Deloitte Access Economics Budget Monitor has been added to Bookmarks.
Deloitte Access Economics Budget Monitor
The virus sprint and the recovery marathon
11 May 2020: The biggest hit to the world and Australian economies since the Great Depression.
With apologies to Paul Keating, this one is the recession we actually had to have.
Even with the amazing success Australia is achieving in the fight against the virus, the oldest problem in economics is that unemployment goes down much slower than it goes up. Subject to the important caveat that forecasts are currently subject to really wide bands of uncertainty, Deloitte Access Economics estimates that national income will fall 1.8 percentage points ($35 billion) below the official projections in MYEFO in 2019-20, followed by a jaw dropping shortfall of just under $200 billion (or 10.8 percentage points) in 2020-21.
Even worse, the recovery thereafter may well be slow:
- Families and businesses have had body blows to their confidence, their income, and their wealth. So, they’ll be more cautious about taking risks – which is why we forecast business investment to drop more than any other part of the economy.
- And the Reserve Bank is already pedal to the metal, meaning this is the first recession-and-recovery that you’ve lived through in which the RBA is essentially already out of ammo.
- Finally, Australia will be outperforming the global economy. But that global weakness may undercut the prices we receive for our resource exports – as is already notably true for gas.
So, our nation will begin its recovery with unemployment high, the private sector scared, the Reserve Bank tapped out, and prices for our key exports weak. That says Australia’s recovery will be strikingly dependent on the extent to which our governments – federal and state – switch their policies away from the virus sprint and towards the recovery marathon.
These forecasts assume the temporary support to get Australia through the coronavirus crisis is unwound on schedule. And although there is a case for those measures to trail off rather than go cold turkey, it’s entirely sensible that these temporary measures end.
But that will also leave the shortfall in national income versus the official projections in MYEFO stuck at 10% in 2021-22 and 2022-23, with only slow improvement thereafter. (The shortfall in economic output – production levels – is about 7%, with the remaining shortfall of 3% down to ongoing weakness in wage and price gains.)
That’s why there’s a very strong case for federal and state governments to keep going hard and going smart through this recovery – accepting a further period of higher deficits (for example, due to more infrastructure spending) and championing a new round of much needed economic reforms.
When can governments ease up once more? Our defence against the coronavirus has been world-leading. But just beating back the virus isn’t enough. The ‘mission accomplished’ signs can’t be put up until unemployment is back at 5%. On our forecasts, that doesn’t happen until late 2024.
The budget is taking a series of staggering blows – because it has to
Some of the damage is due to tax measures such as investment allowances. But the overwhelming bulk of the damage to the tax take is due to the damage to the economy. Fewer workers and lower incomes (many wages are down to JobKeeper levels) mean personal taxes take the biggest hit compared with official forecasts, down a huge $14 billion in 2019-20, and then an even larger $37 billion in 2020-21. In dollar terms the pain is centred in Pay As You Go taxes, but in percentage terms the biggest drop is in ‘other individuals’, where the tax paid from many small businesses shows up.
Refunds will rise too, taking an extra bite out of overall revenues this year and next.
Although there’s a big hit to wages, profits take a pounding as well, meaning profit taxes look set to fall shy of the official forecasts by $8 billion in 2019-20 and $26 billion in 2020-21. Taxes on the gas sector, already low, are smashed by the drop in world energy prices. And the superannuation tax take faces a perfect storm as lower earnings and capital gains take a toll, while job losses and weaker wage gains mean taxes on contributions disappoint too. As usual, though, it is the gorilla of this group – company taxes – which accounts for most of the pain.
The same pain is also being felt in indirect taxes. Australians stopped spending during the lockdown, partly because we couldn’t spend (as shops and cafes were closed), and partly because we’d lost the income to spend with anyway. The biggest impact here is on the GST. That sees indirect taxes drop $6 billion shy of official forecasts this year and by a further $10 billion next.
Finally, lower interest rates eat into some revenues. The Reserve Bank makes some windfall gains when the $A falls and interest rates do too. That may boost the RBA dividend in 2020-21. But the ongoing trend in non-tax revenues comes from lower interest rates. Both the Feds and the RBA earn interest from the money they have in the bank. So even though both the Reserve and, through them, the government, are lending more via the extraordinary loan support to businesses that they’re financing, non-tax revenue may fall short of official estimates by some $0.5 billion this year, though there’s little difference in 2020-21.
The upshot is an enormous hit to revenues. Relative to the official forecasts unveiled just before Christmas, revenues are set to fall short by $29 billion (or 6%) in 2019-20, and that is set to be followed by a shortfall of some $72 billion (16%) in 2020-21. And that’s a good thing – that is more than $100 billion left in the hands of families and businesses at a time when they really need it.
Spending is surging due to policy decisions such as JobKeeper and JobSeeker
The dollars are huge. Yet they could – maybe – cost just a little less than Treasury has estimated. That’s mainly because most of these costings were put together when Australia seemingly faced Armageddon. Growth in virus numbers peaked on 24 March, when there were 4.5 times as many people with the virus as a week earlier. Yet Australia has successfully held virus numbers back and JobKeeper has successfully calmed fears on the economy. On balance, we’ve allowed for a saving of $10 billion on the announced costings: partly on the cash grants to small businesses, partly as businesses may not take up the investment allowance to the extent assumed when it was announced, and partly because JobKeeper has been a bureaucratic jungle (as well as a stunning success), so there’s an outside chance that it too ends up a smidge cheaper than announced.
All up, $209 billion of policy announcements have been made, almost all adding to spending rather than cutting revenue. But we estimate the actual cost of fighting to protect lives and livelihoods may weigh in at $199 billion – still stupendous, but a little less than announced.
The recession also adds to spending amid higher unemployment, increased government borrowing, and a lower $A. But the impact of these automatic stabilisers is pretty small amid the budget dramas of the moment, as there are largely offsetting savings via weaker wages and prices and lower interest rates. That leaves the net ‘automatic’ addition to spending relatively small in 2019-20 (at $1.8 billion) and in 2020-21 (at $3.1 billion). And GST payments to the States will crater, down by $4.6 billion in 2019-20 and $7.8 billion in 2020-21 as consumers hunker down.
Could we be wrong? Yes. The uncertainties are truly enormous. And even if we do get any savings, don’t forget they are likely to be more than eaten up by a need to (1) exit emergency policies slowly rather than going cold turkey, plus (2) pivoting to other spending policies to help grind unemployment back down after an initial fall in joblessness as lockdowns are unwound.
The increases in spending are even bigger than the hits to revenues, generating a $143 billion underlying cash deficit this year, followed by $132 billion next year. Our estimates are $148 billion and $138 billion, respectively, worse than official estimates of cash balances in MYEFO. Our matching fiscal deficits are $143 billion and $133 billion, respectively.
That difference – $286 billion across this year and next – is to be celebrated. Most of those dollars relate to the current six months, and mean the incomes of families and the profits of businesses will be about one third stronger across these six months than they’d otherwise be.
A healthy budget helps nation by aiding both prosperity and fairness – the two key aims of any society. It can particularly aid prosperity when, in a crisis, the budget softens the blow. That is happening now. Had we entered this crisis with the debts and deficits of the US then, even after allowing for our much smaller economy, our budget would have been in deficit by almost $100 billion (rather than in balance) and debt would have been $1.6 trillion (instead of $392 billion). That gave us political permission to mount a bipartisan fight to protect lives.
That fight for lives runs up debt. In turn, that raises fairness issues, because that debt is left to future generations. Yet the big spend now limits the rise in unemployment, which usually hits the young hardest of all, meaning the livelihoods of the young are the biggest beneficiaries of today’s emergency spending. So, although the young are indeed left with the debt, they are still better off than the alternative of a ‘lost generation’ of work opportunities.
This too shall pass – but not without getting an extra push from policy
Rainshadow risks? There are three key risks to the tax take beyond the immediate crisis:
- The speed of recovery may frustrate: After an initial bounce as businesses re-open, the subsequent recovery in the economy and in jobs may be slower than we’d all like.
- Economic damage may linger: And the hit to national income may linger for some years, partly because businesses won’t have invested as much during the crisis and its aftermath, and partly because the weaker world economy may leave a mark on commodity prices.
- Tax lags: Finally, the tax system has built in lags through accumulated losses. That will slow the rebound in each of company tax, super taxes, resource rent taxes, and capital gains taxes.
So, neither the economy nor the budget will be fighting fit for a while yet. That’s why politicians are trying to get reform going. We need the momentum that can deliver: Although the biggest pain in personal taxes will be felt in 2020-21, we see large shortfalls in wages and jobs hurting PAYG, and with ‘other individuals’ tax hit by weakness in small business incomes, in dividends, in rent, and in interest earnings. The resultant damage means shortfalls versus official forecasts of $34 billion (or 13%) in 2021-22 and $25 billion (9%) in 2022-23.
The pain in profits will be exceeded by the pain in profit taxes: The upfront hit to profit taxes of today’s turmoil would be even bigger if the taxman handed back money when firms make losses. But tax doesn’t work that way. What actually happens is that businesses get a promise that they can offset today’s losses against future tax bills. (And no, that’s not evil.) So, despite lower investment deductions, we forecast profit taxes to stay to the south of the official numbers by a hefty $19 billion (16%) in 2021-22 and $15 billion (12%) in 2022-23.
The recovery in our spending will lag too: Our incomes, our wealth and our confidence are taking some heavy blows. And wage and price inflation will lag behind earlier hopes for it. That will leave the taxes on our spending wallowing as well, although at least our appetite for imports should see customs duty on the comeback trail. We forecast these ‘indirect’ taxes shy of their official cousins by $9 billion (some 7%) in each of 2021-22 and 2022-23.
While lower interest rates take a rising bite out of non-tax revenues: It takes time for a change in interest rates – especially long-term interest rates – to flow through. But it steadily does that, cutting revenues by $0.7 billion in 2021-22 and $1.2 billion in 2022-23.
The spending story changes gear: today’s emergency spending support is deliberately designed to phase out, while lower wages/prices/interest rates will generate savings. Overall outlays may be lower than budgeted by $3 billion in 2021-22 and then $13 billion in 2022-23.
So, we forecast cash underlying deficits of $52 billion in 2021-22 and $33 billion in 2022-23 (with matching fiscal deficits of $50 billion and $34 billion). That is worse than the official forecast in
2021-22 by $60 billion, followed by a narrowing of the gap versus official forecasts to $37 billion in 2022-23.
Bracket creep just stopped being creepy
Looking for a silver lining amid the zombie apocalypse? People get pushed into higher tax brackets when wages go up. But the collapse in wage growth now underway means the taxman’s usual ‘stealth tax’ will be in the slow lane in the next few years. PAYG collections this year are $2.1 billion less than if the 2014-15 thresholds had simply been indexed. And the arrival of the second phase of the tax cuts in 2022-23 will leave families paying a handy $6.8 billion less in taxes than if the 2014-15 tax system had been indexed over time.
Our estimates here are a little larger than they were in the previous issue of Budget Monitor. That’s because expected inflation is now less, so keeping up with bracket creep is easier than it was.
The damage to the budget is temporary rather than permanent
The upshot is that the budget has just taken enormous damage – but it probably isn’t permanent damage.
That’s a vital distinction. And much of the debate already swirling about ‘budget repair’ misses that key point. Of all the vast spending by the Feds to fight our way through the current crisis, only a handful of dollars are still being paid out in 2021-22.
If you haven’t thought that through, you should. Yes, Deloitte Access Economics sees large ongoing budget deficits in 2021-22 and 2022-23. But that’s because we forecast ongoing weakness in the economy – especially in job markets.
But if the economy gets better, so too will the budget balance. That’s the key issue addressed in this chapter: the extent to which the current damage to the budget is or isn’t structural.
And our analysis draws the obvious conclusion: if our economy gets better, so will the budget.
To be clear, the structural deficit this year and next is massive as the likes of JobKeeper are deployed.
That’s why we estimate this year as seeing a structural budget deficit of $162 billion, or 8.3% of national income. Next year is also huge, at $110 billion (5.9% of national income).
Then the damage disappears as the vast bulk of the emergency spending disappears too, with a structural deficit of $11 billion in 2021-22 and a budget that’s very close to being structurally balanced in 2022-23.
The budget won’t have returned to surplus in those years, but that’s only because the economy will still be suffering a hangover from the traumas of the moment.
That’s not to say that the next few years will be easy for either the economy or the budget. In fact, chances are that Australia will need a greater call on the budget than already announced as the nation’s fight switches from focussing on our health to focussing on driving unemployment back down once more.
But it does underscore a key point we’ve been making in this issue of Budget Monitor: the need to let growth in the economy shrink the debt, rather than letting attempts to shrink the debt hold back the economy.
It’s time to go hard and go smart
This has been the fastest moving crisis policymakers have ever had to navigate. And Australian policymakers can be proud of their record: our defence against the virus has been world class.
That success has come at a big cost. But that cost – and what to do next – isn’t well understood.
Yes, the budget is badly bent, but it’s not broken. Today’s emergency policy measures are temporary. When they’re gone, the budget will still be running big deficits: but that will be because the economy is still weak. If our economy gets better, the budget will too.
Many people don’t understand that, so they are chasing down imaginary problems. Some are arguing for immediate budget repair, while others say immigration needs to be overhauled.
Both those prescriptions are misguided. As the Prime Minister has noted, the key problem Australia will face on the other side of this crisis will be unemployment. That’s the curve we now need to flatten. Although joblessness will go down fast as Australia reopens, we’re years away from returning unemployment to the 5% rate it was at when this crisis hit. Even more challenging, governments will have to drive unemployment down without any help from the RBA, as the Reserve is already tapped out. That’s never happened in your lifetime, so you’re not used to thinking about it. But you need to, because it changes key calculations.
It means the budget’s fight against the virus has to morph into a fight against unemployment. That will need different policies. It means doing more still with federal and state budgets to drive job gains. That may, for example, mean we need scaled down wage subsidies for a time in the hardest hit small businesses. And we need other job generators, such as infrastructure.
So rapid budget repair would be misguided: the budgetary damage isn’t structural, but the damage to our economy and our jobs would be if we start raising taxes and cutting spending.
Nor have we just messed up the lives of our younger generations with all this extra spending. We had to do it, and the job prospects of the young always suffer most in recessions – so they’ll be big beneficiaries of the spend. Even more importantly, interest rates have never been lower. The extra borrowing costs from all these dramas will only cost the average taxpayer around $3 a week.
Nor would keeping borders closed help bring the unemployment rate down faster. Migrants don’t steal jobs. Australia had this debate in the 1970s, when the evil people accused of stealing jobs were … married women. If someone takes a job – a migrant, a married woman, a Martian – they earn an income, they then spend that income, and that creates the next job. Our job markets aren’t a Game of Thrones episode. If you truly thought migrants stole jobs, then you’d believe married women stole jobs. And you’d never want to have any children, because the little buggers would grow up and steal all the jobs. That’s well-meaning but misguided thinking.
Australia has a strong migration program because it makes sense for us to do so – and it will again on the other side of this crisis. We have what the world wants. Getting young, skilled migrants is a smart play for us. But what we haven’t done over the past two decades is match our fast population growth with a matchingly strong infrastructure spend. That’s led to pressures on transport, health and education systems in the outer suburbs of our biggest cities.
What should we do? To beat the new challenge – unemployment – Australia needs to see a combination of ‘going hard’ (ongoing policy support) and ‘going smart’ (unlocking reform). On the latter front, if we want to give our newly unemployed the best chance of getting their livelihoods back, then we need to be the smart nation that we’ve so often talked about. That will give businesses – big and small – a reason to take bigger bets on the future, unlocking more investment, and with it the potential for more job gains. If we want more growth, then it makes good sense to raise the economy’s growth potential.
One last thing …
Until there’s a vaccine or effective treatments, Australia will stay stuck in a terrible trade-off between risks to our lives and risks to our livelihoods.
In the meantime, however, there’s one very simple and sensible step we can all take: downloading the COVIDSafe app.
The authors of Budget Monitor love our privacy as much as anyone. But right now, that privacy comes at a bigger cost to lives and livelihoods than at any other moment in Australia’s history:
- A cost to lives, especially those of older Australians, those with compromised health, and our front line medical staff, and
- A cost to livelihoods, with $15 billion a month in lost incomes and hundreds more small businesses dying every day.
If you’d like to return to the Australia we knew as recently as February, then the COVIDSafe app is the best weapon we have.