Abbott faces Budget dilemma

Treasurer Joe Hockey will present the Australian Budget tomorrow night. Photo / Getty Images

Avoiding a recession while turning around debt and deficits is a headache for Australia.

Tony Abbott and his Treasurer have two big problems to solve when they present the Australian Budget to the nation tomorrow night. First, they have to ensure Australia doesn't slip into recession.

Second, they have to present a clear plan for restoring the budget position and turning around mounting debt and deficits to ensure Australia retains its cherished AAA rating.

Each of these tasks is difficult enough. Doing both at the same time presents a monumental challenge.

Trying to rein in the growing deficit with deep spending cuts and talk of a "tough" Budget will make consumers and businesses tighten their purse strings rather than loosen them. Crimping spending will also take money out of the economy at a time when it needs all the stimulus it can get.

The Australian economy is in trouble because the end of the mining boom has left the nation without a growth engine.

Last week the Reserve Bank of Australia cut interest rates to a record low in yet another attempt to kick-start the economy, then cut its forecasts to below par growth for the next 12 months. One well-known economist warned: "We stare down the barrel of a recession in 2016."

Abbott and Treasurer Joe Hockey need to use the Budget to restore confidence in the economy and introduce measures that will give a bit of stimulus to growth.

A handful of policies will benefit businesses: a tax cut for some small businesses and depreciation concessions for others; deductions for professional fees associated with starting a business; promotion of crowdfunding; and the reintroduction of share ownership schemes for employees.

Policies promoting productivity growth and a more efficient economy would provide larger and longer-term benefits and restore the faith of business leaders in the political process. But Abbott has shown he has no stomach for unpopular reforms and there's no reason to suppose he's going to start now.

It will be difficult for the Government to do much more to bolster the economy, because these initiatives cost money, and it's money the Government doesn't have.

Australia faces the same long-term budget challenges as most other developed nations: an ageing population will draw more heavily on the Government for pensions and healthcare while a smaller working-age population will have to support it.

Making this challenge so much harder is the end of the mining boom. Australian governments have been spending big for years on the back of resources income, but that revenue source has dried up and the debt and deficit is growing.

(Sorry to keep harping on about the resources boom, but it was the single most important economic and political phenomenon in Australia of the past two decades. Australia's governments and businesses are still floating in its wake.)

The economic situation is worse than the Government was expecting. Hockey will reveal tomorrow night that the Treasury has collected a lot less tax than it expected to a year ago.

A big part of the problem is what's known as "middle-class welfare". When John Howard was Prime Minister he distributed the proceeds of the mining boom to families for things like buying a house, having children, sending them to school and so on, regardless of whether the families needed them or not. Howard also introduced generous tax concessions for wealthy retirees.

Wrenching these handouts away from Australians would be tough for any government, let alone one as unpopular as the current one.

And Abbott's Government demonstrated after last year's Budget that it struggles to sell unpopular changes to voters.

The best example was when Hockey denied that a rise in petrol would hurt the worse off, because poor people "don't have cars or actually don't drive very far".

The Government will make a start on winding back middle-class welfare by cutting back pensions for wealthy retirees, but it will be only the first step on a long and difficult journey.

Economist Tim Toohey expects credit-rating agencies to put Australia on "negative watch" after the Budget. This is essentially a warning that unless the Government demonstrates that it has a realistic plan to reduce the budget deficits then Australia's credit rating will be downgraded.

Losing the AAA credit rating would be a blow in a couple of ways. It would rattle what little confidence businesses and households have in the economy and it would push up the interest rates at which banks can borrow money from foreign investors and this would flow through to interest rates for housing and business.

For Abbott and Hockey, it may come down to a choice: start repairing the budget or bolster the economy.

The indications are that they'll choose to support the economy. Like governments that have gone before them, they can always put off the budget repair job for another year.