Deloitte Access Economics Budget Monitor

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Deloitte Access Economics Budget Monitor

We spy a rabbit…

3 November 2021: What’s the go with the federal budget? There’s good news, and there’s bad news:

  • The good news is that, despite more problems than you can poke a stick at (including Delta’s dawn, iron ore’s collapse, and multi-billion dollar rescue packages), the budget is in much better shape than most people realise.  Even with the series of unfortunate events of recent months, we forecast deficits to total $45 billion less than Treasury does between now and 2024-25
  • But the bad news is that, while we were all watching the daily Dan and Gladys shows, the longer term outlook for the budget slid sharply south. We’ve underspent on social services for years. And we’ll need to spend more yet. At the same time the world has become a more dangerous place for Australia. That makes for more expensive defence costs too. Allowing for these building cost pressures, the budget looks likely to settle at ongoing annual deficits of around $60 billion.
First the good news

We’ve said for some time that, if our economy gets better, our budget will too.  So, it’s no surprise that our red hot recovery prior to the Delta outbreak saw the deficit shrink from a record $204 billion in the year to February 2021, to $101 billion in the year to August 2021.

Delta’s dawn interrupted that recovery. It adds lots to costs (new policy announcements since the budget add $27 billion to spending this year, and most of that money is also non-assessable non-exempt (NANE) for tax purposes, meaning these payments hit the tax take pretty hard too).

Add in the pain for the economy as a result of Delta, and Deloitte Access Economics forecasts a cash underlying deficit of $116 billion in 2021-22. That’s $9 billion worse than Treasury expected at budget time.

But the news thereafter is sweet. We forecast cash underlying deficits of $74 billion in 2022-23, $59 billion in 2023-24, and $49 billion in 2024-25.  Respectively, that’s $25 billion, $20 billion, and $8 billion better than Treasury currently budgets those years to be.

Add all four years together, and that’s $45 billion back in the pockets of taxpayers.

What gives?

How can the news be so bad (Delta’s costs to the economy and the budget, as well as the huge drop in iron ore prices), and yet the budgetary outcomes be $45 billion better?  Four factors stand out:

  • First, we had momentum: Deloitte Access Economics has always championed the view that the best way to repair the budget was to repair the economy.  And, pre-Delta, the economy was running ahead of where Treasury thought, meaning the budget was too. In fact the latest budget was released in May just seven weeks before 2020-21 ended, yet the outcome for last year saw revenues beat official estimates by a striking $20 billion – that’s almost $3 billion a week in write-ups! And, by the way, the international evidence is similar – when nations get sufficiently ahead of COVID for their economies to open up, their tax revenues go on a tear.  We’re part of a wider global trend
  • Second, we fought Delta on a tight budget: Delta-driven policy costs are a very small fraction of the dollars we racked up the first time around. Partly that’s because the feds pushed more of the costs on to the states this time around, and partly it’s because Treasury is hoping that two wrongs make a right (given that policy overdid it in the initial COVID fight, Treasury is banking on some of the unspent stimulus from that first round easing the economic path of the current battle)
  • Third, Australia’s great effort on vaccinations will deliver a recovery that’s more reliable:  Living COVID-free is wonderful, and it’s great for economies and for budgets. But it is also fragile. Unless we’re really well vaccinated, Delta can kick the door down very fast. So Australia’s surge in vaccinations since early August is really good news for both the economy and the budget. It says Australia’s path from here on is safer and more reliable than that of less vaccinated nations
  • Last, Treasury forecast agony for the economy, whereas we only forecast a lot of pain:  This last point is the most important. It isn’t that our forecasts for the economy and the budget are sweetness and light. The official forecasts assume a steady recovery from the car crash of COVID. But they also assume that our export prices – iron ore in particular – are about to crash.  So Treasury sees the nominal economy travelling at crawl speed over an unusually long period of time. Across the six years between COVID arriving (near the end of 2019-20) to the end of the forward estimates (in 2024-25), Treasury sees national income growing at an annual average rate of just 2.8%.

So, as the chart below shows, Treasury (the red line in the chart) sees the bucket of money that gets taxed growing at an extraordinarily low rate for an extraordinarily long time.

Source:  Treasury, Deloitte Access Economics

Our own forecasts (the green line in the chart) aren’t exactly joyful. The six years from the start of the GFC saw an annual average gain in national income of 4.3%, the overall annual average over the last three decades is 5.7%, and our own matching forecasts across this period average 3.8%.

So although we forecast the dollar size of the economy to be miles higher than Treasury does, that says more about their forecast (sackcloth-and-ashes) than it does about ours (just sackcloth).

In turn, that flows through to our forecasts for the budget. We forecast total revenues to fall 3.8% in inflation-adjusted terms in 2021-22 – the worst such fall since the GFC ripped the guts out of the tax take in 2008-09, and the second worst year seen in three decades.

Or, to give another example, it’s worth noting company tax collections were $110 billion in the year to July 2021 (they dipped a little in August). Yet although we forecast a comfortably higher company tax take than Treasury does, by the end of the forward estimates (2024-25) we forecast company tax collections to be nearly 7% below what they were running at until Delta kicked the door down.

That seems like pretty conservative forecasting on our part – it’s just that we’re less conservative than Treasury’s matching forecasts in the budget.

Accordingly, if you were wondering what the surprise would be in the lead up to the coming federal election, then wonder no more:  there’s a $45 billion upgrade in budgetary forecasts coming. Rabbit, meet hat.

And now the bad news

Although there’s good news coming in the budget over the next few years, that’s set to become bad news over time. That’s not due to a hangover as a result of the costs of fighting COVID. Yes, that fight was costly, but interest rates dropped to record lows during COVID.

So although our debt went way up, what matters – the cost of our debt – actually went down.

There’s an appalling lack of understanding about that. The first two columns in the chart are from the budget, showing Treasury’s forecast that net federal interest payments as a share of national income will be lower in 2024-25 (at 0.7%) than they were in 2018-19, before COVID hit (at 0.8%).

Net federal interest payments as a share of national income

Source:  Treasury, Deloitte Access Economics

Yep, lower. Debt went up, but interest rates went down – and the latter gives a double benefit, applying not just to the new debt, but also to rollovers of existing debt. The last column in the above chart is our updated estimate. It takes account of events since the budget in May, including the hit to the economy of Delta’s dawn, and the cost of extra measures to help the economy through that.

And the net impact? We forecast net interest payments in 2024-25 to be $30 million lower than Treasury estimated in the budget. That’s in part because the deficit was smaller than budgeted last year, and as it’s also forecast to be smaller than budgeted after this year too. Yes, our defence against COVID was expensive. But we funded it at the lowest interest rates in history. Get over it.

COVID costs are temporary costs, whereas the real risk to budgets always lies with permanent cost shifts. Sadly, while we were looking elsewhere, life got more costly. The bad news built fast while we were all getting our daily dose of the Dan and Gladys shows. Four problems stand out:

  • Social spending – we haven’t spent enough for years, and governments are in catch up mode in aged care, disability and mental health.  The May budget announced policy decisions adding some $15 billion a year to ongoing spending. And there’s clearly more costs to come in each of these areas. As one example of that, there’s a fast widening gap between what experts expect the NDIS to cost and what’s budgeted for it
  • Then there’s defence – the world has become more dangerous for Australia, and policy is starting to play catch up there too. Defence was already the fastest growth area in the forward estimates, yet what is in the official figures is likely to be only a down payment on what may well be necessary in this new era of great power rivalry
  • We lost people power – COVID closed Australia’s borders, and there’s a big gap between our pre-COVID population forecasts and our current ones. By mid-2025 that gap is almost a million people, meaning we’ll be relatively fewer and relatively older than earlier expected. That comes at a cost to revenues without fully offsetting savings on spending
  • Our tax promises are overdelivering – a series of tax cuts were promised years ago to battle bracket creep. Over time, the problem those tax cuts were aimed at got much smaller. Bracket creep is driven by wage growth, but that’s slumped to record lows. Yet while the problem got smaller, the tax cuts were made larger, and some of them were delivered earlier.  Worse still, the national debate on these tax cuts focussed on fairness, whereas the problem with these tax cuts was always their size. So just when we should be turning our minds to how to pay for higher social and defence spending, we’ll deliver a tax cut that’s too big.

The upshot is that there’s a $60 billion hole in our budgetary bucket – not because we used the budget to fight COVID, but because we’ve underspent on social services and on defence, because we’ve promised tax cuts that are too big, and because our relatively smaller and older population is less ‘budget friendly’ than pre-COVID forecasts.

To be clear, that’s not a $60 billion hole we should try to fill fast:  doing so would hurt a still fragile economy far too much. But there’s a federal election looming, and we shouldn’t let either side go through that campaign pretending there aren’t difficult decisions to make down the track.

How difficult? Making up close to 3% of national income via some mix of higher taxes and lower spending won’t be a walk in the park. Chances are that it will make the political fights in the aftermath of the global financial crisis seem mild.

If you want a yardstick of what might raise $60 billion a year, then:

  • That’s what you’d raise if the GST rate was lifted to 17%, BUT the States didn’t get a cent AND there was no change in pensions or benefits despite a resultant very large lift in consumer prices
  • OR that’s what you’d raise if every dollar above the tax-free threshold of $18,200 was taxed an extra 5.5 cents in the dollar (that is, all marginal tax rates get 5.5% added to them)
  • OR you’d raise that if all company tax rates could be lifted by 20 percentage points (from 30 to 50 cents in the dollar for bigger businesses)
  • OR that’s what you’d save if the defence forces were disbanded AND we halved federal spending on education.

No, we’re not advocating any of those things (and it would only take one of them to fill the looming ongoing hole – not all four). But we are pointing out that Australia’s social compact with itself has been shifting sharply of late.

While our attention was on the daily Dan and Gladys shows, our world became more expensive. Like it or not, that raises budgetary questions that Australia will need to start to think about.

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