Mark Lister, 14 September 2020

One question about our post-COVID financial future is how we’ll pay back the very large national debt we will have incurred by the end of it.

The most recent forecasts from Treasury note that our Government debt was 19.0 per cent of GDP in 2019, that it’s increased to 30.2 per cent today and that it could surge to 53.6 per cent by 2024.

That’s very high by our standards, but it’s still well below just about all other developed countries.

The International Monetary Fund calculates government debt slightly differently but those nuances aside, world debt to GDP is estimated to be a little more than 100 per cent at present.

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It suggests that Australia’s government debt is 57 per cent of GDP, Europe is 105 per cent and the US is about 140 per cent. At the extreme end of the spectrum, Japan has had government debt of more than 200 per cent of GDP for many years without any issues.

There are fundamental differences between all these economies, and one important distinction is that most of these countries have much lower household and mortgage debt than we do.

Serviceability is not an issue with interest rates as low as they are, but I would personally rather see our collective debt a lot lower.

We are a small, open economy with numerous vulnerabilities, and I have always been comforted by the ‘war chest’ of low government debt that has allowed us to fight unexpected crises.

So what are our options to lower it in the years ahead?

The best way to reduce our debt as a proportion of GDP would be for the economy to simply get bigger. This concept is no different than for someone who borrows to buy a house, and as the house price increases the mortgage - as a proportion of the property’s value - falls.

However, decent levels of economic growth could be tough to come by, especially with sectors like tourism facing challenges and population growth more muted as migration remains subdued.

Higher inflation would also be helpful in reducing our debt burden, provided it doesn’t get high enough to become problematic.

In theory, modestly higher inflation would see the value and cost of everything else (including wages) rise, while our debt levels would stay the same. That’s where the phrase ‘inflating your way out of debt’ comes from.

Mind you, as is the case with economic growth, a substantial rise in inflation isn’t looking likely over the near-term.

Outside of those more desirable solutions, the only real options for debt repayment are the ones politicians don’t like to talk about.

Just like a household that has borrowed more than it can afford, a government can either reduce its debt by cutting costs, or by finding a way to bring more money in the door.

Spending cuts don’t tend to be a vote-winner, especially when the economy is already fragile and the services in question are relied on by very broad groups across society.

That leaves higher taxes.

We’ve just seen the Labour party formally announce a new, higher personal tax rate. This would only affect a very small group of extremely high earners, so Labour is unlikely to suffer any real pain at the polling booth.

At the same time, it would only bring in a modest amount and is unlikely to put much of a dent in our mountain of debt. Some would say this policy is symbolic, at best.

High debt levels look here to stay over the next several years. That means interest rates are even less likely to rise, with policymakers set to remain highly incentivised to keep borrowing costs down.

It could also mean that central banks will take a more relaxed approach to higher inflation, in the interests of hoping it might help reduce that debt burden.

However, we shouldn’t rule out rising pressure on future governments to take a fresh look at the tax base, in the hope of finding more ways to bring additional revenue in.