A Surplus Of Fresh Challenges

by Paul Kelly - The Australian

The politics of the surplus - the key to the Howard Government's success over 10 years - has taken a decisive turn with the unveiling of Treasurer Peter Costello's Future Fund.

The fund in the form envisaged by Costello has been challenged by Labor and will provoke a Nationals backlash. It reopens the dispute over how the surplus should be used and the debate over intergenerational equity.

The creation of the fund follows one of the most remarkable episodes in Australia's fiscal history: eight Costello budget surpluses and the effective discharge by the Coalition of Labor's $96 billion debt inherited a decade ago.

This highlights the extent to which the Howard-Costello fiscal and political strategy differs from the US and European norm. Costello's favourite graphs show Australia's budget in surplus and the Organisation for Economic Co-operation and Development country average in deep deficit.

The most important decision taken by John Howard and Costello came in the first week after their 1996 victory; they decided to become a surplus government, despite the deficit they inherited and the pain their spending cuts would inflict.

This decision has been the key to their election success. Running a fiscal surplus instils political and economic confidence. It helps to keep interest rates low. It creates fresh options for retiring debt, cutting taxes and creating new programs (such as substantial family assistance).

They embraced a fiscal rule -- a surplus over the cycle -- contentious at the time though it proved to possess a political utility even more powerful than the old Keynesian deficit financing.

The surplus was the right policy during the long growth cycle emerging from the early 1990s recession. It was both a policy and a consequence, with Japan, Europe and the US succumbing to recessions that Australia avoided. Surplus politics gave a medium-term economic stability and political foundation to the Howard era.

In effect, it became a technique to multiply the advantage of incumbency. Howard and Costello dictated the politics of each election cycle by their decisions on the distribution of the surplus. Labor, in turn, was intimidated by this fiscal power, aware that it must also promise a surplus, unsure of how much money was flowing into the surplus and reduced to last minute, election eve decision-making.

Australia's new situation creates a new politics. The commonwealth's debt is now close to zero (while the OECD average is about 40 per cent of gross domestic product). Costello says: "We have been paying off debt and now the task can become to build a financial asset." Yet this is new territory. It is one thing to discharge debt, but it is another to build an asset.

Costello's fund starts with $16 billion (the 2004-05 surplus plus other funds held by the Reserve Bank of Australia). All future budget surplus will be invested in the fund, established by law, managed by an independent statutory agency with an investment mandate written by government. Privatisation and Telstra sales proceeds will be paid into the fund. Best calculations suggest it will be worth about $100 billion in five years, a figure mentioned by Costello.

Earnings will be reinvested in the fund and the fund will invest in equities and bonds along the lines of a superannuation fund. Yet the proceeds will be devoted only to meeting the commonwealth's superannuation liabilities.

This is a far-reaching commonwealth creation yet it is contested. It is an issue of fundamental party dispute. There are three big political problems.

First, the Nationals must vote for Telstra's sale knowing the entire structure of the fund is designed to deny them access to its proceeds for political purposes. Sense a slight problem?

As my colleague Alan Wood explained last weekend, Finance Minister Nick Minchin has floated the idea that the fund could hold Telstra shares by way of a transfer; that is, that the fund would hold the Government's Telstra shares and sell them down over time as a means of fireproofing the sale from a political raid.

The truth is that Costello has been deeply agitated about the price the Nationals may want for the sale of Telstra. So the Future Fund is an anti-Nationals transparency protection device. It is a political time bomb for the Coalition and a test of the ability of Howard and Costello to create a new phase of successful surplus politics.

The second problem is the Labor Party. The most important part of Kim Beazley's budget reply was not about tax but about the Future Fund. Beazley is a passionate nation-builder and this fund is a potential Labor dream come true.

In his speech, lamenting our infrastructure failures, Beazley talked about "how we plan for the roads, railways, ports and communications networks of the future". He said that Labor "has a different and better plan" for the fund.

It would be used "to help rebuild Australia" and it would be called a building Australia fund. Its income would be "applied for infrastructure purposes". There are many questions; on what financial basis and who would decide?

But Beazley and Labor could not be more explicit. Labor in office would redesign and redirect this fund. Legislation might be needed but Labor would surely get a Senate majority if required. Indeed, this would constitute a perfect political and fiscal arrangement for Labor.

The Coalition would be setting up the new Labor model. When Beazley campaigns on using the fund for nation building and not public service superannuation, he has a winning position with the voters. And why not?

This highlights the third problem, the political utility of the fund. Has this been assessed? There is a strong argument that the present generation should not be required to sacrifice now for public service retirements a generation later when there is no reason to think these commitments cannot be met anyway.

It is true that Australia must prepare itself for an ageing population. But the best response is economic reforms that maximise our future growth. That demands a focus on productivity and participation where the Howard Government should be doing more.

There is one certainty. The politics of the surplus pose a fresh set of challenges for Howard and Costello.