Daniel Weight and Liz Wakerly
Prior to the 2017–18 Budget, the Treasurer began to emphasise
the importance of identifying the purpose for which Commonwealth debt was being
raised, asserting that the majority of growth in Commonwealth debt was the
result of a need to fund ‘recurrent,’ rather than ‘capital,’ expenditure.
In the 2017–18 Budget, the Government has sought to draw a distinction between this
‘bad’ debt (for recurrent spending) and ‘good’ debt (for capital spending). To
better reflect those Government payments which contribute to recurrent
expenditure, the Government has also begun to report the ‘net operating balance’
(which excludes capital spending) alongside the underlying cash balance.
Good debt, bad debt and the ‘Golden
Rule’ of public finance
In Statement 4 of Budget Strategy and Outlook: Budget
Paper No. 1: 2017–18, the Government has, for the first time, provided a
distinction between recurrent spending (ongoing expenses that occur on a
regular basis, such as pension payments) and capital spending (such as the
purchase of buildings which can potentially provide a future stream of benefits).
The capital budget includes Government spending on physical assets,
Commonwealth grants to others (primarily the states and territories) for
capital purposes, and Government spending on financial assets (a loan or equity
contribution to a third party).
Several economic commentators have advocated establishing
separate capital and recurrent budgets as a means of highlighting the
difference between the need to borrow to fund recurrent spending (‘bad’ debt)
versus the desirability of borrowing to fund productive investment (‘good’
debt). Such views are informed
by the ‘Golden Rule’ of public finance, which states that, over the economic
cycle, a government should only borrow to invest and not to fund current
spending. In other words, over the
business cycle, the recurrent budget must balance.
Although the Government’s current fiscal strategy does not refer
to the Golden Rule in its assessment of the
‘adequacy of current budget practices and rules in promoting efficient and
effective government, disciplined expenditure, long-term fiscal sustainability
and budget transparency’, the 2014 National Commission of Audit examined the
appropriateness of introducing such a rule in Australia.
According to a 2015 IMF report, increasing capital spending, financed by
support aggregate demand ... employ resources released by the
mining sector, catalyze private investment, boost productivity, take advantage
of record-low borrowing rates, and maintain the government’s net worth’.
Furthermore, the desirability of restraining recurrent
spending while undertaking ‘a more sustained public investment effort’ was
highlighted in the latest IMF Staff Country Report on Australia.
The Commonwealth can currently borrow at very low interest
rates. Research shows that, for
economies with clearly identified infrastructure needs and efficient public
investment processes, and where there is economic slack (slow growth) and
monetary accommodation (low interest rates), there is a strong case for
increasing debt-financed public infrastructure investment. The evidence
suggests that this is particularly effective in boosting demand and expanding
productive capacity in the long run, without raising the debt‑to-GDP
Some potential concerns
There are some important caveats and clarifications to the above-outlined
benefits of increasing debt‑financed public infrastructure investment. For
- under the Golden Rule, governments may be inclined to borrow
unlimited amounts so long as it is classified as investment
- when debts become ‘too high’ (over 90 per cent of GDP), the
effectiveness of further spending is reduced and growth can end up being
- to ensure sound choices about new investment, clear objectives,
co-ordination between federal and state governments, and sound economic
analysis of projects is required to ensure that the benefits of an investment
exceed the costs
public spending on infrastructure may crowd out private
investment, resulting in less total spending on infrastructure
investment in physical capital may be prioritised over investment
in human capital, innovation and knowledge which are recognised as key drivers
of economic growth but are usually funded from recurrent spending.
Furthermore, recurrent spending on social security and
welfare—notionally allocated by the Government as accounting for 45 per cent of
the increased borrowing since 2007–08—has an important role to
play in the working of the overall economy, smoothing incomes during business
cycle fluctuations. In other words, shifting resources from some types of
recurrent spending to capital spending could have unanticipated consequences.
Change in preferred headline budget
In the 2017–18 Budget, the Government also began to
emphasise a different measure of the Commonwealth budget balance. Under the Charter
of Budget Honesty Act 1998 the Government must prepare its budget forecasts
according to established accounting standards, but it enjoys discretion about
which specific measure to use as its headline measure of the budget balance.
In the 2017–18 Budget, the Government’s preferred cash measure of the budget
balance—the underlying cash balance—is retained, but it has substituted the
accrual ‘fiscal balance’ with the ‘net operating balance’ measure. The net
operating balance excludes direct capital investment by the Commonwealth, focusing
on recurrent expenditure. It thus provides a clearer
picture of whether recurrent expenditure is being funded by recurrent revenues
or additional debt.
S Morrison (Treasurer), ‘Interview
Alan Kohler, 'Talking finance' podcast’, transcript,
29 October 2016.
Australian Government, Budget strategy
and outlook: budget paper no. 1: 2017–18. Statement 4 is typically a
discursive piece focused on a topical economic issue. It is not clear whether
the Government will continue to provide such analysis in future.
See, for example, R Holden, ‘Vital
Signs: it’s time to borrow to build’, The Conversation, 15 July 2016;
J Greber, ‘We
need infrastructure not rate cuts: McKibbin’, The Australian Financial
Review, 12 May 2016, p. 8; and C Emerson, ‘Reforming
budget still possible’, The Australian Financial Review, 12 April
2016, p. 38.
Australian Government, Towards
responsible government: appendix to the report of the National Commission of
Audit: volume 1, February 2014, p. 101.
Budget strategy and outlook: budget paper no. 1: 2017–18, op.
cit., Box 1, p. 3-7.
There is international precedent for such a rule. See, for example, V
Lledo, S Yoon, X Fang, S Mbaye and Y Kim, Fiscal
rules at a glance, International Monetary Fund (IMF), March 2017.
concluding statement of the 2015 Article IV Mission, 24 June 2015.
2016 Article IV Consultation – press release; staff report; staff statement;
and statement by the Executive Director for Australia, IMF Country
Report, no. 17/42, February 2017, p. 21.
See the yield curve assumptions in Budget strategy and outlook:
budget paper no. 1: 2017–18, op. cit., p. 7-14.
A Abiad, D Furceri and P Topalova, The macroeconomic
effects of public investment: evidence from advanced economies, Working
paper, WP/15/95, IMF, May 2015. The OECD also supports reallocating spending
towards infrastructure, education and innovative activities, since these are
likely to raise income in the long run (see, for example, Organisation for
Economic Cooperation and Development (OECD), ‘Chapter
2: Using the fiscal levers to escape the low-growth trap’, OECD Economic
Outlook, special chapter, November 2016.
Towards responsible government: appendix to the report of the National
Commission of Audit: volume 1, op. cit. Other problems can also arise: in
the UK, there was speculation that the then Chancellor manipulated the rules
(in 2005) to permit further borrowing.
F Fall and J-M Fournier, ‘Macroeconomic
uncertainties, prudent debt targets and fiscal rules’, OECD Economics
Department Working Paper No. 1230, 29 June 2015.
surveys: Australia 2014: assessment and recommendations, 16 December
F Carmignani, ‘Highlighting “good and bad” debt will make it harder to fund social
programs’, The Conversation, 4 May 2017.
P Romer, ‘The origins
of endogenous growth’, The Journal of Economic Perspectives, 8(1), Winter
1994, pp. 3–22.
Commonwealth of Australia, ‘Budget
2017–18: Ensuring that the Government lives within its means’, 2017.
See, for example, OECD, OECD
economic surveys: Australia 2017, 2 March 2017, p. 50.
Budget Honesty Act 1998 (Cth), Schedule 1.
Budget strategy and outlook: budget paper no. 1: 2017–18, op. cit.,
All online articles accessed May 2017.
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