It’s Automatic…

If 2020 was a normal year, then this week we would be writing about the 2020 Commonwealth Budget. The 2020 Budget was due to have been delivered earlier this month. However, the Commonwealth Government made the sensible decision to delay the Budget until later in the year, due to the uncertainty about Commonwealth revenues and expenses that the COVID-19 crisis has created.

The Commonwealth has also stated that its planned ‘outcome’ for the Budget – a surplus – will not happen. Because of this, we thought this week it would be a good time to talk about surpluses and deficits in general. A surplus budget is one where the revenue received by the Commonwealth is greater than the money spent by the Commonwealth. A deficit budget is one where this is reversed: the Commonwealth takes in less than it spends. A balanced budget is one where revenue equals expense.

The general consensus on both sides of politics, and in much of our political media is that surplus budgets are always better than deficit budgets. Last year the Treasurer stood proudly in Parliament and stated that next year the Budget would be ‘back in the black.’ The idea that surpluses are always good is a little too simplistic, though, when we consider the effect on the economy of a surplus budget. Usually, a surplus budget will slow economic activity. This is because the Government takes in more revenue than it spends. This leaves less money ‘in’ the economy to be spent by the non-Government sector (basically, businesses and households). For this reason, a surplus Budget is not particularly useful when the economy is weak – like now. This in turn is why no one is really criticising the Commonwealth Government for the fact that the planned 2020 surplus will now not happen: the last thing we need at the moment is a surplus Budget.

As this year shows more than most, whether a surplus is a good thing or not depends on the state of the underlying economy. This can seem a little counter-intuitive, as it is often the opposite of how we manage our personal finances. At home, surpluses are almost always seen as good things. For example, in my household, if I earn more than I spend, then I can save the rest and it becomes my wealth. But Governments are not like households. For a start, according to the OECD (Organisation for Economic Co-operation and Development), in 2015 Government spending accounted for more than a third (36.2%) of GDP. That would make the Government one BIG household! Governments also have to do a whole bunch of things that households don’t do, like the military, the Police, the hospital system, the education system, the Court system, etc. Governments do not spend their weeknights on the couch chilling on Netflix.

So, try to avoid the ‘homely’ notion that Budget surpluses are always good and deficits are always bad. This is especially the case given that the Government of the day has less influence than you might think on the state of its Budget anyway. In any given year, there are two broad factors that determine whether or not a Budget is in surplus: (i) specific revenue and spending decisions the Commonwealth Government will make in that year; and (ii) the ‘automatic’ effect of the state of the broader economy (which in turn includes the effects of the decisions of every previous Budget). Of these two, this year’s deliberate policy initiatives tend to have less effect.

Automatic effects are usually far more significant and this is often a good thing. Some people refer to these automatic events as ‘automatic stabilisers.’ As an example of an automatic stabiliser, think about an economy that is struggling with rising unemployment. In that case, the amount of Commonwealth revenue from income tax will fall as there are fewer people working. At the same time, the number of people qualifying for unemployment benefits will rise. So, from the Commonwealth’s point of view, when times are tough the Budget automatically moves towards a deficit (less taken in as tax, more spent out as social security).

As it happens, when the economy is struggling, a deficit Budget is helpful – which is why this is seen as an automatic stabiliser. The move to deficit reduces the speed at which the economy is slowing.

The opposite happens when the economy booms. The more economic activity that occurs, the more the Commonwealth collects as tax – either income tax or business taxes, with GST also rising as people consume more. Social security payments fall as there are fewer people who cannot find a job. So, the ‘Government’ automatically gets more revenue and spends less, which means it moves towards surplus. This slows the rate of growth and helps keep things like inflation under control – another way in which things are automatically stabilized.

The influence of these automatic effects on Government revenue cannot be overstated. Over the last thirty years, the Commonwealth budget has been in surplus ten times. Each time has coincided with particularly strong revenues. According to Government archives (https://archive.budget.gov.au/), nine of these ten surpluses happened when Government revenue had risen above 24.5% of GDP. When revenue was less than this figure, the budget was always in deficit. Revenue dictated whether a budget was in surplus.

Most Government revenue comes from taxes. It is relatively rare for a Government to deliberately increase taxes. This is why the increases in Government revenue in these nine years was largely automatic: taxes are levied on a particular kind of activity and that activity simply increased in particular years.

What this means is that, of the ten most recent Budget surpluses, at least nine were the result of a strong economy, rather than a Government’s deliberate policy. They were a result of automatic stabilisation.

These automatic stabilisers are usually seen as good things. Being automatic, they happen outside of the ‘political cycle’ and to a large extent they are not within the control of politicians. This means that the impact of Government activity on the economy is largely governed by what the economy needs from the Government sector – not what politicians think that the community wants from its Governments.

Remember, over the last 29 years the Australian economy has avoided recession and grown every year. Built-in stabilisers have been a significant part of most of these years of growth. Automation is good.

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