Hockey must pay off our credit card

Joe Hockey says the government won't 'cherry-pick' recommendations from the Commission of Audit's report.

POLITICIANS like to use homespun wisdom to sell their political lines.

Government debt is often referred to in the same terms as household debts.

Treasurer Joe Hockey employed the mortgage metaphor last month to describe his budget challenge.

"Budget repair is … about ensuring that future generations do not pay for a standard of living for today's generation that they themselves will never enjoy," he explained.

"Continued deficit and debt is borrowing from tomorrow to fund our lifestyle today. We owe it to our children not to leave them with a mortgage that paid for our lifestyle."

Of course, government budgets are not the same thing as household budgets.

For one, governments can control their incomes — give themselves a pay rise, if they like, by raising taxes.

Governments also never die. Well, in safe stable democracies like ours, it's safe to assume the government will continue for many years. As such, their bills never fall due.

And it's much easier for governments to get a loan to cover their debts. Despite concern about Australia's budget outlook, investors are still quite happy to lend to the federal government.

Just last week, the government's debt manager went to the market and managed to borrow $700 million at an interest rate of a little over 4 per cent. It's been lower, but that's still pretty good compared to the credit card rates that households pay.

But Hockey's right that there are crucial similarities between household and government accounts.

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Budget pain ... Treasurer Joe Hockey reacts to the release of the Commission of Audit at Parliament House in Canberra. Picture; Kym Smith Source: News Corp Australia

Both face similar a distinction between credit card style debts and mortgage style debt.

Ordinary borrowers use mortgages to cover the cost of investments. They do so because they expect the value of those investments, like a house, to rise over time and eventually be worth more than the initial debt. For most Australians, this has been the best way to wealth ever invented.

Credit card debt, by contrast, is used to fund current spending. You go to the shops to buy shoes, you put them on the credit card and then pay it off from your next pay check.

Broadly, you should be aiming to pay your credit card off as you go. If you don't, and you died, that money would come out of your estate and yes, your children would end up footing the bill.

If you died and left a mortgage to your children, they could sell the house and hopefully — if it had gone up in value — clear the debt quite easily.

When it comes to government debt, there is a similar distinction.

Government spending can be like purchasing an asset that increases in value over time, like your house. If governments spend their money to build roads, railways and public transport, this increases the economy's productive capacity and future earnings. The increase in value to the economy is more than enough to cover the debts. Of course, that's assuming governments make wise investments, which they so frequently don't.

Spending on education and health can also increase the economy's productive capacity. Highly educated graduates enjoy higher incomes than school leavers. Healthy workers are more productive than sick workers.

Bad news ... Treasurer Joe Hockey and Finance Minister Mathias Cormann at Parliament House in Canberra. Picture: Kym Smith Source: News Corp Australia

So money spend on health and education can also be seen as an investment. It may be worth the government going into some debt to do it.

But it turns out that most of government spending today is made up of welfare payments and benefits. These things go out the door to increase fairness in the economy, not necessarily to boost productive capacity.

When it comes to these things, governments should be able to fund them from their next pay check. In the case of government, that's revenue from income taxes, company taxes et cetera.

Unfortunately, the federal government's current level of income (through taxation) is nowhere near enough to pay for all this "recurrent expenditure" of government.

Put simply, the budget does not add up. We do not have enough revenue raised through taxes to cover our spending on a day-to-day basis. That's why the budget is in deficit. And whenever we're in deficit, the government must borrow to cover the difference.

Sure, some of government spending can be classed as investments. But most of it is not.

If parents don't want to pass on credit card debt to their children, there's only two ways to correct things.

First they can spend less in the first place.

Second, they can work more to earn a higher income.

For governments, it's spend less or tax more.

If we don't want future taxpayers to have to foot the bill of our current lifestyle, we will have to receive fewer services or pay higher taxes.

There's no other way around it.

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