On Tuesday, May 14, Treasurer Wayne Swan will unveil the $390 billion federal budget, which will seek to balance the competing demands of lower-than-expected revenue, high expectations on social spending, and fear of deficits. Crikey has asked eminent economists and public policy whizzes what they would do if they were treasurer. We’ll roll out our fantasy budgets over the next week. First up is John Quiggin.

Our fiscal position is, rightly, the envy of the world. This is primarily the result of an unprecedented period of economic expansion that began in 1990, when the economy was at the low point of the “recession we had to have”. Primary credit for this outcome must go to the Reserve Bank, which made a series of good calls in the 1990s and the early 2000s and to the Rudd government for the rapid shift from “fiscal conservatism” to Keynesian stimulus after the 2008 financial crisis. This was made easier by strong growth in minerals demand from China, and China’s massive stimulus in 2009.

The Howard-Costello government deserves at least muted praise for not making a mess of this. Then prime minister John Howard and then treasurer Peter Costello kept the budget in balance (or just enough above) to report a string of small surpluses, and they did not interfere with the Reserve Bank. In their final years of the pre-crisis boom, however, they made a string of decisions that ensured the budget would be in structural deficit once more normal conditions returned.

The 2009-10 budget, along with the emergency measures taken earlier, protected Australia from the GFC. By contrast, New Zealand, now being praised by everyone on the political Right for returning rapidly to surplus, experienced a recession.

In 2009-10, the government projected a return to surplus by 2015-16. On the basis of some good news that turned out to be illusory, the target was moved forward to this year, and turned into an iron-clad commitment, which was recently abandoned. It now appears likely that the deficit will be around $12 billion, or 1% of GDP, which is about where it should be.

There’s no need for any radical change in strategy on fiscal policy. If the economy slows further, the automatic stabilisers inherent in the tax welfare system will produce a somewhat larger deficit. If strong growth returns, the original surplus target should be reached.

“… the only serious option is under the control of the Commonwealth — an increase in the rate of GST, say to 12.5%, which would raise an additional 1% of GDP.”

The big question for this year’s budget is the long-term levels of public expenditure and taxation. With the announcement — and apparent bipartisan acceptance — of a 0.5% levy to provide partial funding for the NDIS we have finally broken the longstanding taboo on increasing taxation. We can therefore address the central question of fiscal policy: should we pay more tax and get improved services in areas like health and education, or should we pay less and get less?

The case for paying more and getting more is based on the fact that technological change has reduced the cost of most physical goods relative to “human services”, which require skilled labour. At the same time, increasing longevity and the disappearance of unskilled jobs have increased the importance of health and education.

Over the next decade or so, addressing unmet needs in human services is likely to require an additional 3 to 5% of GDP*, or around $40 to $65 billion a year.

Thanks to the dominance of tax-cutting dogma over recent decades, there’s no shortage of options to raise additional revenue. The first would be to scale back the tax cuts for high-income earners originally proposed by Howard in 2007 and adopted in large measure by then prime minister Kevin Rudd. Increasing the top marginal rate of tax to 50% and applying it to income over $150,000 would recapture only a small part of the increased share of income that has gone to those in the top 1 or 2% of the income distribution. Nevertheless, it would be sufficient to raise close to 1% of GDP per year over the next few years.

Then there’s a laundry list of concessions and tax expenditures such as the the Seniors’ Tax Offset and the abolition of income tax on super fund earnings paid to people over 60. Together with earlier decisions to halve the rate of capital gains tax and end the indexation of petrol tax excise, economist Saul Eslake lists these as “the dumbest tax decisions of the last 20 years”.  Again, it would not be hard to find 1% of GDP here.

Given the continued pressure on the states to contribute to the financing of Commonwealth initiatives, and the fact that so much of their own-source revenue depends on inefficient, distorting and regressive taxes like stamp duties and gambling tax, state revenue needs attention. While the states could do better with payroll and land tax, the only serious option is under the control of the Commonwealth — an increase in the rate of GST, say to 12.5%, which would raise an additional 1% of GDP.

Even in my dream budget, I would not introduce these measures all at once. For the moment, the macroeconomic situation does not require further tightening of fiscal policy. But in the long run, these are the kinds of measures that will be needed.

*GDP is the wrong number to use here. The best estimated of the base for taxation available to the government is NDI (Net Domestic Income). But the habit of referring exclusively to GDP  is so ingrained that correcting it seems pointless.