By Leith van Onselen

Little-by-little, inch-by-inch, the common misconception that the Howard/Costello Government were fiscal superheroes is unravelling and the truth is being revealed.

The latest salvo came from the Sydney Morning Herald’s economics editor, Ross Gittens, who published a well reasoned article on Saturday arguing that the lion’s share of the current budget deficit stems from tax and spending decisions undertaken by the former Howard/Costello Government, which moved the Budget into structural deficit, causing revenues to collapse once the once-in-a-century mining boom began to subside:

They say it’s only when the tide goes out you discover who’s been swimming naked…[W]hen you calculate the ”structural” budget balance…Peter Costello was completely starkers… Costello’s luck was a lot better than Swan’s. Costello presided over the first part of the resources boom when the government’s coffers were overflowing, whereas Swan wasn’t in office long before the global financial crisis hit. He spent a lot of money trying to stave off recession but, though he had much success, the government’s revenues still haven’t fully recovered… [Using the mid-point of estimates from the OECD and IMF] the budget began the noughties in structural surplus, but then the structural balance declined steadily between 2002-03 and 2011-12, from a surplus equivalent to about 2.5 per cent of nominal gross domestic product to a structurally balanced budget in 2007, before falling to a structural deficit of about 3.75 per cent of GDP in 2011-12… So what are the causes of this deterioration and then improvement? From the structural balance’s biggest surplus in 2002-03 to its biggest deficit in 2011-12, the structural level of revenue fell by about five percentage points of GDP, while the structural level of spending rose by about one percentage point… The budget office says more than two-thirds of the initial five percentage point decline in structural revenue was caused by the cumulative effect of the six tax cuts in a row delivered or promised by Costello… A further quarter of the five points, the office tells us, results from a decline in excise receipts, caused [mainly] by Costello’s decision to end the indexation of petrol excise in the 2001… The Libs keep saying the problem is Labor’s unrestrained spending but, in fact, it’s almost all on the tax side. The tax weakness arises overwhelmingly from Costello’s eight delivered or promised tax cuts.

Gittin’s critique of the Howard/Costello Government’s fiscal record concurs with arguments expressed recently at MacroBusiness (see for example here). While the Coalition paint themselves as good fiscal managers and Labor as incompetent, the primary factor separating the diverging budgetary fortunes is that Howard/Costello governed during a period of benign macroeconomic conditions, both locally and abroad, whereas conditions have been largely unfavourable to the Labor Government.

While the inexorable rise in commodity prices under Howard/Costello’s reign and the unwind under Labor’s watch has been well documented, perhaps the best illustration of the diverging fortunes of the Coalition and Labor are shown by the below chart:

As you can see, household debt levels literally exploded during the 11 years that Howard/Costello Government was in power. This extra demand (spending) by the household sector meant that the Federal Government was able to run bigger surpluses, without adversely affecting overall demand in the economy (see next chart).

Since the Labor Party came to office in late-2007, however, the ratio of household debt to disposable income has flatlined as households dramatically lifted their savings rates. This deficiency of household demand (spending) effectively left a whole in the economy that had to be filled by increased demand (spending) by the Federal Government, which pushed the Budget into deficit.

Had roles been reversed and Labor was in power during the Great Moderation and the once-in-a-century mining boom, the chances are that it would now be claiming fiscal superiority over the Coalition.

The Howard/Costello reign was a case of good luck and being in the right place at the right time over good fiscal management.

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