As we make our way through the first month of a new financial year, political economic debates are dominated by inflation, interest rates and “full employment”. But the discussion of interest rates is generally focused on their impact on inflation at the macro-level, and on mortgages and cost of living at the micro-level. The impact of interest payments on government budgets is usually noted in budget night commentary on the deficit/surplus scorecard, but promptly forgotten for the rest of the year.

However, an unusual occurrence (at least in recent times) in the South Australian state budget should serve to illustrate why interest rates matter to government and to the community. In 2023-24 the amount of government expenditure going to servicing state debt ($1,254m) will eclipse the budget for the Department of Human Services (DHS) ($1,148m). This difference grows over the forward estimates with the DHS budget subject to real cuts (low indexation and older operational savings) while interest payments increase substantially. By 2026-27, interest payments are predicted to be $1,684m, by comparison with a DHS budget of just $1,233m.

In practice, this means that we are spending more on debt repayments than we are on the Department that is the primary provider of support services for the most vulnerable and disadvantaged people in our state. That feels wrong – but apart from the shock value, does it really matter, or it is just a statistical coincidence with no budget or social impact?

A Debt Problem?

As I pointed out in SACOSS’ post-budget analysis, government debt and deficits are not necessarily a problem – and may represent important economic stimulus or long-term investment. And there is no suggestion that this level of debt in unsustainable, although the budget papers show that a 1 percent point increase interest rates in 2023-24 would equate to an extra $203m in service payments. That would obviously be a significant imposition on the budget, but even with the debt-to-income ratio rising, the government can clearly still maintain payments. However, if debt is unchecked or interest rates continue to rise, at some point interest payments either become unsustainable, or more likely, a significant constraint on budget spending in other areas.

In that sense, the comparison of interest payments and the DHS budget is important because it reminds us of the potential impact and opportunity cost of state debt. I am not suggesting that if we were not paying that money in interest, we would be spending it on human services. That would be wishful thinking! However, all government spending has distributional impacts, and interest payments are no different. The comparison with DHS expenditure simply serves to focus the interest payment discussion on inequality.

Debt, Interest Payments and Inequality

In providing concessions and emergency supports to those on low incomes, and funding charities to provide a range of other supports, the Department of Human Services functions to transfer money and resources from the budget to those most in need. By contrast, interest payments are a transfer from the budget to government bond holders – who, by definition, are those with excess cash to afford to lend money to the government (by buying bonds).

As Piketty has pointed out, (and [as ever] some of the concerns here come from my reading of his work) it is far more advantageous to those with capital to have public deficits and receive interest on their money than to have that capital taxed to balance the budget (Capital in the Twenty-first Century, p.130). So, in creating government debt we have already chosen to favour those with capital by borrowing rather than taxing their money and creating an ongoing flow to rather than from that capital.

Seen in this light, the contrast between the DHS budget and the amount going to debt servicing is an indicator of choices about government priorities – the choice to provide relatively less to the poorest in society (via government expenditure) than to those who are better off (via taxes foregone and interest paid out).

Caveats

Of course, as with everything in economics, it is not as simple as that. The initial use of borrowed capital may be used for things which support those on low incomes, and inflation may quite separately have a counter-balancing impact by undermining the real value of bonds and the interest payable on them. Further, bond-holders may not be South Australian residents and may therefore be outside the tax ambit of the state government. In that sense the taxing v borrowing from capital argument above is not about individual bondholders. Rather it is illustrative of the options of government in general and operates at the level of class: that is, the state government has options to tax local capital rather than borrow from capital in a national or global market.

To the extent that we can look at individual bondholders, it is also worth noting that, as Piketty points out, they are no longer necessarily the wealthiest people in society (as the super-rich can invest more lucratively elsewhere). ABS wealth statistics do not record bonds as a separate category, so it is hard to confirm this. However, it is clear that the low-inflation era of the first years of this century made bonds a safe investment for middle class superannuation and investment funds, so when we talk about bondholders it is likely we are talking about middle and above-average income earners (often via superannuation or investment trusts). In that sense, the DHS/interest payment comparison is not so much about rich vs poor, but about a form of middle-class welfare instead of a transfer to those in most need of the supports that a DHS might offer them.

Finally, there is another (non-taxation) route to balancing the budget and avoiding interest flows to capital owners. That is by cutting expenditure. However, cuts to expenditure (and therefore to services) usually impact disproportionately on the poorest people. Those with the fewest economic resources are likely to be most reliant on support services and have limited or no alternative options, so expenditure cuts usually also impact most on the poor. Further, it is notable that in this SA budget, government debt continues to increase even with operational surpluses from 2023-24 onwards, so balancing the budget is not simply done by cutting expenditure. However, there is little doubt that when government services are cut (the “austerity approach”) this exacerbates inequality, so if fairness or equality is a consideration in balancing the budget, we must ultimately return to revenue issues – and our preference for borrowing rather than taxing capital.

Why Debt and Interest Payments Matter

Budget deficits and surpluses matter, but not for the reasons often touted in economic commentary (“responsible government”, “living within our means”). They matter because they determine the level of debt, which in turn, within any given interest rate regime and revenue base, impacts on the money available to spend on services. And as interest rates increase, so too does the cost of servicing government debt. The choices made to borrow rather than tax capital increasingly manifest in a distribution of government revenue to the middle and upper middle classes rather than to those on the lowest incomes who would benefit most from government service provision.

The fact that the SA state government interest payments now eclipse spending on the Department of Human Services should make us think about government priorities and the need for a stronger tax base.