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(originally published as a comment to the Business Spectator site two years ago)

The economy goes in cycles. If there’s a downturn, governments will run deficits. If there’s an upturn they will run surpluses. In Australia, the Rudd/Gillard Labor government ran deficits because there was a downturn (worst since 1930s) and revenue went through the floor. The Howard Coalition (Liberal-National) government ran surpluses because there was an upturn (longest on record) and revenue went through the roof.

The Keating Labor government ran deficits because of a downturn. The Hawke Labor government ran surpluses due to an upturn. The Fraser Coalition government ran deficits due to a downturn. (In New Zealand, the previous Labour government ran surpluses due to an upturn; the National government ran deficits due to a downturn.) The pattern of deficits and surpluses is very clear. It depends on the world and therefore Australian economic situation, not on who is in government.

In the last five years of the Howard Coalition government, the average annual increase in federal government revenue was 7.8%. Had this rate of increase continued, the amount of extra revenue in the five years 2008-09 to 2012-13 would have been $298 billion. Most of the decrease in the growth in government revenue (it actually fell in 2008-09 and 2009-10) during the downturn was due to lower company profits and therefore lower taxes.

Let’s assume a company has sales of $10 million in year 1 and its costs are $9 million, leaving $1 million in profit. Assume that the world and therefore Australian economy is buoyant. In year 2, the company increases its sales 5% to $10.5 million. Its costs go up about 4% to $9.4 million. It makes a profit of $1.1 million, up 10% on year 1.

Let’s assume a different scenario for year 2 instead. A downturn in the world and therefore Australian economy means sales only grow by 2% to $10.2 million. The company is able to contain or even reduce some costs but many are fixed costs and its overall costs still rise by 3% to $9.3 million. This means its profit falls 10% to $0.9 million. Government taxes fall. The government can cut back on a few things but most programs are ongoing and cannot be easily cut back, especially in the short term.

Now let’s go to 2008. Large countries around the world are quickly falling into recession; their governments run deficits and build up debt because if they didn’t, they would fall into deeper recession with more companies struggling or going broke and even higher unemployment (so long as debt doesn’t get right on top of them, such as Greece). Australia was in a better position than many of these countries, partly due to the mining boom but also various other reasons, but it knew that it still had to run deficits to avoid going into recession and it had to do it fairly quickly.

Short term programs were needed which, in hindsight could have been done better. But there wasn’t time for longer term programs such as extra infrastructure. As it was, the government was still able to keep expenditure increases at a lower rate (average of 3.9% from 2008-09 to 2012-13) than during the last four years of the Howard government (6.5%).

Had the Labor government tried to balance the books as per the policy of governments around the world up to and including the 1930s, we would have gone into fairly deep recession, with the result that we would now be considerably worse off with many more companies struggling or bankrupt and much higher unemployment.