bowen? That’s your problem with it? You’re OK with bad policy if it’s announced in advance?

I do give the shadow treasurer partial credit for borrowing a line from Ferris Bueller’s Day Off — but he missed the real voodoo in the government’s economics.

First, Australia does not have a debt crisis. Or, to put it another way, Australia does not have a debt crisis. Far from it. Commonwealth net debt is about 11% of GDP, the third lowest in the OECD (the average is 50%), and low by historical standards. Government borrowing rates are at all time lows. Indeed, it was only a few years ago that we were discussing how Australia’s debt being so low was a serious problem because it might lead to the government bond market drying up.

But isn’t all debt bad? I mean, shouldn’t the country live within its means and not spend more than it “earns”?

As Nobel Laureate and New York Times columnist Paul Krugman has pointed out repeatedly: government finances are fundamentally not like personal finances, for multiple reasons. One of them is the huge payback that social investments can deliver.

Government debt levels should typically not be zero. The Commonwealth government can borrow long term at around 5%. The social returns on wise social and infrastructure investments are often more than 15%. Not borrowing at 5% and lending at 15% is to miss huge opportunities.

Governments can invest in projects that we never can as individuals: healthcare, schools, major infrastructure, national defence — and that’s what makes the large returns possible. It is just very different than thinking about maxing out your Visa card to go skiing.

But suppose you don’t believe any of that. The debt levy is still a bad idea. It won’t raise very much money, and it will set a terrible precedent.

Suppose there is a 1% levy on all incomes over A$105,000, for one year — that is, the top 10% of tax payers. This would, by my back-of-the-envelope calculation, yield about $1.9 billion in revenue, all else being equal. That would reduce federal government debt by about three-quarters of 1%. That’s basically a rounding error in the scheme of things. So is it going to be bigger, longer, apply to more tax payers? It gets you thinking …

And there’s the “all else being equal” part, so often overlooked in public discussions about taxes. If announced for the coming year, workers will rationally adjust the amount they work, hence earn, and hence pay in taxes. Economists of all stripes know that labour supply adjusts to taxes. The result would be not only less revenue than might naively be predicted, but slower growth and private spending as well.

Of course, it could be made to apply retroactively to avoid the labour supply issue. And this brings us to precedent. In this respect a debt levy would be truly disastrous.

If it becomes acceptable for governments to simply jack up taxes because they don’t approve of the policies of the previous government, then public confidence will be shaken. It will create a climate of fear and uncertainty that will deter investment in physical and human capital — with potentially severe economic consequences.

One should feel a bit for Hockey. He has got a really bad job. This budget won’t please many people, and it will entail some tricky politics. But it can, at least, be good, grounded in good economics.

When it comes to the debt levy the Treasurer should heed the Reagan mantra. Nancy Reagan, that is, and “Just Say No!”

Richard Holden is a professor of economics at the Australian School of Business. A version of this post has appeared on The Conversation.