By Chris Berg

Photo: The wartime politics of John Curtin and treasurer Ben Chifley have come back to haunt Joe Hockey in 2014. (Supplied)

Joe Hockey has come smack-bang up against a fiscal illusion Ben Chifley created in the 1940s, which is proving a very real constraint on economic reform, writes Chris Berg.

Joe Hockey's father named his son "Joseph Benedict" after Ben Chifley.

Little did the family expect their child to be struggling with the legacy of his namesake at the most critical moment in his political career.

Hockey's first budget is haunted by a political bait-and-switch Chifley made way back in 1942 and 1943.

The story goes like this. Wars are incredibly expensive. During WWII, the Australian government inflated the currency and borrowed massive amounts of money. Nevertheless, when Labor took power in 1941, there was still a huge budget shortfall that needed to be addressed.

And like the Coalition today, Labor had made much political capital opposing the previous government's taxes, particularly those levied on low income earners.

Once in government, the new Prime Minister John Curtin doubled down. When the first uniform tax case came before the High Court (which effectively eliminated state income tax in favour of Commonwealth income tax) Curtin promised the electorate that the Commonwealth's new power would not be used as an excuse to raise income taxes.

Labor's no-tax pledge was unsustainable.

Throughout 1942 it became clear to Curtin and his treasurer Chifley that the government had to close their huge revenue-expenditure gap.

There was a war to be fought, so cutting spending was out. Printing money was out too. Inflation was already a problem. There would have to be some additional taxation. And some would necessarily hit those on incomes below £400 per year.

(There was another rationale for higher income taxes being pushed by the government's young Keynesian advisors: the need to suppress excess consumer spending during war.)

The solution devised by Chifley was a classic example of policy misdirection.

For the previous decade, parliament had been debating whether to introduce a national social security scheme. One of the key questions in this debate was whether it should be funded by general taxation, as Labor traditionally favoured, or individual contributions, as the conservative Lyons government had proposed in the late 1930s.

So when Chifley announced that they would increase income taxes on rich and poor alike, they also announced a "National Welfare Fund" alongside it.

This National Welfare Fund would fund welfare measures like pensions, unemployment relief, child endowments, even health care. The fund is often seen as the launch of Australia's welfare state.

Unlike a contributory scheme, the fund would be financed by the new income tax increases. But there were two tricks.

First, Chifley said the revenue from the tax increase was specially earmarked for the National Welfare Fund. Thus Labor wasn't breaking its promise not to increase the burden on low income earners - they would be getting social security for their money. (Think of the fund like our Medicare Levy today.)

And second, most of the great new social services weren't to start until after the war. Cabinet agreed that only £5 million of the estimated £40 raised would be directed towards immediate social spending. Money is fungible. The rest could quietly be used for the war effort.

The National Welfare Fund has long passed into historical obscurity. But the mythology of welfare contributions it engendered remains - one that imagines the welfare state as a giant piggy bank.

As the historian Rob Watts points out in his book The Foundations of the National Welfare State, what looks like groundbreaking Chifley welfare reform was really just a smokescreen for unpopular wartime tax rises on lower income earners.

The Menzies government folded the National Welfare Fund money into general revenue a few years later. (It is good budget practice not to hypothecate specific revenues to specific programs). But the fund remained in name until the 1980s.

The social contract has always been a complex mish-mash of popular mythologies about what the state owes to the citizen. We are still living with the political consequences of Chifley's clever little political ploy.

His scheme made it seem like the Australian tax system was a quasi-contributory and fully-funded insurance program.

One former Department of Social Security employee summed up this belief well in Green Left Weekly: "In the late '60s and early '70s, many applying for the pension would say, 'I'm only getting back the money I paid into the National Welfare Fund'."

The National Welfare Fund has long passed into historical obscurity. But the mythology of welfare contributions it engendered remains - one that imagines the welfare state as a giant piggy bank.

In 2014, Joe Hockey has come smack-bang up against Chifley's fiscal illusion.

Hockey says he wants to end the Age of Entitlement. But welfare measures like the pension feel a lot less like unjustifiable entitlements to those who believe they've already paid for state retirement benefits.

As one aggrieved person told the Treasurer on Q&A, "many pensioners have worked all their lives and paid tax in order to receive the pension and Medicare".

In other words, the piggy bank model of welfare is not about the well-off supporting the less fortunate. It's about churning everybody's money back to them.

So there's no place for means testing if welfare is less an old-age safety net and more a de facto retirement savings account. (In fact, quite the opposite. The more you put in the piggy bank the more you deserve what you get out).

If the welfare state is just a big piggy bank, there is no case - for instance - to include the family home in the pension assets test, something the Audit Commission recommended.

It's easy to ridicule people living in multi-million-dollar homes clinging on to the pension. Yet, thanks to Chifley, many Australians worked and paid taxes all their lives believing that was exactly what the social contract made possible.

Is Chifley's welfare-system-as-piggy-bank good policy? Certainly not. Over time it will fade away as superannuation carries the burden of the pension system.

But right now, as Joe Hockey has learned, it is a very real constraint on economic reform.

Chris Berg is a Research Fellow with the Institute of Public Affairs. View his full profile here.

Chifley's time bomb 70 years in the making - The Drum (Australian Broadcasting Corporation)