Is Rudd a libertarian on fiscal policy?

Prompted by the exchange between Gruen and Gittins on NSW privatisation, I asked myself a much broader and pertinent question: what should be the proper role of government in the allocation of capital in Australia?

At the two ideological extremes, the answer is simple.

The interventionist Left says that governments have an obligation to correct deficiencies in economic infrastructure such as in roads, ports and railways; build up the stock of human capital, such as public health, education, housing, employment programs; protect our natural environment; safeguard or improve the quality of our living and working conditions; and ensure that every citizen gets an equal opportunity to succeed, irrespective of the circumstances of their birth and upbringing (the much beloved level playing field). These five long term societal goals require massive economic, social and environmental investment over time and this job cannot be left to private commercial markets which do not have regard for wider social and economic externalities. So government involvement is necessary to achieve the desired goals. If in the process it crowds out or discourages some private sector activities, then so be it. That’s what the public say they want.

At the libertarian end of the ideological spectrum, the argument is that while the goals outlined above might be desirable, so too are other goals such as individual freedom of choice. So, they say, governments need to defer some of the goals i.e. achieve them over a longer time period, while some goals should be left to private capital markets to fix up (perhaps with a bit of subsidization at the margin). Governments should largely stay out of capital allocation decisions as their direct involvement would mean higher taxes, with their serious disincentive and distorting effects; higher interest rates; undisciplined execution (they stress the many examples of government failure in design or implementation) and slower economic growth.

Most economists do not adopt either of these two extreme positions. In fact their stance tends to be agnostic

Mainstream economists refuse to generalize about
– the relative importance of market and government failure;
– the relative merits of public over private goods;
– the intrinsic superiority of the private sector as an owner-manager of infrastructure relative to governments;
– the effects of higher taxes;
– the economic superiority of private debt over public debt;
– the impact deficits might have on interest rates or its consequences for economic growth; or
– the precise state of public opinion on taxes, government spending and public borrowing.

These economists prefer to look at each investment proposal on its merit that is, they like to examine, case by case, how benefits and costs stack up, what might be the optimal method of financing the investment and the optimal role of governments and private markets in risk-management, design, construction and operation.

Adoption by governments of such an agnostic stance is only plausible if the fiscal stance of governments is flexible and responsive i.e. if there is no investment straightjacket in the public sector. Unfortunately, this is exactly what we had under Howard, where it did not matter much because of the gushing revenue from the resources boom. And it is what we look like having under Rudd, where it will matter greatly in the more restricted revenue outlook.

The Rudd Government has in effected adopted the libertarian stance on fiscal policy. It has virtually frozen its capacity to invest on a sustained basis by promising (in the election run-up) that, over the business cycle
the budget will be balanced or in surplus i.e. there shall be no net government borrowing (no increase in public debt), so all government expenditure, whether of a recurrent or capital nature, must be more than fully paid for out of ongoing revenue (mainly taxes); and
the tax burden will remain constant or fall relative to national income, thus severely constraining the ability to use revenue to pay for economic and social investment.

This extreme form of fiscal conservatism may have helped Rudd win the elections but it will make it very difficult for him to deliver a strong report card on his education, health and infrastructure goals. It will also force it to adopt infrastructure financing options that are economically less efficient than borrowing and denying Australians a genuine, well informed choice on the appropriate balance between public and private goods.

The structural fiscal goals are not as rigid at the state level but, under our lopsided federal system, it is the Federal Government that has the largest and fastest growing revenue base and the greatest capacity to borrow. So it is the federal fiscal stance that will be crucial for the achievement of the Rudd vision. Yet Rudd’s libertarian stance has left him little or no room for manoeuvre.

Sadly and ironically, an opportunity might open up for Rudd if (as I fear) the economy stumbles badly in 2009. This will then require both a fiscal and monetary stimulus and, with advance planning, this could give Rudd the chance to implement short-gestation infrastructure spending and indulge in some one-off social and environmental investment initiatives. But there must be an easier way for a government to pursue its vision of a fair and productive society. It involves keeping an open mind and an open-ended policy on borrowing and taxes over the economic cycle.

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Fleeced
13 years ago

You think he’s a libertarian because the surplus is increasing and individual taxes are coming down?

Firstly, a libertarian would prefer a smaller surplus, and for the money to be given back. But the reason Rudd can do both (ie, bigger surplus + tax cuts), is because the economy is still growing. Look at Howard: he slashed individual tax rates, but still managed to increase total tax revenue by an enormous amount – and though he had ever increasing surpluses, he achieved this at the same time as massive increases in spending. Rudd and ALP are simply continuing this trend.

You actually think his policies are an “extreme form of fiscal conservatism”? Would you say the same of Howard?

A better measure is how much they spend. It increased under Howard (in real terms), and will no doubt increase under Rudd.

John Greenfield
John Greenfield
13 years ago

Ah, there is no such thing as a libertarian fiscal policy. Where would the state get any money to spend? Taxes? Quelle horreur! ;)

Sinclair Davidson
13 years ago

I think you’re being a bit hard on Kevin Rudd. Whatever his views are on capital allocation (I suspect he’s towards the ‘left end’ – his rhetoric certainly is) Mr Rudd is pragmatic. Public opinion needs to be shifted on the merits (or otherwise) of a change in fiscal intervention. That job is best done from goverment and not opposition.

SJ
SJ
13 years ago

Fred, I suspect that your argument is going to confuse some of our libertarian friends.

They’ll look at it absolute terms, i.e. is the existing situation libertarian, rather than in terms of possibilities of future changes in direction.

Brendan Halfweeg
Brendan Halfweeg
13 years ago

Fiscal policy is a marginal consideration for libertarians in the face of a state that consumes over a third of the gross domestic product. I suggest that a libertarian government would be pragmatic in its fiscal policy, with small swings between surplus and deficit. The swings would be small, simply because the budget would be considerably smaller, and so the negative impacts of surpluses and deficits would be minimised. Long term trends would see budgets increase in proportion with population growth, but decrease relative to GDP.

So Kevin Rudd running a perpetually surplus budget isn’t libertarian at all, but rather a conservative fiscal position. A libertarian government would be less concerned about fiscal swings, long term budget surpluses greeted with tax cuts, long term deficits greeted with budget cuts. Even considering the social democrat government we have now under Rudd and the social democrat government we had under Howard, as a libertarian I’d be pressing for tax cuts and budget cuts even if it momentarily caused the government to go into deficit. I don’t think Rudd is proposing budget cuts, just growing the budget slower than economic growth.

Rudd is a fiscal conservative, not a libertarian.

NPOV
NPOV
13 years ago

I do wonder what statements like “a state that consumes over a third of the gross domestic product” actually mean. For a start, how would you measure how much of the gross domestic product the state creates (indirectly or directly)?
If taxation became voluntary tomorrow, and everyone continued to pay the same amount of tax (because they individually determined that they were getting good value for money for the services that the state provides), would the state still be consuming a third of the GDP, even though nothing else had changed?

Patrick
Patrick
13 years ago

If taxation became voluntary tomorrow, and everyone continued to pay the same amount of tax (because they individually determined that they were getting good value for money for the services that the state provides)

If pigs flew past my window, could I shoot them and say they were heffalumps?

Fred Argy
Fred Argy
13 years ago

Sinclair, fair point. Governments do have a great capacity to re-educate the public. I believe Costello’s brilliant but mischievous assault on Beazley’s “black hole” helped create the current fiscal mentality. But we may have to wait for the next term of government and even then it will depend on the stance taken by the Coalition Opposition.

SJ, you are right to pick me up. Rudd is no libertarian in terms of the kind of society he wants to achieve. I only meant to say that the fiscal constraints he is imposing on new public investment are more consistent with the libertarian stance than with either the interventionist or agnostic stances.

John Quiggin
John Quiggin
13 years ago

Fred, I’m not sure that the balanced budget commitment has the implications you suggest. Although the Howard government tended to play it down, we’ve moved to accrual accounting, so expenditure to buy assets is budget-neutral. That said, I haven’t checked the fine print of the election commitments.

Fred Argy
Fred Argy
13 years ago

John, the Howard Government was committed to “maintaining budget balance on average, over the course of the economic cycle”. The budget balance is expressed in cash terms not in accrual terms and it is defined as total revenue less outlays (capital or recurrent). It is broadly consistent with the “net lending (borrowing”) concept in the national accounts and it approximates the direct contribution of the Commonwealth budget sector to the national saving/investment balance (the current account deficit).

Under that formula, if the Government invests in financial assets it has no effect on the budget balance but if it invests in physical infrastructure it increases outlays and thus reduces the budget surplus or increases the deficit.

My understanding is that Swan has embraced the same set of goals. At least that’s how the election promise read when I last saw it. Perhaps there is a loophole I am not aware of.

Fred Argy
Fred Argy
13 years ago

PS. I notice that the Treasury (in its Budget Papers) defines the budget balance as “the difference between government saving and investment” and claims it “measures the government’s net call on other sectors of the economy and so corresponds to government’s direct contribution to the current account balance”.

If that is the Rudd commitment it means it is precluded from net borrowing over the cycle.

Fred Argy
Fred Argy
13 years ago

PS no. 2. John, there are tricks governments can get up to such as setting up a separate entity in partnership with the private sector and investing in it. This may be treated as a financial acquisition rather a real outlay and not therefore affect the budget balance. Of course, we know it would have exactly the same effect on aggregate demand as a reduction in the budget surplus, so it would side-step the intent of the fiscal commitment – which is to ease pressures on aggregate demand and on interest rates. Governments can try this trick once or twice before they get laughed out of court.

John Quiggin
John Quiggin
13 years ago

Fred, I’m still not seeing this. If the budget balance is the difference between government saving and investment then an investment project doesn’t change the balance. That’s the difference between accrual, and cash accounting where the balance would be the difference between income and expenditure.

So, there’s no problem with making such investments and financing them by the issue of bonds. Over the cycle, governments can borrow an amount equal to their net investment, which is about right.

In political terms, since the government has made the commitment already, it’s important that we stress the sensible interpretation rather than the silly one.

Fred Argy
Fred Argy
13 years ago

John, you and I agree of course that long term infrastructure investment projects SHOULD be financed by the issue of bonds of similar maturity.

What we are debating however is how the medium term budget balance target is ACTUALLY being interpreted by Treasury (and presumably by Swan). And my reading of it is clear. The underlying Budget Balance is defined as Revenue less Recurrent outlays less Capital Outlays. So the fiscal target envisages that all new capital outlays (meaning outlays on physical capital) will be paid for out of recurrent revenue – i.e. there shall be no net government borrowing over the cycle

It is a silly view and we both wish it were not so – but it is the political reality. We can’t hide our heads in the sand and pretend it is not so. On the contrary, we should both be pointing out the stupidity of that structural target.

Brendan Halfweeg
Brendan Halfweeg
13 years ago

NPOV,

Of course the state also provides some goods and services that can be counted towards the GDP, but it also consumes income. It does through the direct cost of employing a civil service to administer and enforce the tax code and the budget expenditure, and through the indirect cost of private citizens and businesses ensuring tax compliance and tax minimisation. There is also the cost of tax as a disincentive to effort, particularly for the lower paid, and the opportunity cost of using the income paid in tax for other purposes that would actually be more efficient, and generate more wealth.

James Farrell
James Farrell
13 years ago

For what it’s worth Fred, there’s a fairly clear definition of Treasury’s terms for different aggregates in the Budget Papers.

The ‘operating balance’ is the difference between revenue and expenses (which are defined as transactions that reduce net worth, so they don’t include investment). That’s what we mean by public saving (although depreciation is not included as an expense here). The fiscal balance is the operating balance minus net capital investment (net purchases of non-financial assets minus depreciation). It’s explicitly intended as a measure of the saving-investment balance, and in turn the public sector’s contribution to the national account.

The reason this is confusing is that the operating balance sounds at face value like a more naive measure, but in fact it’s a better indication of what you and I mean by the public sector deficit, i.e. the G-T in the twin deficits identity.

NPOV
NPOV
13 years ago

Brendan, sure, but how much does enforcing the tax code really cost? And is the cost of this more expensive than the costs that would be incurred if all goods and services currently provided by the government were provided by private operators via voluntary trading? After all, private operators have various expenses that governments can generally avoid.

I don’t personally see a lot of evidence to suggest that the goods & services that are provided to us by the Australian government are done so particularly inefficiently, or that private operators could do immensely better. I’m not sure I’d say the same for the U.S., where the proportional amount of tax paid is about the same, but the level and quality of government services strikes me as being generally quite poor. And the U.S. has huge advantages of economies of scale and population density over Australia.

That’s not to say there aren’t other good arguments for allowing private operators to compete with the government on providing said goods and services.

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Brendan Halfweeg
Brendan Halfweeg
13 years ago

NPOV,

Anyone who works for the ATO is an overhead of the tax system. Anyone who works in the civil service adminstrating the budget is an overhead. Any tax accountant is an overhead. Any tax lawyer is an overhead. The whole infrastructure of the state is an overhead, including the politicians themselves.

Even if you state that private businesses would have overhead costs, these overheads would ocme out of the bottom line of private capitalists, not taxpayers. Welfare costs don’t just include the cost of money in the pockets of the poor, but also the civil servants who dole it out.

It isn’t just a question of efficieny either. If everyone in Australia was trained to make left foot running shoes, and that is all we did, we’d be very efficient at making left foot running shoes. This ignores the opportunity cost of making left foot running shoes, and the opportunity cost can only be determined by individuals deciding what thewy would rather invest or spend their money on. Efficiency of resource allocation in a capitalist market isn’t about minimising wastage, it is about maximising utility. The state is not adept at maximising utility, which makes it a poor manager of resoruces, even if each individual project it undertakes minimises waste.