Between now and the election later this year, expect to hear repeated warnings of Australia losing its AAA credit rating – the strong implication being that without it, the sky will fall.
When Treasury Secretary John Fraser raised the topic on Thursday evening, most news coverage focused on how likely such a downgrade was, rather than its impact.
The short answers to those questions are ‘not likely for a while’ and ‘a fairly modest impact’ – so why raise it at all?
Well for those who missed it, John Fraser was appointed to the key role of Treasury Secretary by a rather unpopular prime minister, Tony Abbott – unpopular for his one-eyed pursuit of budget cuts, against the advice of many economists and with only grudging support from the former Treasury Secretary Martin Parkinson.
So although Parkinson was widely considered to be doing an excellent job, Fraser was perceived to be more amenable to the Abbott government proposition that “we have a spending problem, not a revenue problem”.
Actually, all sensible commentary admits that we have both kinds of problem.
But that does not mean that slashing spending and increasing revenue should be pursued with equal vigour at this time.
Public spending in Australia, including state and local government spending, amounts to roughly 30 per cent of GDP.
That’s modest by OECD standards – as reported last year, in the UK a debate has been raging about how to get spending below 40 per cent of GDP.
But Australia has problems all of its own. The dramatic reduction in mining capital investment has knocked a couple of points off annual GDP growth, and the flow-on hit to corporate tax, capital gains tax and income tax have ravaged the federal budget.
Problem is, addressing this imbalance with spending cuts means reducing final demand at a time when we need a demand boost.
The Abbott government set itself the task of getting federal public spending down to 23.9 per cent of GDP, despite the fact that even the Howard government had allowed it at one point to blow out to 26 per cent.
Fraser was the man drafted to help generate consensus that the 23.9 per cent target was good thing.
Don’t mention the wealthy
Meanwhile, on the revenue side, there are plenty of ways to boost the budget bottom-line.
Fraser does not like the idea of course, saying that boosting the overall tax take “runs the real risk of distorting economic incentives and lowering international competitiveness with negative impacts on investment growth and job creation”.
Well that would be true only if inefficient taxes were simply jacked up – particularly those most effecting middle and lower-income Australians, whose strong propensity to spend their money on consumption is key during a downturn.
What the Coalition, and Fraser, tend to skate over is that we are currently handing back tens of billions of dollars each year in fairly pointless tax concessions, mostly to wealthier Australians.
Those ‘tax expenditures’ cover things such as income tax reductions related to negative gearing, capital gains tax concessions and superannuation tax concessions.
Because those billions go disproportionately to wealthier Australians, that money is less likely to be spent on consumption, and more likely to be squirrelled away to boost the inheritances of their heirs.
The government’s preference for focusing on reducing spending instead is largely ideological – it calculates that cutting or constraining health and education spending, say, is easier than asking wealthier Australians to give back some of those juicy concessions.
And to get that preposterous notion past the punters ahead of the next election, it’s much better to pretend the sky will fall if there’s a credit downgrade.
The three international ratings agencies that matter – Moody’s, Standard & Poors, and Fitch – will probably look at a downgrade when net federal debt hits around 30 per cent of GDP. That’s some way off, as the current level is around 18 per cent.
But more importantly, even if they do cut Australia’s credit rating from AAA to AA+ or similar, what impact will it have?
Not much, actually. As the chart below shows, all three agencies only pushed Australia up to a AAA rating in the past 13 years, and government borrowing costs did not fall precipitously as a result.
When Fitch joined the other two agencies with a AAA rating in 2011, the yield on 10-year bonds (i.e. the cost the government pays to borrow) did decline somewhat. Not too much should be read into that, however – the price of borrowing fell for governments in most other developed countries at the same time.
It is true that the major banks would face higher funding costs, as their own credit rating is linked to their government’s implied guarantee of their bloated mortgage books.
That would force them to pass on costs as higher interest rates – but how much higher is debatable. Remember that in 2015 both owner-occupiers and investors copped out-of-cycle rate increases without too much commotion.
For my money (and a tiny sliver of it is my money), this is the wrong time to attack federal government spending. Nurturing the currently anaemic level of economic growth is a far bigger priority.
If a government wants to cut spending, it should be honest about its reasons. Dodging a credit rating downgrade just isn’t a good enough reason at this precarious point in our history.