Chapter

1 Australia

Author(s):
International Monetary Fund
Published Date:
March 1986
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Compared with most of the smaller industrial economies, Australia has a small external trade sector—foreign trade amounts to approximately 15 percent of GDP. Although this and abundant energy resources have acted as a buffer to external shocks, the authorities have nevertheless been faced with the task of reducing fundamental imbalances in the economy that had developed in the first half of the 1970s. Somewhat paradoxically, these developments can be traced in part to the discovery of vast mineral resources in the late 1960s and the improved prospects for exports, which implied an exchange rate that restrained activity in the manufacturing industry. Also, and more important, a wage explosion in the 1973–75 period resulted in declining profit shares, and in subsequent years the authorities pursued a restrictive economic policy to restore balance.

These developments, together with weak foreign demand, contributed to a low growth rate of GDP throughout the period, averaging less than 3 percent a year. At the same time, the rate of unemployment rose steadily from 2½ percent to 7 percent from 1972 to 1982. The discovery of mineral resources induced capital inflows that triggered an inflationary spiral, the breaking of which has been a challenge to economic policy since the mid-1970s. Inflation rates exceeded 15 percent in both 1974 and 1975, as a result of the wage explosion and the direct external oil price impact. Since 1977 annual inflation rates ranged between 8 percent and 11 percent. After recording surpluses in 1972 and 1973, the external current account swung into deficit in the following year when domestic demand soared. Subsequently, the current account was in deficit every year, reaching a high of just over 5 percent of GDP in 1982. Despite the Australian authorities’ seemingly successful containment of public expenditure growth, a fiscal deficit has been recorded in every year of the period, ranging from 0.3 percent to 5 percent of GDP.

Expenditure

Commonwealth government expenditure rose sharply as a proportion of GDP in 1975, or by 5 percentage points to 29½ percent. This was the result of a deliberate policy to stimulate the economy and to enlarge public sector provision of various social services and participation in transportation. In 1976 a new government reversed the expansionary stance, with the result that the proportion declined until 1980. Between 1972 and 1982 the ratio of commonwealth government expenditure to GDP rose from 24½ percent to 28½ percent, which is among the smallest increases in this group of countries over the same period.

The composition of expenditure in terms of economic categories has changed considerably. Expenditure on goods and services, which accounted for 25 percent of total commonwealth government expenditure in 1972, had declined to less than 22 percent by 1982, while subsidies and other current transfers increased their share in the total from 47½ percent to 63 percent during the same period. This change in emphasis was in part brought about by the “New Federalism” policy pursued since the mid-1970s. The policy aimed at increasing the Commonwealth Government’s financial contribution to the states in the form of general purpose grants. Such transfers amounted to 27 percent of total expenditure in 1982, having risen from 19 percent in 1972.

Interest payments on government debt declined as a proportion of total expenditure from 6½ percent to 4½ percent from 1972 to 1976; they have since been on the rise, and between 1980 and 1982 amounted to just under 7 percent of the total. Capital expenditures showed a declining trend in the latter half of the period. These accounted for some 6 percent of the total in 1982, compared with 10 percent in 1972. Net lending, which amounted to 10 percent to 14 percent of total expenditure up to 1975, has since declined sharply and in 1982 was 2½ percent of the total. This development represents a shift in financing of capital expenditures by authorities outside the budget. Until the mid-1970s, such capital outlays were largely financed through advances from the budget, whereas subsequently the entities concerned have increasingly financed their capital programs by own borrowing.

Revenue

Between 1972 and 1982, total revenue of the Commonwealth Government expressed as a proportion of GDP grew moderately from 24 percent to 28 percent. This is a lower ratio than in most of the smaller industrial countries and may be explained in part by the absence, for most of the period, of social security taxes, as a number of social security schemes are funded outside the public sector. A specific levy of 2.5 percent of taxable income was imposed in late 1976, but this health insurance tax was abolished in 1978, as was the compulsory health insurance scheme that had been introduced in mid-1975.

Australia: Selected Economic Indicators, 1972–82
19721973197419751976197719781979198019811982
Real GDP, percentage changes3.66.21.42.23.50.93.63.32.03.90.7
Rate of unemployment2.62.32.64.84.75.66.26.26.05.77.1
Consumer prices, percentage changes5.89.515.115.113.512.37.99.110.29.611.1
External current account balance as percentage of GDP1.41.3–3.0–0.6–1.3–2.6–3.5–1.5–2.3–4.8–5.2
Source: Organization for Economic Cooperation and Development, Economic Outlook, December 1984.
Source: Organization for Economic Cooperation and Development, Economic Outlook, December 1984.
Australia: Consolidated Central Government Finances, 1972–82(Year ended June 30)
19721973197419751976197719781979198019811982
Total Revenue
(as a percentage of GDP)24.322.624.025.425.726.326.725.626.327.328.0
Percentages of total revenue100.0100.0100.0100.0100.0100.0100.0100.0100.0100.0100.0
Income taxes57.958.661.164.563.163.663.660.660.862.063.5
Social security contributions
Payroll (manpower) taxes1.20.20.20.20.30.30.20.10.10.10.1
Property taxes0.90.90.70.60.60.50.50.40.20.10.1
Taxes on goods and services21.721.921.519.120.519.519.522.323.423.022.0
Taxes on international trade5.15.35.15.75.75.95.15.65.45.25.2
Other taxes
Nontax revenue and grants13.113.011.49.99.810.211.210.910.09.59.2
Total Expenditure
(as a percentage of GDP)24.624.324.529.430.729.630.428.928.128.128.3
Percentages of total expenditure100.0100.0100.0100.0100.0100.0100.0100.0100.0100.0100.0
Expenditure on goods and services25.124.123.420.619.520.120.120.020.421.021.7
Of which:
Wages and salaries
Interest payments6.66.45.64.94.35.76.06.76.86.96.8
Subsidies and other current transfers47.649.850.249.156.258.761.062.863.463.263.2
Of which:
Social security funds
Capital expenditure9.89.810.211.210.38.87.66.66.46.25.9
Lending minus repayments10.89.910.614.29.66.65.34.02.92.62.4
Surplus/Deficit
(as a percentage of GDP)–0.3–1.7–0.5–4.0–5.0–3.3–3.7–3.3–1.8–0.8–0.3
Financing:
Abroad–0.1–0.2–0.30.20.41.81.30.2–0.10.3
Domestic0.51.80.84.04.82.81.92.01.60.90.1
Monetary authorities–2.6–0.20.70.82.41.60.30.50.7–0.60.1
Deposit money banks1.01.2–0.22.20.3–0.10.50.30.50.2
Other12.10.80.31.12.21.31.61.10.60.9–0.2
Memorandum Items:
General government expenditure and net lending/GDP32.331.732.238.238.938.839.237.936.937.237.6
Central government debt outstanding/GDP234.829.828.827.928.029.830.428.624.922.7
Source: International Monetary Fund, Government Finance Statistics Yearbook, 1983 and 1984.

Includes adjustments.

Source for debt data: Commonwealth Government, 1983–84 Budget Paper No. 8 (includes Commonwealth and State Governments).

Source: International Monetary Fund, Government Finance Statistics Yearbook, 1983 and 1984.

Includes adjustments.

Source for debt data: Commonwealth Government, 1983–84 Budget Paper No. 8 (includes Commonwealth and State Governments).

The financing of social benefits with general revenue has in turn resulted in heavy reliance on income taxes whose share in total revenue rose from 58 percent in 1972 to almost 63½ percent in 1982. The rise is accounted for entirely by the personal income tax, as the corporate tax declined in relative importance from 29 percent of combined income taxes in 1972 to 20 percent in 1982. The rise in personal income taxes occurred despite a series of ameliorating measures during the period, such as indexation of the tax in 1976 aimed at moderation of wage claims and rate changes to reduce fiscal drag.

The second largest revenue category consists of taxes on goods and services, with a share in total revenue of around 22 percent at the beginning and end of the period. The most dynamic element in this category is a levy on domestic crude oil imposed in 1977, which is to be progressively increased until full import parity pricing is reached. In 1982 this levy, together with other—and declining—excise duties, accounted for 15 percent of total revenue, whereas total excise duties amounted to 13½ percent of the total in 1972. Nontax revenue and grants, mainly property income, declined from 13 percent to 9 percent of total revenue between 1972 and 1982. Other taxes are less significant and have not changed much over the period.

The Fiscal Balance and ITS Financing

Commonwealth government finances recorded deficits throughout the period 1972 to 1982. These grew substantially to 4 and 5 percent of GDP in 1975 and 1976, respectively, partly as a result of the official policy of the Labor Government to achieve a fundamental social reform and keep employment up through increased public spending. Subsequently, a stricter policy stance was adopted at the commonwealth level, mainly through expenditure restraint, as a result of which the deficit declined to the equivalent of 0.8 percent of GDP in 1981 and 0.3 percent in 1982. It should be noted, however, that in the past few years of the period covered, the deficit of state and local authorities increased as a result of restrictions on federal funding of outlays by these authorities.

While commonwealth government deficits were small in the early years of the period, they were financed in large measure by the sale of government securities to the private sector. In 1972–73 the aim of fiscal policy was to support monetary policy in reducing liquidity, and more was borrowed from the nonbank private sector than was needed to finance the deficit. Throughout the period, the nonbank private sector covered a significant portion of the Commonwealth Government’s financing requirement. Foreign financing was resorted to in the period but not to a significant degree, except in 1978 and 1979 when external borrowing covered, respectively, one half and over one third of a large deficit. Since the mid-1970s, combined financing by the monetary authorities and the deposit money banks has often amounted to one half of the commonwealth government deficit. Government debt, expressed as a ratio to GDP, declined from 35 percent in 1973 to 23 percent in 1982 according to official sources, while the share of the external component in total debt rose from 8½ percent to 16 percent over the same period.

Fiscal Policy

The framework. While Australia’s constitutional system of government is characterized by large subnational units, the commonwealth budget is nonetheless the dominant instrument in formulating fiscal policy, owing both to the national character of the Commonwealth Government’s role in managing the economy and the sheer size of its activities. In 1982 total general government expenditure was equivalent to 37½ percent of GDP, of which the commonwealth sector accounted for three fourths. More than one fourth of commonwealth government expenditure takes the form of transfers to state and local governments, amounting to almost one half of their total revenue and grants. The power of the states to impose taxes is strictly limited and the Commonwealth Government commands the most productive and elastic sources of revenue. Moreover, although the Commonwealth Government has limited direct control over outlays of other public entities, its indirect influence through controlling revenue sharing and through the Loan Council is substantial. The Loan Council, dominated by the Commonwealth Government, aims at coordinating all public sector borrowing, including borrowing for public works and housing programs at the state and local government level. The amount of commonwealth financial assistance to the states is based on agreements that are negotiated every five years. Despite the formal arrangements favoring commonwealth government dominance within the public sector, experience in the past few years suggests that the states nevertheless enjoy a fair amount of autonomy in expenditure matters. Thus, during the period of expenditure restraint since the mid-1970s, they were able to sustain increasing expenditure levels in real terms by drawing on their own resources and securing financing of growing deficits.

In 1971 a system of three-year forward estimates of expenditure, which had been initiated in 1965, was further elaborated to include new as well as existing programs that, unlike the previous system, required ministerial endorsement. The forward estimates procedure was integrated with the annual budget cycle and constituted, in effect, a rolling planning system. Later, the forward estimates again excluded new programs and are now more fully integrated with the annual budget cycle. While the implications of forward estimates submitted by the departments to the Department of Finance form part of the context in which the broad fiscal strategy is determined, the three-year estimates as such are not seen as policy documents. Rather, they are internal documents viewed as an aid to decision making and do not constitute a multiyear expenditure commitment on the part of the Government.1

Aims and measures. Prolonged success in economic performance during the 1960s provided a favorable basis for the Labor Government that took office toward the end of 1972 to promote its social policy objectives. In conformity with its policy objectives, the Government set out to increase the share of resources taken up by the public sector and to change the distribution of income over a short period of time. Measures to this end included increased rates of pension, unemployment, and sickness benefits retroactive to December 1972; also, the budget for fiscal year 1973–74 contained major increases in expenditure for social services. Increases in old age and invalid pension rates were met by raising indirect taxes rather than social security contributions (which, as already noted, were absent in Australian taxation for most of the period). In 1975 a compulsory health insurance scheme was introduced for the first time.

Fiscal policy reaction to deepening recession and rising unemployment was to strengthen the already expansionary stance through reductions in income and company taxes. Employment-oriented advances to state and local governments were maintained at a high level, and special measures were taken to safeguard employment in the motor vehicle industry. The Government, faced with rising rates of inflation and a deteriorating external position, refrained from taking traditional demand management measures, which were seen as likely to cause still higher rates of unemployment. Instead, preference was expressed for action that directly attacked the wage-price spiral. The fiscal component of this strategy took the form of income tax reductions, introduced in late 1974, designed to reduce pressures for wage increases, which would, in turn, reduce inflation.

The upsurge in prices between 1972 and 1975 generated mounting concern about the detrimental impact on output and employment and on the external position. The new government that assumed office toward the end of 1975 regarded inflation and the sharply enlarged role and relative size of the public sector as major causes of depressed private sector activity and loss of business confidence. Revival of the private sector was seen as a precondition for sustained economic growth, but whether fiscal policy could stimulate employment amid the pessimism generated by pronounced inflation was doubted. The stage was thus set for a reversal of the previous expansionary stance of fiscal policy. Bringing inflation under control and reducing the rate of expansion of public sector absorption of resources were declared major aims of policy. In 1976, as part of the effort to slow inflation, indexation of the personal income tax was introduced. This measure had a dual purpose: moderating wage claims and thereby restoring profitability in the business sector, and containing the size of the public sector in the long run. Restrictive expenditure policy, however, was a more direct approach to containing the public sector and the Commonwealth Government followed it until almost the end of the period. Apart from general restraint in budget formulation and execution, special measures taken for this purpose included reductions in advances to state and local governments, staff ceilings for the civil service, direct expenditure cuts in specified areas, and the abolition in 1978 of the compulsory health insurance scheme (Medibank).2

Toward the end of the period, substantial slippages occurred in the restrictive stance, even if the consequences are only partially reflected in the statistics for 1982. Owing to increased expenditures to support employment and social security services, the share of total expenditure in GDP started to rise in 1982 after five years of stability or decline. The deficit, while declining in 1982, has since widened sharply.

Overview and implications for future policy. The period covered thus witnessed a fundamental reversal in fiscal policy stance in Australia. From 1972 to 1975 the Government sought to reap the fruits of the successful economic performance in the 1960s by embarking on a course of expansion of social welfare services and an enlarged role for the public sector. The sharp increases in government expenditure resulting from this policy, together with expansionary development in other areas, led to growing imbalances in the economy. After a change of government at the end of 1975, policy was redirected to curtailing the role of the public sector and restoring overall economic balance. An important objective related to fiscal balance was to bring inflation under control, using tax policy as a significant factor of the strategy. The restrictive fiscal stance relied largely on expenditure restraint, and substantial success was achieved in containing the government sector. Actually, expressed as a ratio to GDP, the size of the commonwealth government sector was reduced by 2 percentage points between 1976 and 1982. In view of the experience in other countries in the group, the absence of compulsory social security schemes may have contributed significantly to this result. More recent developments, however, point to a renewed upsurge in expenditure growth, and a public health insurance scheme has been reintroduced.

Success in containing expenditure growth accompanied a reduction in the fiscal deficit between 1976 and 1982, although revenue increase was limited by, inter alia, tax concessions to stimulate private sector activity and to moderate wage demands. The reduced deficits at the central level were consistent with the Government’s anti-inflation policy, which was seen as a precondition for achieving sustainable economic growth in the medium term and higher employment. It should be noted, however, that although the deficit was substantially reduced at the commonwealth government level in the 1980–82 period, the improvement was partly offset by the deteriorating financial position of the state and local sector.

The overall public sector deficit thus remains high and is cause for concern because of its inflationary impact, through both the monetary implications of deficit financing and the inflationary expectations it generates. As already indicated, only limited progress has been made in reducing inflation, which has remained one of Australia’s main economic problems, and the achievement of better balance in the public finances is likely to remain a major task of future policy. The effort needed is accentuated by recent slippages in the pursuit of fiscal policy toward this end.3

1

James Cutt, “The Evolution of Expenditure Budgeting in Australia,” Public Budgeting and Finance, Vol, 3 (Summer 1983), p, 18.

2

The operation of insurance schemes outside the public sector is encouraged through tax incentives for the insured.

3

As a result of successive expansionary budgets since 1983, the budget deficit has risen sharply. Deficits in the state and local sectors have also widened. While the rate of inflation has abated in recent years, it still remains high compared with the experience in main trading partner countries. These developments have accentuated the need for fiscal adjustment to support efforts to establish sustained noninflationary growth and reduce the high rate of unemployment.

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