KPMG Economics Australia has come out with a research report: Debt, deficit and Australia’s credit rating: what it all means. Essentially, the approach was to model 5 different options to reduce Australia’s debt to GDP ratio by 5 percent against the Base Case between calendar years 2016 and 2020. The approach that yielded the best GDP end result was to cut spending.
Here are some insights from this report:
- The often cited net debt to GDP ratio of 15% is only counting the federal government and does not include state, local and multi-jurisdictional levels of government. It also does not include the unfunded superannuation liabilities and employee entitlements of both Federal and State government workers. Once we include these, the net debt to GDP ratio rises to 49.5%.
- The report also discusses the impact of a downgrade in Australia’s government credit rating, and what that does to public financing. This has come up in the news recently here by S&P, here by Moody’s and is thus very topical. If Australia’s credit rating fell from AAA to AA, based on recent bond prices this would be a 0.28% bond yield differential. This might not seem much but quoting the KPMG report: “the incremental interest payments would be about $1.06 billion per annum. This is about equivalent to what it cost to build the recently opened Comprehensive Cancer Centre in Melbourne.”.
- The modelling showed that cutting spending would have a ‘short term pain, long term gain’ impact relative to the other options. See the Dark Blue ‘Exp’ line on the graph:
Also fascinating is this analysis showing what kind of impact government debt has on the GDP growth of the economy:
We should be encouraging politicians to cut government spending. Over the long run, there is a big difference between growing at 4.2% versus growing at only 3.1%. Anybody who conceptually understands compound interest should understand this point quite well.
Australia’s true net debt to GDP is higher than the often cited 15% figure, cutting spending is a better way to reduce the budget deficit than raising taxes, and our society will prosper more effectively when Public Debt/GDP is lower.
This is a guest post by Stephan Livera. Mr Livera is a corporate internal auditor with a passion for communicating libertarian ideas. He blogs at www.stephanlivera.com where this article was originally published.