Deloitte Access Economics Budget Monitor

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Deloitte Access Economics Budget Monitor

Bread and butter, or a budget jam?

11 OCTOBER 2022: Make no mistake, the global economy is facing a serious and significant downturn. Just as most economies around the world were emerging from the pandemic, the next global shock has arrived. As a result, the context in which plans for the 2022-23 October Budget are being finalised is complex and uncertain. It’s a heady mix of financial market gyrations, policy announcements, data releases and sensationalist headlines, and it means that the margin for policy misstep is minimal.

Releasing the October 2022 edition of the Budget Monitor report, Deloitte Access Economics Partner and report lead author, Stephen Smith, said: “The budget backdrop is daunting, but it is made slightly less intimidating by an astonishing improvement in the bottom line over the past two years. The timely and necessary emergency support in response to the pandemic led to massive increases in spending and debt. However, the budget has staged a remarkable comeback.

The fact that Australia has emerged from the pandemic with a budget position far healthier than most of our peers owes a lot to the strength of the economic recovery. Remarkably enough there is likely still some more left to bank, with Deloitte Access Economics expecting a further $114.4 billion in additional revenue over the next four years to be revealed in the October Budget.

“The upswing in revenue is entirely the result of cyclical serendipity – a clear example of passive budget repair. That passivity is serving Australia well for now, as the path back from some very large deficits becomes clearer.    

“But this is likely to be the last budget to unveil an unanticipated write up in government revenue for the foreseeable future. Continuing to repair the budget from here will require a more active strategy. That means making some difficult decisions. Those decisions will involve navigating the stand-off between ‘good policy’ and ‘good politics’ that keeps most Treasurers up at night.

Deloitte Access Economics Director and report co-author, Cathryn Lee, said: “If Australians want the government to continue to fund existing programs, and to meet the cost of a long list of important spending priorities – from aged care and childcare, to disability care and defence – they need to be prepared to pay higher taxes over time. Alternatively, Australians could decide that they don’t, in fact, want or need some of that spending quite as much as they initially thought they did. Or they may choose some combination of the two.

“Realistically, those tough decisions are more likely to be made in later budgets, say in 2023 or 2024, ahead of an early 2025 election. The upcoming Budget will be more boring (or “bread and butter” as the Treasurer has put it). Watch for a modest set of savings. It’s always easier to make cuts to the pet projects of your opponents, and even better when those cuts come years away from an election.”

Deloitte Access Economics Partner, Stephen Smith, added: “Deloitte Access Economics is looking for the Budget to set a sensible tone for the future – getting Australians primed for a series of modest changes that add up to a more sustainable fiscal position over time – while keeping one eye on near term economic challenges. Sensible changes to prune waste and tighten spending will help to ensure that the Federal Budget is in the best possible shape to aid in a response to a downturn.

That’s a difficult balance to strike. So, when the Treasurer stands up on budget night to deliver both the news of a big improvement in the bottom line and the news of difficult times ahead, he’ll be exactly right.”

Deloitte Access Economics’ forecasts for key budget aggregates are shown in the table below. Building on the unexpected strength of revenue in 2021-22, the Budget released in October is expected to reveal a further $114.4 billion in additional revenue over the next four years compared to the forecasts included in the 2022-23 March Budget. Spending is also expected to be higher, even when only accounting for policy announcements to 30 September 2022. Cumulative underlying cash deficits are expected to be $45.5 billion lower over the next four years, shaving more than 5.6% off the ratio of net debt to GDP in 2025-26.

On the subject of the Stage 3 tax cuts, Deloitte Access Economics Partner and report lead author, Stephen Smith, said: “The public discourse relating to the Stage 3 tax cuts has become a ‘will they or won’t they’ guessing game on election promises. That is a shame, because there are important policy questions to be debated.

Economic conditions have weakened since the May election, and the path to a soft landing has narrowed. While the outlook now looks more challenging, the budget bottom-line has actually improved markedly from the expectation provided in Treasury’s Pre-election Economic and Fiscal Outlook. Taken together, that may not necessarily provide the basis to undo an election commitment.

“However, whether the Government should break a commitment is not the substantive question. The better question is: are the Stage 3 tax cuts good policy? That is, do they contribute to ensuring that Australia’s tax system is the best it can be, based on the usual economic priorities of efficiency, fairness, competitiveness and administrative simplicity? Additionally, are the tax changes appropriate for the current fiscal conditions?

“The Stage 3 tax cuts were always decent policy. By reducing the marginal tax rate that applies to income over $45,000 from 32.5 cents in the dollar to 30 cents, the Stage 3 cuts provide relief to most taxpayers. But by extending that 30 cent rate up to $200,000 – abolishing the 37 cent rung of the income tax system in the process – the policy primarily advantages high income earners (with Stages 1 and 2 favouring low and middle income earners). The tax cuts scheduled for 2024-25 maintain, in general, the progressive structure of personal income tax. However, they are also expensive, and they over-achieve in terms of unwinding bracket creep in the near term. That makes them ‘decent’ policy rather than ‘good’ policy.

Why are they decent policy? Three key points have been largely overlooked in the public debate:

  1. Across the Organisation of Economic Cooperation and Development (OECD), Australia is second only to Denmark in terms of the proportion of total tax revenue that comes from taxes on individuals.
  2. Even with the Stage 3 tax cuts in place, Deloitte Access Economics calculates that income tax on individuals (including the Medicare levy) will increase as a share of Federal Government taxation revenue from 48.1% in 2021-22 to 50.4% in 2025-26. That share has been higher than 50% in the past, but without the Stage 3 tax cuts it would rise to 51.8% – a level not seen since before the introduction of the GST in 2000.
  3. Even with the Stage 3 tax cuts in place, Australia is on track to levy the highest average rate of personal income tax on record in the coming years.

“To be clear, Australians are signing up for a sustainably higher level of spending in the future, and the Federal Budget is already in a significant structural deficit. The Federal Budget will need to raise a greater level of revenue in the future, but that doesn’t necessarily need to come from income tax on individuals. Ensuring that Australia has the right tax mix deserves to be a broader conversation than the narrow framing of election commitments.”

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