Illustration: Andrew Dyson. Take the existing budget problems first, which the Coalition was still denying just 10 days ago. They are formidable problems, which it will inherit. First, tax revenue has collapsed, and Treasury secretary Martin Parkinson warns that, on current settings, it will stay weak for years ahead. The high dollar has flattened profits or driven them down in much of the economy. Mining companies are making big profits, but they use depreciation deductions to write off their $284 billion of investment over the past decade against taxable income. Second, Labor has introduced three big new fiscal commitments without the revenue to pay for them. The mining tax was meant to fund the government's share of the increase in superannuation contributions from 9 per cent to 12 per cent, but that is now essentially unfunded. So is the commitment to $9.4 billion of new education spending from the Gonski report and so is the national disability insurance scheme. Third, the pressures of an ageing society on the budget, which Treasury has warned of for years, are becoming real. The Howard government only intensified this with new entitlements for older Australians, and Labor has done too little to right the balance.

The doctors and hospitals are doing a wonderful job of increasing our life expectancy. That is blowing out spending on health and aged care, but I suspect that is Australians' top priority, and governments just have to find new ways to pay for it. The Howard government not only gave seniors a lower tax scale than working Australians, but allowed us to take our superannuation tax free on retirement. The bottom line is that something's got to give. Australia cannot continue this level of spending with this level of revenue. Excluding east Asia, our government spending is already the second-lowest in the Western world, behind only Switzerland. Both tax rises and spending cuts will be needed to get our budgets back in balance. The tax rises are easy: you don't need to raise tax rates, just plug the loopholes that now cost state and federal governments tens of billions of dollars a year. The spending cuts will be hard, but they need to be done. The end of the mining boom, however, could throw all this out. Garnaut, a former ambassador to China, says we underestimate the seriousness of China's rulers in planning to shift its economy to a more gradual, less resource-intensive growth path. He points out that last year, coal use declined in Chinese power stations. ''The Chinese economy is a huge ship, and it takes time to turn around'', he notes, but turn it will. While a services-oriented China will open opportunities for Australian exports, mining investment here has already overshot likely demand, and is set to plunge. That won't come immediately, as we have big LPG mining projects under way that also take time to turn around. But every mining boom since the war has ended in a bust, and there is no reason to think this time will be different. It was a very big boom, so it could be a very big bust.

What should the government do? Garnaut's advice is to cut interest rates - hard. ''We need to take interest rates down closer to the rest of the developed world'', he told an Australian National University seminar. ''The difference between Australia and the rest of the world is still very big.'' It has held up the exchange rate as commodity prices have fallen. A steep cut in interest rates should bring the dollar down, relieving pressure on businesses competing with the world, and allowing them to pick up the slack as mining investment falls. If it fails to do so - but only if - Garnaut suggests the Reserve Bank consider the Swiss option of fixing a cap for the currency, and printing dollars to sustain it. The Reserve, he notes, has been at the extreme end of ''hands-off'' policy in letting the currency float up without any intervention to keep Australia competitive. Second, the sense of entitlement needs to give way to restraint, almost across the board. In competition policy, the cosy deals done in easy times need to be unwound as they enter hard times. Fiscal policy needs to be tightened as monetary policy is eased; Garnaut urges spending cuts by targeting middle-class welfare, and closing tax loopholes to get ''even-handed taxation of all income''. Wage growth must be restrained, and productivity growth, in all areas, become the priority. Environmental policies should be made ''economically efficient'', while ''productivity-enhancing infrastructure'' is the one area of spending that should grow.

But a recession is still likely. That would certainly bring down interest rates and the dollar, but at severe cost. It would be better to act now to head off the damage. We have been relaxed and comfortable too long. We now have to dump our sense of entitlement, and face up to the pain of adjustment, with fair burden-sharing: and do it fast. Tim Colebatch is The Age economics editor. Follow the National Times on Twitter