Budget Monitor April 2018
Are the rivers of gold back?
30 April 2018: Happy, happy, happy, happy… Scott Morrison laughed off the suggestion he’d be Santa Claus on Budget night. Yet chances are, he’ll hum a little of Pharrell Williams’ hit Happy on the evening of May 8. He has every reason to.
The Rivers of Gold are running again, with the global and Australian economies doing the Budget plenty of favours. It’s an almost picture perfect backdrop for the taxman: not only are there more dollars in the economy than Treasury forecast, but companies and super funds have also increasingly run out of the losses they racked up during the GFC – meaning that good news on the economy is being turbocharged in terms of its effects on the tax take.
That’s why recent months saw a humongous improvement in the Budget. In the four months to February (latest available as we went to press), the rolling annual cash deficit shrunk by $15.4 billion, a pace of improvement only seen twice before in the history of the Budget. Better still, there’s more where that came from. We project continuing outperformance versus official revenue forecasts pretty much across the board in both 2017-18 and 2018-19.
Profit taxes generate two-thirds of that revenue revision. Wassup? The world economy is the best it’s been in years. And because some of that strength is in China, there’s also good news in commodity prices, which are a direct driver of today’s stronger company profits.
Even better, there’s a key accelerator effect. A bunch of businesses lost money in the GFC, while coal companies also lost another lump in 2014-15 and 2015-16. But the taxman doesn’t write a cheque when companies make a loss – it lets that ‘phantom tax refund’ lie fallow until the business makes money once more. But that’s exactly what’s happening now, meaning a given lift in profits is generating a larger lift in taxes than it has in a few years. And nor is that mix of good news true only for the company tax take. Many super funds have also used up all their GFC tax losses, meaning a sharp surge in revenues from that front too.
Outside profit taxes, Australia’s record job gains have finally won their arm wrestle against wage weakness, generating good gains versus official forecasts for personal taxes. Finally, the spending taxes are still showing a turn of speed too, with strength in consumer spending lifting the GST take, while strength in imports is boosting customs duties.
Yet it isn’t all beer and skittles. Extra money coming in as PAYG has an echo effect in higher refunds, there are tax incentives leaning against FBT collections, plus there’s both tax and economic negatives affecting ‘other individuals’ (with small retailers and builders either doing it tough or becoming companies to take advantage of the new 27.5% rate for small firms).
But that’s mere quibbling: the Rivers of Gold are back. Nominal GDP (a proxy for national income) will rise $73 billion this year, yet Federal revenues will rise $41 billion. Remarkably, the marginal tax rate for the nation as a whole this year will be a truly boggling 56 cents in the dollar. Deloitte Access Economics forecasts overall revenues to grow by 9.8% in 2017-18 (the strongest such increase seen since 2000-01), with that then followed by a further 5.7% gain in 2018-19.
We therefore see total revenue in 2017-18 beating the official forecasts issued just ahead of last Christmas by $7.6 billion. That’s followed up by a similarly happy 2018-19, with revenues set to outperform those official forecasts by an additional $6.7 billion.
Budget bottom lines in 2017-18 and 2018-19 both improve by more than $7bn
On the spending front the dollar dazzlers being leaked to the tabloids include $5 billion for a Melbourne Airport rail link and another billion for upgrading the M1 Corridor in Queensland.
Yet these will only go ahead if the State Governments come to the party. And it takes time to spend big bucks. So if you’re looking for the extra dollars set aside on infrastructure in this Budget to be as big as some politicians are making them sound, you’ll be sadly disappointed. Meanwhile the Government has otherwise kept its policy powder dry, with relatively little money promised of late (helping out the Barrier Reef and junior miners).
The upshot is that total spending may be a net $540 million higher than official forecasts this year, with higher GST payments to the States more than accounting for that effect, albeit with some offsets coming from cheaper interest costs and savings on the Government’s wage bill.
By next financial year – 2018-19 – there may be net savings on spending of $50 million. The small reduction in spending comes from an accelerating trajectory in savings from a healthier economy and a better Budget bottom line, driving even better savings on interest and wages, but with lower GST payments to the States also subtracting from spending, offset by increased spending on already announced policies and by some savings measures stuck in the Senate.
Add all those factors together, and they spell some pretty happy news. It’s been a long time between drinks, but a virtuous circle is notably improving the Budget bottom line. Overwhelmingly driven by revenue write-ups (notably centred in better news on profit taxes), we see the Budget bottom line as better than the official forecasts released in late 2017 by $7.0 billion this financial year, and then by a further $7.2 billion next year.
That translates into underlying cash deficits of $16.6 billion in 2017-18 and $13.3 billion in 2018-19. The matching fiscal deficits are $11.4 billion and $7.5 billion, respectively.
But don’t count your budgetary chickens just yet. For all the talk of commitment to Budget repair that has come from both sides over the years, it looks as if the Government and the Opposition will take this love to town – adopting the well-worn alchemy of turning better news on the economy into a new set of permanent promises.
We doubt the wisdom of that. Treasury’s methods of projecting medium term outcomes mean that they’re likely to take the good Budgetary news of the moment and effectively assume it to be permanent. However, events may not unfold quite so happily.
Besides, even if we stay on this better Budget trajectory for longer than Deloitte Access Economics expects, there’s danger in promising too much, too soon off the back of uncertain economic outcomes. Like it or not, it makes sense to see the whites of the eyes of a surplus or two before rewarding ourselves with a pack of Tim Tams. Yes, we know that sound economic and budgetary advice will be ignored. But you need to recognise the approach of the election – still winnable by either side – may see politicians once again over-promising. Don’t applaud too loudly when those tax cuts are announced.
That key caveat says the figures above, while very welcome, are also artificially good: they leave out the cost of what is likely to be the centrepiece of the coming Budget (and the duel that will dominate the next Federal election) – promises of personal income tax cuts.
Besides, the Rivers of Gold may turn back to a trickle by 2019-20 and 2020-21
So it’s good news galore… as of today. Not only is the economy outperforming official expectations, but the tax system is smashing official forecasts for it. But how sustainable is that? The economic drivers of this Budget boost are the best (and most synchronised) global growth in years, which is showing up in jobs, in profits, and in markets in Australia.
The tax-specific drivers of today’s surge for surplus are that better news in the economy means businesses and super funds have run out of the tax losses they’d stashed away in the bad times faster than they’d otherwise have done. That says a given lift in the economy is generating a better boost to taxes. And lower-for-longer interest rates mean striking capital gains, especially in housing, so that taxes on capital gains are finally gathering momentum.
That’s great, but not all of it is permanent. The better that global growth is now, the harder it’ll be to maintain that thereafter as global capacity tightens and interest rates lift. And ditto the outperformance of the tax system – an earlier end to the impact of tax losses and a stronger than expected lift in capital gains taxes are both essentially timing shifts.
Yet that’s not how Treasury forecasts – for 2019-20 and 2020-21 its forecasts essentially shift onto autopilot, with a bunch of growth rates moving back to trend. That approach is entirely understandable. It’s designed to deflect criticism that Treasury cooks the books in favour of the Government of the day. In practice, however, the official approach tends to bake current good news into the medium term outlook, because using ‘projections’ rather than ‘forecasts’ means Treasury won’t pick up much of the “better news now implies worse news later” that shows up in our forecasts.
Meanwhile, we see wage gains continuing to fall short of the Treasury view. That means personal taxes, expected to drive revenue write-ups in 2017-18 and 2018-19, start to wear black hats thereafter – falling more than $9 billion shy of the official forecasts by 2020-21.
(Note that would read “almost $5 billion shy”, except the Government has just announced that it won’t go ahead with the scheduled July 2019 increase in the Medicare levy.)
And although profit taxes stay ahead of official forecasts (we have them up by $1½ billion in 2020-21), that’s well shy of the huge revenue revisions they’re generating this year and next.
So whereas we saw revenues running ahead of official numbers by $7.6 billion in 2017-18 and $6.7 billion in 2018-19, we forecast revenues to drop back to behind the MYEFO numbers by $4.4 billion in 2019-20, and then to move south of them by $8.7 billion in 2020-21.
There’s not heaps happening on spending, although weaker wage and price growth leads to bigger savings (versus the rather larger pain for the Budget that combo causes the tax take). Interest costs will be lower thanks to smaller deficits this year and next, as well as being due to lower interest rates than Treasury is assuming. At the same time GST payments to the States may be lower as our weaker wage trajectory shows up as weaker spending in shops.
Allowing for that, and absent further policy changes (such as the personal income tax cuts likely to be announced within weeks), we forecast a cash underlying deficit of $5.3 billion in 2019-20, moving to a surplus of $3.8 billion in 2020-21 (with a matching fiscal deficit of $1.1 billion in 2019-20, followed by a surplus of $8.4 billion in 2020-21).
That is $2.6 billion worse (in 2019-20) and then $6.4 billion worse (in 2020-21) than Treasury projected in MYEFO.
No Medicare levy increase means no to getting to surplus a year early
Even before the Medicare levy increase was ditched, we’d have seen a small deficit in 2019-20. But the Medicare announcement means that we’d say there’ll be no surplus in 2019-20. (The way Treasury moves to ‘autopilot’ projections in later years means they assume today’s budgetary benefits will linger – so the official figures may still come close to a surplus in 2019-20 even with the ditching of the Medicare levy and a small tax cut. But we doubt they’d make it.)
Will we get back to surplus in 2020-21?
Yep, 2020-21 looks likely. (Even after ditching the Medicare increase, we forecast a cash underlying surplus that year of $3.8 billion, so a small personal tax cut announced on Budget night would leave a few bottle-tops as a surplus. But we’d say a tax cut larger than that would mean no surplus in sight.)
Given the bloody-mindedness of the Senate, “back to surplus” would be pretty good going. The Government deserves congratulations for the progress that it’s continuing to make.
Yet given that Budget economists are grumpy types, we’d also note the caveats:
- The Budget is determined more by China than it is by Canberra: So if China turns out weaker than we forecast, then the return to surplus would drop off the radar pretty fast.
- The looming election is a threat to prudent policymaking: Both sides show every sign of throwing other peoples’ money at their respective election prospects. Worry about that.
- Half a sandwich and half a milkshake: Getting back to surplus means the net cost of the promises either side makes shouldn’t hurt Budget repair by more than some $4 billion a year. If solely spent on a personal tax cut, that’d buy a half a sandwich and a half a milkshake a week.
- Budget repair is underway thanks to higher taxes: The chart below is a reminder that the surge to surplus underway is mostly being paid for by higher taxes. And, besides ...
- It’s about time: Don’t lose sight of the big picture: the most prosperous generation that Australia’s ever seen ran up a decade of deficits, so it’s long past time we got to surplus.
Bracket creep is part of the reason why personal tax cuts are on the cards
Inflation keeps pushing people into higher tax brackets. That’s an ungainly and unfair way to raise taxes, and it’s a key reason why the Government is looking to announce personal income tax cuts in the Budget. But with wage gains stuck in low gear, creep is still crawling. PAYG collections in 2017-18 would be $4.0 billion lower this year had the 2014-15 thresholds been indexed for inflation since then.
Bracket creep advances to $6.3 billion in 2018-19, $8.8 billion in 2019-20 and to $11.6 billion in 2020-21 (meaning the tax paid by taxpayers in 2020-21 will be $11.6 billion more in that year than if they faced indexed 2014-15 rate scales).
So, unless policy changes, personal taxpayers will fork out more. That is simultaneously driving both Budget repair and political pain. That’s why the Medicare levy increase was just dropped, and it is also why Budget night will include additional tax cuts ...
Australia’s latest nerd debate – should franking credits be refundable?
Should Australia’s dividend franking be fully refundable? Or should we have the company tax rate as a minimum tax rate? Paul Keating’s original reform adopted the minimum tax approach, whereas Peter Costello’s extension shifted the system to the refundability model.
Purists see full refundability as the right policy: all income or gains should be taxed at the investor’s rate of tax. And, given that Deloitte Access Economics are, of course, purists, we see the aim of dividend imputation as being to stop the same income being taxed twice, thereby ensuring such ‘double taxation’ doesn’t mess up the incentives that investors face.
Given that goal, franking refundability is the right policy. Yet the ALP clearly has a point:
- Even though we see the policy rationale as strong, in practice the treatment of super (especially SMSFs) can turbocharge the impact of refundability. In effect, a good policy is being rorted. The ALP tweaked its original suggestion by taking pensioners out of the picture – a fix focused on fairness. But that still leaves a few babies thrown out with the bathwater, as it leaves retirees and working people facing different investment incentives.
- The best compromise may be to provide ‘percentage refundability’ – an approach that would limit the potential to rort without unfairly penalising retirees. Yet we’d readily admit that’s an expensive fix: Labor would lose much of the Budget savings it is looking for.
- And we’d also admit that there’s no perfect policy here – not the ‘no change’ position implicitly advocated by the Government, not the big change proposed by Labor, and not even the type of ‘percentage refundability’ compromise we advocate above.
Want better policy? Superannuation is where the true issues actually lie. The coincidence of high asset values and low tax rates (think SMSFs) combined with franking refunds makes for a potent mix. That says the battle over franking refunds is a proxy for the real debate that Australia should be having – one about better superannuation settings. By the way, these problems would be much smaller had Parliament opted for the superannuation reforms Deloitte laid out in Mythbusting Tax Reform. Just sayin’.
Wanna know what we’d really like to see on Budget night?
We’d love to see comprehensive tax reform (and a pony). But given that comprehensive reform isn’t currently on the table, we’d be more than happy to see the company tax cut get up – there’s no upside in letting the perfect be the enemy of the good. As Treasury’s own analysis notes, company tax cuts deliver benefits to the economy that personal income tax cuts don’t.
But there’s more to reform than taxes. In a Canberra which has lost the art of compromise, there’s one thing that we’d heartily applaud – a lift in unemployment benefits. Newstart hasn’t kept up with national living standards for more than a quarter of a century, shrinking sharply as a share of average and minimum wages, and relative to the age pension. And it’s set to shrink even further, as it is indexed to prices rather than wages. That’s why the Henry Review specifically called out the collapsing ratio between Newstart and the age pension.
We should add $50 a week to these payments, and immediately index them to wages. That would be $3 billion well spent. As you know, we are huge fans of Budget repair. And we remain so. But Budgets aren’t just about debts and deficits: how well we tax is vital to our prosperity, while the quality of the spending we make is vital to fairness.
On that latter front, if we had to nominate the single standout fairness failure in Australia in 2018, it is undoubtedly our embarrassingly inadequate unemployment benefits.
As a nation, we can and should do better. History will judge us harshly if we don’t.