How the budget scare was $150 billion too big

Before the budget Scott Morrison promised us "good debt" and "bad debt". What we actually got was less radical but more sensible.

The government has come under increasing pressure from the Reserve Bank of Australia to draw a clear distinction between its borrowing to cover "recurrent" spending (on day-to-day operations) and borrowing to cover investment in capital works ("infrastructure").

It was wrong to lump them together and claim the combined deficit constituted the government "living beyond its means", as the Coalition often has.

Government borrowing to pay for infrastructure that will deliver a flow of services to the community for many decades to come is not in any way irresponsible.

The Reserve's reason for pressing the government was its desire for "fiscal policy" (the budget) to give its "monetary policy" (low interest rates) more help trying to stimulate faster economic growth.

Make the recurrent/capital distinction and the government can move to repair its budget and avoid unjustified borrowing, while still investing in new infrastructure projects that both add to demand in the short term, and later - provided the projects are well chosen - add to the economy's potential to supply more goods and services by improving our productivity.

In this budget Malcolm Turnbull finally capitulated to this pressure, overturning decades of Treasury dogma.

Sort of.

Fighting back

Treasury's fought a rear-guard action, retaining the old world while seeming to move to the new. In the process it's been obliged to make clear all the budgetary cupboards in which it hides the government's spending on capital works.

In so doing it has revealed that the line between budget accounting and creative accounting is thin.

Let's start with what in accounting passes as theory. There are two main ways you can measure the financial performance of an "entity" such as a business or a government: the rough-and-ready "cash" basis, or the more careful "accrual" basis.

The private sector has been using accrual accounting for more than a century, whereas Australia's public sector moved from cash to accrual only in 1999, after the United Nations Statistical Commission shifted the national accounts framework to an accrual basis in 1993 and the Australian Bureau of Statistics complied.

The cash basis measures the government's financial performance merely by comparing the cash it received during a period - usually a financial year - with the cash it paid out during the period.

By contrast, the accrual basis puts much effort into ensuring the incomings and outgoing are properly "matched", so they are allocated to the accounting period to which they rightly apply.

If, say, on the last day of the year you paid for an insurance policy to cover you for the following year, an adjustment would be made to shift that cost to the following year's accounts.

When the feds moved their accounts and budget onto an accrual basis at the turn of this century, however, Treasury declined to play ball.

It stuck with cash, making the debatable argument that recognising government transactions according to when the cash changed hands gives a better indication of those transactions' effect on the macro economy.

(It couldn't admit the real reason. The cash basis leaves much more scope for creative accounting: quietly moving receipts and payments between periods so as to make the books look better or hide something the government finds embarrassing.)

Split languages

So, to this day, the budget papers are written in two different financial languages. The bit prepared by Treasury is written in cash, whereas the much bigger bit prepared by the Finance department is written in accrual - as it's supposed to be.

Get this: our bilingual budget means the budget papers offer us four different measures of the budget bottom line to pick from.

There's the "underlying cash" balance (the one Treasury wants us to focus on), the "headline cash" balance (please don't ask questions about this one), the "fiscal" balance (the close accrual equivalent of underlying cash) and, buried up the back, the accrual-based "net operating balance".

The news is that Treasury is sticking with underlying cash as "the primary fiscal aggregate" - the one it will make sure we focus on - but will ditch the fiscal balance (always just a face-saver cooked up by Treasury) and replace it with - give "increased prominence to" - the net operating balance, henceforth known as the NOB.

Bringing the NOB from the back up to the front will "assist in distinguishing between recurrent and capital spending" because, in accountingspeak???, "operating" and "recurrent" mean the same.

Wear watched

Point is, the biggest practical difference between cash and accrual is their treatment of spending on capital works. In cash, it's lumped in with recurrent spending, whereas in accrual it's not. Instead, accrual includes as a recurrent or operating expense an estimate of a year's worth of "depreciation" (wear and tear) of the feds' stock of physical capital - as it should if you believe in "matching" (which Treasury doesn't).

With this unprecedented casting of a spotlight on its accounting practices, Treasury has had to admit that the NOB actually overstates the recurrent balance because it includes as an expense the feds' capital grants to the states to help cover their spending on infrastructure.

Correcting for this reduces the coming financial year's NOB from a deficit of almost $20 billion to one of just over $7 billion (just 0.4 per cent of GDP). So we're already close to a balanced recurrent budget and should be there in 2018-19, after which (if Treasury's economic forecasts prove reliable) we'll be up to a recurrent surplus of $25 billion by 2020-21.

Turns out that, from the time the budget dropped into deficit in 2008-09 until the year just ending, focusing on the underlying cash deficit rather than the corrected NOB has exaggerated the extent of our budget repair problem by a cumulative $150 billion.

So how much have the feds been spending on infrastructure? Long story. Watch this space.

Ross Gittins is the Herald's economics editor.