Bit by bit, the debate over fiscal policy in Australia is being dragged into the real world. And, for once, even the opposition is ahead of many in the media.

For a long time our major politicians were locked into a “surplus: good, deficit: bad” mentality that at best assumed a quick return to normal pre-GFC economic conditions and at worst was an extended exercise in self-delusion.

Treasurer Wayne Swan was the first to take the red pill, last December. Last week it was shadow treasurer Joe Hockey’s turn. Joe woke up in a horrible, blasted fiscal world in which forces beyond a government’s control, like a stubbornly high dollar and an anaemic global recovery, keep undermining tax revenue, and the economy isn’t strong enough to bear a horror budget to slash spending. It’s a very different world to the simple one he’d been asleep in for so long, one in which the only fiscal problem was Labor’s genetic predisposition to burning vast bonfires of taxpayers’ money.

Joe will keep pretending that it’s all Labor’s fault, but his and his leader’s retreat from the surplus commitment are a dead giveaway that he knows he’s no longer living inside a dream.

So our Treasurer and shadow treasurer have now joined many of the better economists, who long criticised the determination to immediately return to surplus as political and potentially dangerous. But there are still some commentators who are stuck in the matrix. Austerity advocates like businessman David Murray insist ripping the heart out of spending is an urgent priority.

“We’ve reached the point where there’s an understanding that a surplus is not an end in itself … “

Nonetheless, we’ve reached the point where there’s an understanding that a surplus is not an end in itself, but that fiscal policy is a tool of economic management. And we’re now moving toward a serious debate over the next issue — ensuring that fiscal policy can continue to operate as an effective tool. That can and should be a separate debate from how to use the tool, but they’re clearly linked, both by politics and by policy.

Part of the reason for why the budget looks increasingly likely to remain in deficit over the medium term — an outcome by the way that, so far, ratings agencies appear entirely relaxed about — is for the reasons, identified above, that are beyond the government’s control (or, in the case of the dollar, normally should remain beyond the government’s control). But one of the reasons is because successive governments have failed to address underlying problems with the budget.

The biggest is that we have made our tax base more pro-cyclical, courtesy of the Howard government using a temporary increase in revenue from the first stage of the mining boom and unsustainably high consumption to fund permanent personal income tax cuts and middle-class welfare handouts. This has made us more reliant on corporate tax revenue, particularly from the big banks and mining, which is more sensitive to economic conditions.

But Labor has been culpable as well. It’s made some good cuts to middle-class welfare but continued the personal income tax cuts and failed to tackle the big tax expenditures eroding future revenues — the recent superannuation changes being a case in point. The result is that our tax:GDP ratio dropped to just above 20% during the financial crisis and is only forecast to reach 22.2% this year. It averaged 23.4% over the life of the Howard government.

Moreover, as Saul Eslake noted in The Australian Financial Review, the structural adjustments the government has been making to the budget have been redirected toward other spending (like Gonski or the NDIS) rather than being banked as a means of making the tax base more sustainable.

The low tax:GDP figure is matter of pride for Labor figures, who like to note that if the tax:GDP take was the same as under former PM John Howard, the budget would be in surplus. But that merely prompts the question as to why, if they’re in government, they don’t do something about it.

It also, in the long run, makes fiscal policy less effective, both at addressing long-term expenditure growth in areas like health (as today’s Grattan Institute report notes), and in responding to short or medium-term challenges — say, if there’s a global slowdown or Chinese growth slows.

That’s not a good position to be in, because we’re already down one economic management tool with the refusal of the dollar to fall, and another tool, monetary policy, is reaching the limits of its utility.

If present polls are correct, all this will soon be Joe Hockey and opposition finance spokesman Andrew Robb’s problem. They’d like us to believe the answer lies in reducing the size of government — reducing expenditure to fit a world of 22% tax:GDP. But they themselves are heading to the election with a corporate tax rise.

Then there’s the problem of the states’ tax bases. They too have taken a structural hit from changes in our patterns of expenditure. Removing exemptions from the GST and perhaps lifting the rate (with compensation) are the only long-term fixes there, especially if we want any governments investing in infrastructure in our cities, given the Coalition is likely to return to its bizarre conviction that the Commonwealth has no business investing in infrastructure where it’s needed most.

At least Hockey and Robb won’t have News Limited screaming “class warfare” at every spending cut or tax rise that might disproportionately affect higher-income earners. But so far, the opposition’s fiscal rigour is directed at lower-income earners, not at those who can most afford it.

Having a simultaneous debate about both how to use fiscal policy and how to ensure fiscal policy remains effective is probably too sophisticated a challenge for a polity that has only just progressed from “four legs good, two legs bad” barnyard baying. But it’s one the next government will have to grapple with.