Is Australia’s government debt sustainable?

by David Richardson

The Budget deficit for 2022-23 is expected to be $36.9 billion. That will amount to a deficit of 1.5 per cent of GDP in 2022-23 followed by deficits of 1.8, 2.0, and 1.8 per cent of GDP in that order for the following years.

The deficit figures should not scare us. Since the global financial crisis Australian Governments have averaged a deficit of 2.6 per cent of GDP.

Our calculations based on the historic data going back to 1970-71 show the average budget balance has been a deficit of 1.0 per cent of GDP and the average for the deficit years was a deficit of 2.2 per cent of GDP. So the deficit in this year’s Budget is well within Australia’s experience.

It is also worth noting that in the later years of the Budget forecasts, the deficit will be higher as a result of the stage three tax cuts, due to begin in 2024. These are estimated to cost $254 billion over a ten year period.

Australia’s public debt is not only within the normal range of our own history – In comparisons with other countries Australia is well within the norms experienced elsewhere and hence, government debt is unlikely to be a concern. For example, Australia is a fair way down the list if ratings agencies want to target high debt countries.

The previous government talked about growing its way out of a debt problem and former Treasurer Josh Frydenberg, referred to the “fiscal dividend from a strong economy”. Most likely he was referring to the effect of economic growth on any outstanding debt which gradually falls as a share of the economy. There is also the improvement in the budget balance associated with strong economic growth. Strong economic growth boosts tax revenue while saving on some outlays such as unemployment benefits.

A deficit of 2 per cent of GDP adds 2 per cent of GDP to the net debt figure. If GDP is growing at 5 per cent (the long run forecast) then new debt to new GDP is 40 per cent (2 divided by 5). If we keep adding debt at 40 per cent of new GDP, we are heading towards a total debt to GDP of 40 per cent in the long run. If this seem difficult to follow, think about adding peas and mash to your dinner plate in the ratio 2 to 5. No matter what ratio you started with, you might start with all mash and no peas, but you head towards a dinner plate with a ratio 2 to 5 as you add more and more peas and mash in the ratio 2 to 5.

40 per cent would be an increase on the present debt to GDP ratio of 22.5 per cent at June 2022. To prevent debt going higher than the present 22.5 per cent of GDP the deficit would have to be kept to around 1.1 per cent of GDP. Generally, the ratio of the deficit share of GDP divided by the growth in GDP gives the long run tendency for the debt to GDP value. As might be expected from the formula, 1.1 is close to the historic deficit to GDP ratio of 1.0 since 1970-71.

In the accompanying article on international comparisons, we found there are some countries with high debt to GDP ratios of around 100 or more. These include Spain, France, Portugal, Italy, and Japan. As it happens these countries tend to be low growth economies. Given the formula above, even modest deficits combined with low growth produce high debt to GDP ratios.

Suppose for arguments sake that Australia’s GDP growth were a low 1 per cent per annum. In the above formula, and with a deficit of 2 per cent, Australia would then be heading for a debt to GDP ratio of 200 per cent. That is similar to the experience of the high debt countries, low growth and modest deficits which means debt keeps adding up each year, but GDP growth remains fairly low. These results also add weight to the view that debt ratios are best controlled by high economic growth. However, the results also mean that debt to GDP ratios do stabilise according to the ratios outlined here. They may get high, but they tend to be stable. This should be of some comfort to those who worry about government debt being too high.

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