A lot of the debt (both new and refinanced) over the next few years will become more onerous given the interest rate environment. Interest costs will be one of the fastest growing expenses for governments. This is evidenced by the strong rise in 10-year yields, with the states paying a higher interest rate (or spread) over the Commonwealth Government’s 10-year yield. A deterioration in government finances may also trigger downgrades by credit rating agencies, and this too raises debt costs.
The importance of fiscal sustainability and implications for the economy
Fiscal sustainability is the ability of a government to maintain public finances at a credible and serviceable position over the long term. It is also a requirement for macroeconomic stability and sustainable long-term growth.
High and increasing debt levels are harmful to governments’ fiscal positions and can cause a vicious cycle of growing debt, reducing the potential for economic growth as funds are diverted away from productive investments13. Governments will either need to divert spending away from other public services, increase taxes, sell assets or further increase debt as a result of higher borrowing today.14
There are extensive and significant implications as a result of elevated levels of government spending. It creates multiplier effects through the economy, from infrastructure spending on transport to non-market activity such as the National Disability Insurance Scheme (NDIS) spending. It could also crowd out private sector investment and use up labour in a capacity-constrained economy. There are also implications for inflation as expansionary fiscal policy is working against the Reserve Bank’s contractionary monetary policy.
Long-term structural deficits are the crux of the fiscal problem. If the issue is not tackled, this could lead to a further rise in taxes. The solution is to ensure more value for money is achieved on current spending as well as cutting spending or making long overdue reforms to the tax system to make it more efficient and help drive productivity.
We acknowledge tax reform is easier said than done, but there remains a strong need. The Government’s latest Intergenerational Report may help bring the merits of reform to light. Intergenerational equity should be a key motivator, with the financial burden being pushed onto younger generations.15
The rising cost of debt also draws government funding away from other services. In FY24 alone, the total interest cost on borrowings across all Commonwealth and state governments is expected to total over $43 billion and is forecast to continue to rise across the next few years. This is equivalent to the entire FY24 Defence budget, or the cost of the NDIS for the Commonwealth Government. On a state basis, it’s equivalent to the total NSW general government employee expenses in FY24.
High debt levels and large deficits also impact on governments’ ability to weather an economic downturn or future crisis such as a pandemic or financial shock. Government spending is one of the main defences in times of crisis, and being in a more fiscally sustainable position is an important part.
To move the government finances into structural balance and limit the amount of borrowings, we believe governments must do three things. Firstly, limit additional spending without at least offsetting the spend elsewhere – ensuring to maximise the use of tax payer funds – while also re-evaluating current spending plans. Also, change existing policy to lower spending and find new or more efficient revenue that will persist over time such as raising the GST and reshaping our company and personal tax system. And finally, putting in place policies to assist the private sector to maximise its productivity and improve our potential growth, which doesn’t necessarily require significant government investment. Prioritising pro-competition policies would be a good example of this in light of the current Commonwealth Competition Review.16
This will mean tough decisions about existing policies and the need to communicate these reasons to the community, but in the long run it will benefit the Australian economy.