Fiscal Policy Australia Homework Help

Fiscal Policy- Australia

Fiscal policy entails the use of a country’s budget in directing and influencing economic objectives. Australia’s 2013/2014 budget indicates that the carbon tax and the Mineral Resources Rent Tax among other taxes have failed to raise expected revenue for government to perform effectively. The government still needs to find ways of reducing existing expenditure. Overall, Australia’s 2013/2014 budget has the effect of reducing the ratio of government expenditure to GDP. This means that the government is using contractionary fiscal policy measures whose impact will be to reduce national income (output). Therefore this report applies the IS-LM framework to explain that if Australian government has to increase national income (output), then there is need to adopt expansionary fiscal policy stance.
Use of Fiscal Policy
Fiscal policy is done through measures aimed at varying the amount of government spending and revenue to attain a fiscal surplus, fiscal deficit, or a balanced budget with a view to change the level of economic activity in a particular fiscal period. There are two ways in which budget outcomes can be formed. First, there is the cyclical component where budget outcomes are formed when automatic stabilizers including government spending (through transfer payments) and tax receipts adjust to the state of economy. The second way is the structural component where economic activity is altered through government’s discretionary, proposed changes such as reduced spending.
In most cases, governments rely heavily on discretionary fiscal policy instead of automatic stabilizers. This is because despite fact that automatic stabilizers play a counter-cyclical role within the budget, they are rarely strong enough. When government aims at stimulating growth within the short-term, an expansionary fiscal position is employed. To do this, the government makes use of increased government spending and reduced taxation. This has the effect to substantially increase consumption and investment consistent with Keynes’ multiplier model. On the other hand, in order to slow down the economy, government uses a contractionary fiscal approach. This will also have the effect of limiting foreign liabilities and current account deficit. Furthermore, the results of the fiscal policy position can have a significant bearing on the level of income distribution and resource use direction within an economy.
Australia’s Budget 2013/2014- Winners and losers
The 2013/2014 budget had a number of winners. First, the Defense docket which was funded to a tune of $113 billion over the forward estimates, which was an increase of $10 billion compared to the 2012/2013 budget. Second was Disability Care Australia which received $3.3 billion with a $19.3 billion total investment in scheme over seven years, implying a $14.3 billion in new money to be spent. Infrastructure docket also gained in that it managed to receive a new spending of $3 billion over the forward estimates, which was being part of the $24 billion infrastructure package. The specific infrastructural projects to benefit from this funding included: the Melbourne Metro rail project whose allocation was $1.8 billion meant for Sydney’s WestConnex motorway, Sydney’s F3-M2 link whose allocation was $400 million, and Brisbane’s Cross River Rail project with an allocation of $715 million. Another big winner in the 2013/2014 budget was the Medicare docket with an allocation of $2.2 billion for investment in Medicare benefits over five years, plus $2.2 billion towards private health insurance rebate for four years and $226 million on cancer care. Among the many winners, other notable winners included Childcare reforms and jobseekers with allocations of $300 million in both cases.
There were many losers as well in the 2013/2014 budget. Firstly, the 2013/2014 budget presented massive revenue write-downs totaling to $170 billion in the last five years only. This involves a $18 billion deficit for the 2013-2014 financial year, a $19.4 billion deficit for the current financial year, and a $10.9 billion deficit for the 2014-2015 financial year. Secondly is the substantial cut down in tax receipts totaling to $60 billion over the forward estimates. This reduction in tax receipts was largely attributed to the high Australian dollar and the challenges presented by global conditions. Thirdly, the mineral resources rent tax was reduced to $3.3 billion over the forward estimates from the $13.4 billion original forecast.
The budget also proposed a reduction in higher education funding by $2.3 billion, as well as a $2.8 billion in tax cut associate with carbon trading scheme. The 2013/2014 budget also proposed substantial changes in superannuation tax arrangements targeting to raise $900 million in revenue from these changes that will see earnings of more than $100,000 on superannuation pensions and annuities that were previously tax free now taxed at 15 per cent. There was introduction of $665 million cut from the teachers’ bonus over the forward estimates, as well as $580 million in cuts to the public service over the forward estimates. These are only but a few losers among the many affected by the 2013/2014 budget.
Australia’s Budget 2013/2014- Fiscal Policy Issues
When Treasurer Wayne Swan unveiled Australia’s 2013/2014 budget, the most outstanding feature was the $19.4 billion deficit and an estimated debt of $178 billion. In what observers have termed ‘a mere blame game, the current government attributes the outcome to the failure by previous regimes to live within their means, which they only inherited. For instance, economic analysts who share a similar view singles out the latter years of Howard government that saw the Costello budgets in which were included a raft of tax cuts and handouts whose impact was to erode the otherwise healthy surplus. Some of the contributory factors to the erosion of the tax base included wages growth, jobs growth and exceptional falls in unemployment which led to increased tax receipts.
Other than the Howard government, the two and hall years’ leadership under Rudd’s Labor government also exhibited high debts and ill-fated economic policies in a period that was dominated global financial crisis. When Rudd came into power in 2007, there was an estimated $45 billion in terms of net government saving. However, by the time Rudd was leaving office in 2010, there was an estimated net government debt of $42 billion. Although the Rudd administration had the stimulus spending idea gain significant support, the issue that elicited great debate was the amount and form of spending.
Figure 1 below illustrates the government net debt of Australia over the years.

Figure.1: Government net debt of Australia over the years.
Source: Commonwealth of Australia
The budget 2013/2014 reveals that Australian government has failed to curb spending and/or widen the tax base. This is the case despite fact that the budget proposed the minerals resources tax and the carbon tax. Consequently, instead of addressing the budget deficit, the government has in fact delivered more budget deficits. The budget introduces public service cuts over the next four years which will include job cuts as a way of saving. This will see government save $580 million. However, analysts argue that meaningful savings in government spending need to come from cutting programs as opposed to public servants.
Policy Implications and sustainability Issues
Australia’s 2013/2014 budget indicates that the carbon tax and the Mineral Resources Rent Tax among other taxes have failed to raise expected revenue for government to perform effectively. The government still needs to find ways of reducing existing expenditure. This presents a real structural problem for government and is also compounded by the need for government to pay for its additional expenditure promises.
The government aims at having a surplus budget by 2016. This means that the medium term will have the economy continue to grapple with the debt burden while the markets continually readjust to fiscal policy measures of (increased government spending). As mentioned earlier, fiscal policy can be implemented through discretionary changes in government spending or the tax rate. Overall, Australia’s 2013/2014 budget has the effect of reducing the ratio of government expenditure to GDP. This means that the government is using contractionary fiscal policy measures whose impact will be to reduce national income (output). If Australian government has to increase national income (output), then there is need to adopt expansionary fiscal policy stance. This can be explained using the IS-LM framework.
Australia’s Budget 2013/2014- IS-LM Application to Fiscal Policy
The IS-LM is an important economic framework used within mainstream approach to assess the impact of fiscal and monetary policy changes on output (income) and interest rates, and also the effect on employment stemming from such policy changes. While the effect of changes in monetary policy results into a shift in the LM curve, the effect of change in fiscal policy leads to a shift in the IS curve. For the purposes of this report, the focus is on fiscal policy only.
The IS curve shifts to the right with the increase in the government spending. This happens because, for a given interest rate, increase in autonomous spending leads to an increase in equilibrium level of national income. This shift in IS curve depends on the size of the expenditure multiplier and on the magnitude of the change in autonomous spending. A smaller expenditure multiplier with a given change in autonomous spending leads to a smaller shift in the IS curve.
Figure 2 below illustrates the impact of increase in government spending (an expansionary fiscal policy change).

Figure.2: Impact of an expansionary fiscal policy change (increase in government spending)
Source: http://bilbo.economicoutlook.net/blog/?p=25024
It is assumed that the economy was at an existing fiscal policy stance represented by IS1. At the original fiscal policy position, the combination of the level of equilibrium for the interest rate and national income is marked by point i*1, Y*1. The intersection of IS1 intersects and LM, form the equilibrium point, which is identified by A. Thus, there exists an output gap given as (YFE – Y*1) where YFE is the full employment national income while Y*1 is the current national income level. Therefore the need to stimulate aggregate demand and to avoid mass unemployment associated with the current low level of output would drive Australian government to increase government spending. This has the effect to shift the IS curve to IS2 thus establishing a new point of equilibrium at B which represents higher interest rate and higher national income at the new equilibrium at i*2, Y*2.
Ordinarily, firms produce more output and hire more workers at a higher level of aggregate demand. It is for this reason that there is rising national income in this scenario. Since the higher national income leads to increase in transactions demand for money, there will be higher interest rate within the IS-LM framework. This is because at the original equilibrium interest rate (i*1), increased demand for money leads to excess demand for money since money supply is fixed. The rising interest rates will encourage people to hold less cash. This implies that the expansion in income could have been more than the one shown by the shift from Y*1 to Y*2 if the interest rate would not have gone up.
It is important to note that the final aggregate demand represented in figure 2 above is less than the initial aggregate demand. This is because the increase in interest rates has a negative effect on private investment. This negative effect (also known as financial crowding out effect) therefore offsets part of the increase in government spending. It if government spending would continue increasing until the IS curve shifts to ISFE, it would have been possible to attain full employment at point C. Furthermore, the gradient of the LM curve tends to determine the extent of the financial crowding out. Where the LM curve is vertical therefore, the fiscal policy will be rendered ineffective. This would mean that a given rise in government spending would be offset with the same magnitude of decline in investment as the magnitude of increase in interest rate.
Conclusion
In summary, fiscal policy is the use of government budget to direct and influence economic objectives. The budget 2013/2014 reveals that Australian government has failed to curb spending and/or widen the tax base. This is the case despite fact that the budget proposed the minerals resources tax and the carbon tax. Consequently, instead of addressing the budget deficit, the government has in fact delivered more budget deficits. Overall, Australia’s 2013/2014 budget has the effect of reducing the ratio of government expenditure to GDP. This means that the government is using contractionary fiscal policy measures whose impact will be to reduce national income (output). If Australian government has to increase national income (output), then there is need to adopt expansionary fiscal policy stance as explained earlier using IS-LM framework.

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