Why Accidental Surpluses are the Only Good Surpluses

2 January 2024

Jim Chalmers has overseen two budget surpluses in his time as Federal Treasurer. He didn’t plan either of them. Strangely, this is the best thing about them. Unexpected surpluses are the best surpluses.

A Government surplus sounds like a good thing, especially when contrasted with a budget deficit. After all, who wouldn’t prefer a surplus to a deficit?

Except… the Commonwealth Government is not a business and it is not a household. It is an utterly unique participant in the Australian economy, whose spending accounts for around 25% of all economic activity. The Government is the single largest participant in the economy, and it’s participation in the economy has a huge impact on our economic wellbeing.

In order to achieve a surplus, the Commonwealth Government must take in more money than it spends. This must, in turn, reduce the amount of money circulating in the economy. If the surplus is achieved by increasing taxes, then the 75% of the economy that is not the Government has less to spend – because they are the ones paying the tax. This must reduce economic activity and suppress GDP. Alternatively, if the surplus is achieved by reducing Government spending, this directly suppresses GDP because Government spending forms part of GDP. Either way, a Government surplus reduces GDP from what it would otherwise have been. Government surpluses reduce economic growth.

This is usually not something we want to happen. The only time that we might want to reduce growth is at times of high inflation. In fact, restricting GDP is the express purpose of the recent round of interest rate increases. The RBA is looking to (i) discourage new lending, and in particular business lending; and (ii) reduce personal consumption, by reducing the amount or money people have left after they pay their interest bills. So, right now, the RBA is trying to restrict GDP. Given that surpluses achieve the same result, a Government surplus right now is at least consistent with RBA policy.

Treasurer Chalmer’s surpluses have mostly been the unexpected result of an increase in taxes, paid by both individuals as wages and salaries grow and by companies as business profits grow. GST, which is calculated as a percentage of the price of goods and services, also rises naturally when prices rise. All of these increases are known as ‘automatic stabilisers.’ They are automatic because they happened without any specific change being made. And they are stabilisers because they stop the economy growing too quickly during this time of higher prices. 

So, right now, the unexpected surpluses are taking money out of the economy, which will reduce demand and should help to stop inflation. This is what makes these particular surpluses a good thing. What’s more, because money paid as tax is completely removed from the economy, these surpluses are actually better atreducing inflation than interest rate rises. Interest rate rises largely redistribute money from borrowers to lenders – that’s why bank profits have risen so remarkably in the past two years. But those profits are income for shareholders, and that income can be spent. So, higher interest rates don’t reduce overall spending – they simply change the person who does the spending. Borrowers have less to spend but lenders have more. (Higher interest rates do reduce overall demand in another way, by discouraging new borrowing. I am talking here about the impact of higher interest rates on existing debt).

If you want to reduce demand, it is much better to take money out of the economy via taxes than to redistribute money via interest rate rises. These surpluses are perfect for our times.