Friendly fire is just as lethal as any salvo from your avowed enemies. In politics it is probably worse, especially if the salvos are being fired by the nation’s longest-serving treasurer. Peter Costello’s assessment that the Abbott promise of “lower, simpler, fairer [taxes] is looking like some kind of morbid joke” is a case in point. Although to call it friendly fire is giving Costello the benefit of the doubt. It’s certain he knew where his bullets would land.

The fusillade came as there are tentative signs that Tony Abbott’s game plan for survival might just be working. Certainly that’s the view of his party allies, who are mightily encouraged by a second influential Newspoll showing the decline has stalled. The government and Labor are now virtually lineball. Other polls are not so encouraging but they don’t carry the clout of The Australian’s fortnightly political pulse.

Cold fury could best describe the reaction away from the cameras and the microphones. Treasurer Joe Hockey, scrambling to reassert his credentials as an economic manager Liberals can be proud of, hit back hard. People should “stop looking back to what was and focus on the challenges of today and the challenges of tomorrow. No matter who they are, we’ve got to look to the future rather than longing for yesterday.”

And in sorrow as much as anger, “I really wish I had the revenue coming into the budget that Peter Costello had ... If I had the same revenue as he had, then I’d be getting $25 billion extra each year to be able to spend on things.”

Labor couldn’t believe its luck. The real hurt was to the reputation of brand Liberal in the one area where the polls suggest it has automatic ascendancy.

Prime Minister Abbott described Costello as a “distinguished former treasurer” entitled to his view, but said he was wrong. “We are a tax-cutting government.” Assistant treasurer Josh Frydenberg lamented on radio that the Costello contribution was “a distraction”. He then began to dismantle the former treasurer’s legacy. This year the tax take is expected to be only 22 per cent of GDP, whereas in the last year of the Howard–Costello government it hit 23.6 per cent.

Labor couldn’t believe its luck. The real hurt was to the reputation of brand Liberal in the one area where the polls suggest it has automatic ascendancy. After all, the Abbott government blames all its economic woes on Labor’s profligacy and incompetence. Peter Costello’s “look at me” moment had invited closer scrutiny of his contribution. And it’s not a pretty sight.

It is now clear that Costello’s 2006 budget plunged Canberra’s books into structural deficit. Labor’s first finance minister in 2007, Lindsay Tanner, told his colleagues in the Rudd cabinet this was the case, but few were prepared to acknowledge it. The overhang of the resources boom was still dazzling everybody, even then treasury secretary Ken Henry.

Costello had legislated for permanent tax cuts worth $37.6 billion a year. Most of the benefit went to the top 10 per cent of incomes. A capital gains tax discount cost another $5.8 billion. There was similar largesse with a baby bonus. But it was the area of superannuation tax concessions and treatment of share taxes that built in ongoing and burgeoning demands on the budget.

Economist Richard Denniss says just five of the changes are worth about $56 billion and more a year. He says, “The reason we have a budget deficit today is in no small part due to the efforts of Costello.” Poorer Australians received one-off cash payments of $1000 to carers, and aged pensioners received a one-off doubling of the utilities allowance. These are no longer on the books. The wealthy received a more enduring boost. Denniss says the former treasurer is now calling on the government to cut spending, “to pay for the irresponsible tax cuts he made that mostly benefited the rich”.

Deloitte Access economist Chris Richardson told The Australian, “We enjoyed the biggest boom we’ve ever had and made the mistake of assuming it was permanent and spent the lot.” Richardson says the Labor governments that followed must share the blame. But that is a long way from saying, as the current government declares incessantly, that it is all their opponent’s fault.

Joe Hockey is faced with the task of delivering on this government’s promise to repair the budget and return it to surplus. That promise is now on the never-never as the coalition faces the distinct prospect of its debt and deficit being higher at the end of its term than it was at the beginning. No wonder he is looking for more tax from multinationals and less generosity to high-income retirees.

The politics of winding back this generosity is diabolical. We are talking about the Liberal heartland here. But if Abbott and Hockey are going to deliver on their latest promise that this year’s budget will be “responsible, measured and fair”, how else can they do it?

Already we are seeing a crabwalk away from the extent of the much hyped families’ package. Plans to divert to it a 1.5 per cent levy on 3000 of the biggest companies have been shelved. The Productivity Commission suggested that one way of paying for reforms was tighter eligibility for couples with a family income above $160,000.

Someone will have to pay – a point acknowledged in very clear terms by the prime minister to business midweek: “I should repeat, because it’s absolutely critical: there will be no new spending that’s not offset against savings.” How he squares that with his promise not to make families bear the burden of his budget difficulties will be wondrous to see.

The confusing signals abound. The treasurer says his budget will be “mildly contractionary”. That means taking money out of the economy. Spending less. At the same time he told The Australian Financial Review: “Quite obviously it would be absurd for the budget to be in an arm-wrestle with monetary policy.” Clearly if the Reserve is making access to money cheaper to stimulate the economy, the government would be checkmating it if it started to withdraw spending. The absurdity can only be resolved by Canberra deepening the deficit. No one thinks Hockey will get as lucky as Costello and have a revenue surge with rivers of gold in a new commodities boom.

While Peter Costello was accusing the Abbott administration of Liberal heresy by raising taxes and spending, more “friendly fire” was coming from the West. Liberal Premier Colin Barnett was threatening to withdraw all co-operation from the commonwealth and look to Asia unless his state gets a fairer share of the Goods and Services Tax revenue. The risks here for Abbott are no less daunting.

Abbott seems to realise it. That’s why earlier in the week he was virtually begging the states to act like grown-ups and come up with a solution to help out poor old WA. The adults had done their homework. The very system that is seeing the West’s share of GST plunge to record lows is the one that made it a beneficiary for 90 of the past 114 years of federation. And the benefits flowing across the Nullarbor are not ancient history. Respected economics writer Tim Colebatch on the Inside Story website warned the new rules sought by Barnett would have cost the state $7 billion during the three biggest boom years.

There is a precedent for a treasurer ignoring the findings of the independent Grants Commission. John Howard did it in 1981, but that was before the GST agreement. The 2000 arrangement still gives a treasurer overriding discretion. In an unprecedented intervention, the finance minister, WA’s Mathias Cormann, argued strongly for his state to receive special treatment. Never mind other states were warning it would turn every premiers’ meeting into the sort of unedifying bunfight that marred commonwealth-state relations in the past.

The real risk for Abbott is an electoral backlash in the states forced to receive less of the pie. According to a senior Labor strategist from New South Wales, it won’t be from his state or Victoria. He says both expect to play that role in the federation. Bob Carr, when premier, tried for years to make Sydney’s perceived raw deal from the Grants Commission a political issue. He failed and gave up in the end. No, he says, it is the smaller states – Tasmania, South Australia and even Queensland – that would arc up. Two have Labor premiers. Tasmania’s Will Hodgman, though a Liberal, is beset by tight opinion polling. Capitulating without a fight would be a very poor option.

Shaping the entire argument for the Abbott government’s second budget is a public mood shift away from “trickle-down” economics. Defending concessions for the rich as a way of looking after the poor is losing its cachet. The prime minister belatedly seems to get it – at least rhetorically. Demanding fairness is no longer served by the putdown; it is simply the politics of envy. Peter Costello is still in the thrall of Reaganomics. In the end, his attack misfired. Sure, it was unhelpful to his own side, but it was out of date.

Ronald Reagan made his run for the presidency late in life. Another politician coming to the end of her seventh decade is replacing his economic paradigm. Hillary Clinton in Iowa put it this way: “I think it is fair to say if you look across the country, the deck is stacked in favour of those already at the top.”

That was the verdict on the first Hockey budget. The treasurer’s challenge is to make sure it doesn’t fit his second. Ignoring the “friendly fire” would be a good start. Some in Labor fear he just might.