By BOQ Chief Economist, Peter Munckton.
- The 2018-19 headline Budget deficit is forecast to be around $2b;
- A small surplus is projected for the 2020 financial year;
- Most of the major policies were well flagged, with income tax cuts getting the headlines;
- The Budget is broadly appropriate for the current state of the Australian economy;
‘Good economic is good politics’
Back in the 1980s and 1990s, the Budget was the main economic event of the year. There was particular focus on the size of the deficit, and there was always the odd rabbit to be pulled out of the hat. There remains plenty of community focus on the Budget outcome (notably who are the winners and losers), with the media attention as big as ever. Over the past couple of decades financial market focus has shifted to monetary policy. But fiscal policy is starting to step back into the spotlight in recent years given how the global economy has performed in the post-GFC low-rate world.
The most over-rated talking point of most Budgets is the search to find the overly-optimistic assumption. A couple of years ago it was the outlook for the Chinese economy. There was the Budget where the worry was about the iron ore price forecast. Last year the debate was about an excessively high wages projection (which remains perhaps the biggest question mark over this year’s Budget). It may well be that the wages growth forecast made last year will be a bit higher than the final outcome. But this will be offset by substantially stronger-than-expected jobs growth. Indeed one year on the aggregate forecasts in last year’s Budget have held up pretty well.
Major Budget 2017-18 Economic forecasts
|Real GDP||2.75%||Budget forecast in line with the latest RBA view from the May 2018 Monetary Policy Statement|
|Employment||1.5%||Likely to underestimate the actual outcome. The jobs market went gangbusters in calendar year 2018. Slower (but still decent) growth likely in 2018-19.|
|Unemployment rate||5.75%||The RBA expects the unemployment rate to be modestly lower (5.5%, the current rate)|
|CPI||2%||In line with latest RBA forecast.|
|Wages||2.5%||The controversial forecast of last year’s Budget. End result will likely be around quarter percentage point lower.|
|Nominal GDP||4%||Forecast is in line with the latest figure from December quarter 2017 National Accounts data.|
Employment, wages and CPI all though year June quarter 2018 change. Unemployment rate average for June quarter. Otherwise the data is year-average.
Sources: 2017-18 Commonwealth Budget, May 2018 Monetary Policy Statement, Datastream, ABS
The reason why there is so much focus on the Budget assumptions is that where the economy (or more precisely income growth in the economy) goes government revenue follows (the economy also influences spending, particularly on items such as the Newstart allowance). So a bit of excessive optimism on the forecasting front can do wonders for the Budget bottom line. But history indicates that Federal Treasury forecasts typically have the same bias as most forecasters; they are too pessimistic in the good times and too optimistic in the bad.
The main forecasts this time appear reasonable. The global economy is doing well. Unemployment rates in many countries are at decade-low levels. Central banks in a number of countries are feeling confident enough about the outlook (notably the US) to raise interest rates. Domestically, business confidence is high and consumer sentiment is improving. The global economy is helping exports. Infrastructure spending is strong (helped further in this Budget). The Budget growth and inflation forecasts are in the same ball park as the RBA. Treasury still expects wages growth to pickup. If wages do not rise in line with their forecast the RBA might find it hard to achieve their inflation target. It is interesting that despite decent growth Treasury does not expect the unemployment rate to decline to 5% for another 4 years.
Main economic indicator forecasts for 2018-19
|Wages price index – Treasury||2.25||2.75||3.25||3.5||3.5|
|Nominal GDP – Treasury||4.25||3.75||4.75||4.5||4.5|
Source: Budget papers 2018-19, May RBA Monetary Policy Statement
The headline budget deficit is projected to decline from around $13b for this financial year to only a touch over $2b for 2018-19 (as a proportion of GDP it narrows from 0.7% to 0.1%). Essentially the Government is saying that next financial year we will have a balanced budget. By 2019-20 the Budget is projected to be back in (a small) surplus. You are right if you feel like you have seen this movie before. Each of the past few years we have been treated to the same forecast pattern; first a deficit and then a return to the promised land of budget surpluses. In fairness, the improving economy does make the possibility of a surplus sometime in the foreseeable future more likely on this occasion. In particular, a starting point of a budget deficit of under 1% of GDP makes it a lot easier to envisage a surplus than the 2%-plus deficits of preceding years.
In aggregate terms the Budget will be adding a little less to the economy than preceding financial years. This is not unreasonable given the improvement in the economic outlook and with interest rates still very low. The IMF estimates that the structural budget deficit (the size of the deficit after allowing for the impact of the economy on taxes and spending) is less than 1% of GDP (Treasury has that deficit in 2019 at a bit over 1%). A deficit of that size looks about right given the spare capacity still evident in the economy.
Past Budget deficits has seen Government net debt rise to almost $350b. As a proportion of GDP it is a less scary sounding 19%, although that is the highest level that ratio has been for almost 50 years. The Government is forecasting that ratio will start to decline from the 2019 financial year (the same year it believes that the level of net debt will peak). The better economy and improved budget outcomes should see some improvement in the Government’s net debt position in coming years. The key question is how much debt will be reduced. That will depend upon how long the economy can stay strong (and whether politicians can resist spending the proceeds). It remains the case that while the current net debt ratio is high by Australian standards it remains low on a global comparison.
The improvement in the Budget over the past year has essentially reflected an improvement in the economy. Money has flowed in, partly offset by Government spending and taxing decisions (mainly tax). Economists may frown that not more of the extra money is being used to pay down debt. But they are not seeking re-election. The bigger picture is that the budget position has been improving because of stronger tax receipts (a result of a stronger economy and past government decisions). The tax to GDP ratio is approaching cyclical highs (a reason why the government has introduced income tax cuts). The contribution of lower spending to the improvement in the Budget bottom line has been more modest.
The big infrastructure projects were the major new spending decisions, and had generally been well flagged. Transport projects get most of the new funding, with something for every state. The other big announcement was more money for aged care (particularly for at home care). More money was also available for the Great Barrier Reef, as well as more funds for medical research. Extra funds will also be made available for the pharmaceutical benefits scheme.
The big picture is that despite the modest pace of economic growth, spending growth has been reasonably contained over recent years. Indeed, the pace of spending growth over recent years is not dis-similar to that of the early Howard-Costello budgets (but higher than the Hawke-Keating times). But we have not unwound the significant rise in spending that took place both prior, and during, the GFC.
One of the reasons that spending growth has been contained is that the reduction of interest rates has reduced the cost of the government servicing its debts (despite the higher budget deficits). In recent years most other spending categories have increased at broadly the same pace. The one exception is spending on social security which is being substantially boosted by the introduction of the NDIS. Further big increases in NDIS spending are projected for the next couple of budgets.
As noted the Budget spending headlines were mainly gained by the infrastructure projects. The big increase of population over recent years suggests that an ongoing high level of infrastructure spending will be required. The projected infrastructure spending by the Government is forecast to peak this year (both in dollar terms, and relative to the size of the economy). Thereafter the size of infrastructure spending declines, albeit remaining at around a 2%-plus of GDP range in coming years.
The biggest headlines went to the cuts in personal taxes directed at low and middle-income earners. The cuts are planned to come in 3 stages. The first is a change to the low-income offset which will provide cuts of up to $530 (much of which is likely to be spent, or used to payoff debt). The second stage will be to increase to increase the level of income from when the 32.5% tax rate cuts in. The 3rd stage will be to abolish the 37% tax rate completely (but not until 2024). The first stage will certainly be introduced, and there is a reasonable chance the second will be implemented. Whether the 37% tax rate ends up being eliminated is far from clear.
The company tax cuts from the previous budget remains, as does the instant asset write-off for small business. The better revenue outlook has enabled the government to stop the planned Medicare Levy increase.
Some cut in income tax is understandable given that income taxes (both personal and company) are near their highest level relative to the size of the economy in almost forty years. Indeed, the proportion of revenue earned from income tax in Australia is amongst the highest in the world. A tax cut will help improve households disposable income. This is an economic plus, given that consumer spending has been a risk for the economic outlook.
As an economist I agree with Paul Keating: good economics is good politics. This economics of this Budget is reasonable. The Government has received a lot of money from a better economy and has resisted the temptation to spend it all. My understanding of Labour policies is that they will collect more in taxes, leaving them the potential to boost increase spending or payoff debt quicker (or a combination of both). Over the next year we will find out which idea will play best politically.
We live in interesting times.