There is plenty of focus on deficits and government debt in the Australian political debate. This is fair enough. But I am glad that our levels of private debt have been getting more attention lately. Ballooning leverage and foreign debt undermines our financial stability and provides for dangers in the event of a global downturn.

It’s not the government’s responsibility to dictate to households and businesses whether they should borrow money and how they spend it. But it is a government’s responsibility to ensure that policy settings are appropriate and do not distort economic decision making. On this, the government simply remains asleep at the wheel, or worse, is knowingly failing on its duty to ensure the economy remains financially stable and continues to grow.

With rapidly increasing debt levels in Australia, policies such as negative gearing and capital gains concessions, which encourage leverage and excessive debt, should be curtailed.

Australia's $1tr foreign debt rated 'extreme' by S&P Read more

Warnings have been coming thick and fast recently regarding the rapid build-up of Australia’s foreign debt. The amount of money Australia owes the rest of the world has swelled to new record levels and now sits above $1trillion. While several advanced economies deleveraged after the global financial crisis, household debt in Australia has surged to more than 180% of disposable income, one of the highest household debt-to-income ratios in the developed world.

Australia received a special mention in the International Monetary Fund’s most recent Fiscal Monitor, which named us as one of just three economies where private debt has continued to accumulate at a “fast pace”. As recently as this week, Standard & Poor’s said Australia’s foreign debt had reached “extreme” levels.

But given much of this debt is private, is it really a problem? The International Monetary Fund thinks so. Soaring debt levels limit the future ability of households to go out and spend on goods and services in the economy. As the IMF states, “high private debt not only increases the likelihood of a financial crisis but can also hamper growth even in its absence, as highly indebted borrowers eventually decrease their consumption and investment”.

We may be starting to see some early indications that record household debt is constraining the spending capacity of families around Australia. The most recent national accounts released by the Australian Bureau of Statistics show the contribution to growth from household consumption halved between the March and June quarters, the lowest contribution in more than three years. Given spending by households makes up more than half of all activity in Australia, when it falters, the economy falters. It’s no doubt one of the reasons why, despite interest rates at record lows, it hasn’t been enough to sway non-mining businesses to invest. They are worried where their future sales will come from.

Despite several warnings from its own advisers and eminent organisations that negative gearing and capital gains concessions distort investment choices and encourage excessive borrowing and leverage, the government continues to sit on its hands.

In his financial systems inquiry, David Murray put up in flashing red lights that negative gearing and capital gains concessions are “major tax distortions” that “encourage leveraged and speculative investment”. He’s not alone. The Grattan Institute has also pointed out repeatedly that “the greater leverage encouraged by negative gearing arrangements also reduces the stability of the Australian financial system”. And most recently, the IMF got in on the act, saying “tax distortions favouring debt over equity should be gradually eliminated”.

What part of this advice does the government not understand?

Rising debt levels not only hamper economic growth but leave Australia more vulnerable if another globally induced crisis hit our shores. As Ken Henry has put it, if foreigners lost confidence and decided to stop lending to Australia,

unemployment would obviously go into double-digit figures, businesses would fail, banks would be unable to continue to provide credit to homeowners, to businesses, small and large, [and] infrastructure financing would stop dead in its tracks.

Labor’s policies on negative gearing and capital gains tax are good for the budget. They are good for housing affordability. And they reduce the distortions in our tax system which encourage the leverage and debt levels that are worrying well-qualified observers of the Australian economy. When policies achieve multiple outcomes like this, the government’s unwillingness to pursue them is deeply disappointing. And the day may well come when they look back and regret not taking them up.

