Will the real fiscal conservatives please stand up?

With the marked deterioration in the economy over the last 12 months, the Rudd Government felt compelled on Tuesday night to deliver the biggest budget deficit in Australian history.

But despite the deficit, the Rudd Government has been big on keeping its election commitments, a task that is becoming very difficult since the recession knocked the stuffing out of public finances, and Rudd is doing an admirable job in light of the circumstances.

One of the key commitments in Labor's election campaign was Labor's pledge to keep the budget in surplus "over the cycle". This promise was a cornerstone of Rudd's branding as a "fiscal conservative", as voters were promised a new Labor era of fiscal austerity, backed by strong election commitments to maintain budget finances.

So will the Rudd Government keep the budget in surplus over this economic cycle?

The answer is, no.

The table below sets out the actual budget outcomes and forward estimates and projections by dollar amount for the period of the last economic cycle, the bust-boom of 1987 to 2008, and for the current economic cycle, the boom-bust of 1998 to 2013. The net position for each cycle, as well as the position over each boom and bust, is tallied at the bottom of each column.

(Sources: See here (PDF 108KB) for historic figures and here (table 1) for forward estimates and projections.)

As the Coalition has pointed out, the forward projection figures are a bit rubbery, particular up to 2014 when we apparently will return to surplus, but they are sufficiently accurate for discussion purposes.

So what do the figures tell us?

Over the last full business cycle, there was a net surplus of $42 billion.

The Howard-Costello years represent the boom years of the second half of the last economic cycle and of the first half of this current economic cycle. Over this period the Coalition government ran a budget surplus in every year other than 2002, during which it ran a small deficit, and was able to generate a total surplus of about $112.5 billion.

If the Rudd Government was serious about keeping the budget in surplus over the current economic cycle, it would have limited its spending in the downturn to the $112.5 billion in the kitty from the boom years. The Rudd Government plans to spend nearly double this amount.

It seems that Rudd was never very serious about delivering a surplus over the cycle, and fiscal conservatism was the first promise out the door once Rudd and Swan saw the financial trouble that was brewing. The Government tacitly acknowledged this when it lifted the Commonwealth debt limit from $75 billion to $200 billion in February this year.

The Government's plan for returning to surplus within six years looks hopelessly optimistic.

According to Treasury modeling, to return to surplus within this timeframe the recession would need to be a short one and the Australian economy must quickly achieve and sustain above trend economic growth - in the vicinity of 4.5 per cent year on year. Treasury is also counting on inflation remaining under control, even though growth will be running hot and despite having spent the last three years or so pumping cash into the economy hand over fist. An ambitious result coming off the back of the "worst economic crisis since the Great Depression".

More sober economists believe government debt will ultimately end up around $300 billion, and many wonder whether Treasurer Wayne Swan will ever deliver another surplus budget again.

But is Labor to blame?

In the face of such a massive economic crisis, is it simply not possible to keep the budget in surplus over the current economic cycle?

Perhaps this is true, but it does not excuse the Government's wasteful spending like the cash splash. The two rounds of cash handouts were only ever going to cause a temporary upturn in GDP figures.

Call me a cynic, but I believe the two sets of cash handouts, occurring six months apart, were designed to deliver positive GDP growth numbers in two non-consecutive quarters so as to prevent the economy from falling into technical recession - defined as negative growth in two consecutive quarters - thereby allowing Labor to avoid the stigma of presiding over the first recession since Labor was last in power. Alas, the downturn was too great and the cash splash did not work.

The Government argues that the spending was justified at the time because something had to be done immediately. Treasury's advice was to "go hard, go early, go households". Instead of the Government going into debt, it would have been better to use monetary policy to fuel short term demand. Interest rates were extremely high at the time so there was (and still is) plenty of room to move, and a steep drop in interest rates could have stimulated the economy and freed up household income. The Aussie dollar would have experienced a marked depreciation as a result, which would have stimulated the export and tourism sectors and have improved our current account position. All at no expense to the taxpayer.

The cash handouts were a dumb idea, but it is only part of the story - most of the Government spending is focused on infrastructure. This is the right approach, but there is good and bad infrastructure spending. Spending that increases the capacity of our ports and rail systems will deliver growth for Australia over the long term, and is a sound investment. On the other hand, it is difficult to see how installing pink batts in school classrooms will deliver a solid return on taxpayer dollars. On infrastructure spending, the Rudd Government's report card is mixed.

Is the Coalition to blame?

Should the Howard government have squirreled away more in the boom years so that we were better prepared for the inevitable downturn? This was certainly the sentiment of voters at the last election.

The early Costello budgets savagely cut spending on research and development (R&D) and education, among other areas, in order to balance the budget it inherited from Hawke and Keating. As the boom kicked in, tax receipts grew considerably, but instead of investing the surplus in key sectors like R&D, education and infrastructure, the Howard government funneled large chunks of it into middle class welfare.

To the Howard government's credit, significant cuts to income tax were made during the boom years. I would rather see taxpayers pay less tax than have their tax churned through the bureaucracy and then given back to them in the form of middle class welfare.

The boom years masked a level of government spending that was simply not sustainable. We are not dealing with a "revenue gap" that will get better once the economy improves. The budget will remain in deficit, and will never return to surplus over the cycle, unless governments make structural reforms to taxation and public spending.

The Rudd Government will be judged on their own performance, not on the mistakes of past governments. Swan promised in his first budget to take a razor to wasteful public spending, but the result was underwhelming. This budget promised "tough decisions", and the Government went a small way to eliminating middle class welfare, but more needs to be done to fix the structural deficit.

I would not describe any of the Labor front bench (except perhaps Finance Minister Lindsay Tanner) as fiscal conservatives. The Rudd Government must try harder if it wants to escape Labor's reputation for profligate spending and financial mismanagement.