This week we finally received the 2020 Commonwealth Budget that was initially expected in May 2020. As expected, this is a whopper of a Budget and we will look at much of its content over coming weeks. This is our usual move, as it allows us time to fully digest what the Budget has to offer. For this week, we will focus on the part of the Budget that is generating the most headlines: the deficit. According to Treasurer Frydenberg, the Commonwealth expects a Budget deficit of $213 billion in the current financial year.
This is easily Australia’s largest ever Budget deficit. That might sound scary, so we want to spend some time talking about Budget deficits in general. If nothing else, this will hopefully reassure you that our Commonwealth Government, at least, is alright.
First of all, what exactly is a Budget deficit? Very simply, a Budget deficit is where the Commonwealth Government collects less in revenue than it spends during a given year. Government revenue comes in various forms. Mostly it is taxes, but it can also be charges for Government services, levies, earnings on Government-owned assets, etc. Spending is equally broad: welfare payments such as disability or aged pensions, payments to public servants, expenditure on health services, the military, the Federal Police, etc.
Most people instinctively worry about a deficit. For households and businesses, deficits mean spending more than you are collecting, which can obviously only be a temporary thing. At some stage, households and businesses running deficits will run out of money. So, we humans are primed to view deficits as inherently bad.
Happily, Commonwealth Government deficits are a different matter. The main reason for this is that the Commonwealth Government is nothing like a household or a business. In countries like Australia, it is not really possible for the Commonwealth Government to ‘run out’ of money, as that Government controls our own currency. And yes, that does mean that the Commonwealth Government can simply create more money if it needs to.
People often shudder at the prospect of simply creating (or ‘printing’) money. For many, the concept brings to mind episodes in human history when printing money has distorted some countries’ economies horribly – usually in the form of massive hyperinflation. Inflation is where the prices of goods and services grows. Hyperinflation is where those price rises are both large and uncontrollable.
Inflation happens when there is more money available than there are things to spend that money on. People use that ‘excess’ money to compete for the things available to purchase. This drives prices higher. Inflation therefore has two broad elements: the amount of money, and the number of things that money can be spent on. Economists sometimes call this second element the ‘real economy.’ Inflation does not become a major issue unless the capacity of the real economy is fully utilized and the economy cannot expand to match the increase in money supply.
One of the major elements of the real economy is human labour. At the moment, our economy unfortunately has a lot of under-used labour – aka unemployment and its close cousin, under-employment. Indeed, it is the presence of very high unemployment that has led the Commonwealth Government to deliver this historic Budget. As a result, any increase in money caused by the Budget deficit can be ‘absorbed’ by the currently unused labour without driving prices higher.
Another thing to remember is that, on Tuesday night, Treasurer Frydenberg was not talking about the whole economy being in deficit. He was talking about his Government being in deficit. His Government is not the economy; it is only one participant in the economy. Yes, it is the largest participant in the economy – Government spending will account for about 25% of all economic activity in the 2020/2021 year, as measured by GDP. But that means, of course, that about 75% of the economy exists in some form other than Government spending. The Government is not the economy.
Because the Government is not the whole economy, the Budget deficit is not a deficit for the whole economy. In fact, a Government deficit actually causes a surplus in the non-Government section of the economy. Think about it: if the Government spends more money into the economy than it ‘removes’ as revenue, the economy must be left with more money in it. This is the very purpose of a deficit Budget: to increase the amount of money circulating in the economy, in the hope that this circulation will boost economic activity and, in particular, create new jobs. So, when the Government runs a deficit, the non-Government section of the economy ends up with more money than it would otherwise have. The Government’s deficit is a surplus for the rest of us.
A third thing to remember when it comes to the Budget deficit is how the Commonwealth Government generates it revenue. Mostly, this comes in the form of tax. Tax is usually levied on economic activity – think GST when you buy things, income tax when you earn things, capital gains tax when you sell things, etc. Put simply, although quite accurately, the Government imposes a tax pretty much every time money moves within the economy. The more money moves, the more tax it collects. Money moves due to economic activity. So, stimulating economic activity increases the Commonwealth’s ability to generate revenue.
The concept is known as a fiscal multiplier. By spending money today, the Commonwealth Government increases its own tax collections in the future. Looked at from the other perspective, if the Government did not spend today, its revenue would fall in the future. This fall in revenue would push the Government towards a future deficit anyway (unless it also cut spending). This is why the Government is much better served to ‘take the initiative’ and deliberately create a deficit today through increased spending. There will be a deficit anyway, so it is much better that the deficit be attached to a larger economy.
So, while you digest this particular Budget, please do not fret too much about the simple size of the deficit. Far more relevant is the impact that the Government’s spending and taxing will have on the overall economy. And we will look at these in coming weeks.