China and Australia: ‘friends with budgetary benefits’ again – or not?
1 May 2017: For five years an ‘income recession’ took its toll on the tax take and on the wider economy. But it’s time to dig out your dancing shoes: it seems China and Australia are once again ‘friends with benefits’, as China’s stimulus coincides with a strengthening global economy.
And wait, there’s more. China’s rebound and the better global backdrop started arriving just as the Reserve Bank cut interest rates twice in mid-2016, meaning that a second wind has gone into housing prices (and reverberated through the economy more generally) as the RBA add extra Bundy to the punch at the party. That combo has led to the sharpest upswing in national income (and its close cousin, nominal GDP) for a number of years:
- MYEFO forecast nominal GDP gains of 5¾% in 2016-17 and 3¾% in 2017-18, followed by further gains of 4¼% in 2018-19 and 4½% in 2019-20.
- The matching Deloitte Access Economics forecasts are for gains of 5.7% in 2016-17 and 4.2% in 2017-18, followed by further gains of 3.2% in 2018-19 and 3.8% in 2019-20.
National income is jumping by $100 billion this year, equalling the gains of the previous two-and-a-half years in the one gulp. And, better still for the Budget, the good news is mostly in profits: the most heavily taxed part of our incomes. The news is clearly getting better...
How much better? Company profits before income tax rose by 65% during 2016. Yep, you read that right – within a whisker of being two-thirds higher. Not surprisingly, that rocket was powered by mining profits, which went up by more than a factor of six across the same period. But don’t underestimate the ability of a rising tide to lift all boats. Thanks to a surge late in the year, company profits before income tax outside of the mining sector managed to lift by a more-than-healthy 14% through 2016.
Those are eye popping numbers, but MYEFO already banked the bulk of that. Yes, we do see more money in the economy than MYEFO does in 2017-18. But we remain sceptics on the medium-term, with easing commodity prices weighing on national income in 2018-19 and 2019-20. Besides, although the news is good on profits, it is poor on wages and jobs – and so on personal income taxes.
It’s time we had ‘the talk’
The debate was poor and the decisions were often dubious, lacking a coherent vision for society: it has been mostly about misreading China’s boom and throwing money at marginal electorates and marginal States – not about supporting the nation’s future prosperity and fairness. But none of that matters. It’s a done deal: Australia has chosen to lift spending.
Each ratchet in our spending then becomes sacrosanct ... Recent attempts to reallocate the social safety net show that. The key element wasn’t to save money, but to shuffle some from family benefits to child care subsidies in a way that would have (1) delivered more money to the less well-off and (2) encouraged people to work. That would have been good policy, boosting both fairness (by directing taxpayer support away from middle class welfare and towards those more in need) and prosperity (by encouraging more people to work).
It didn’t happen, getting lost in new layers of compromise. Don’t be surprised: these days parliament struggles to agree on motherhood and milk – let alone marriage. We’ve been adding 0.15% a year of national income to our spending habit for over a quarter of a century. In today’s dollars, that’s $2.5 billion extra each and every year for taxpayers to fund. But taxpayers don’t know that yet, as we’ve put the last decade of cost hikes on the credit card.
Remember the bumper sticker “spending the kids’ inheritance”? It’d be funnier if it weren’t so true. And young Aussies – as disengaged as they are – don’t realise the most prosperous generation this nation has ever seen is stiffing them with the bill for our decisions.
Einstein defined insanity as “doing the same thing over and over again and expecting different results”. Political scientists have long since noted that, once granted in the first place, entitlement programs are harder to kill than Rasputin. Just ask Boney M. That’s true of good policy (think of President Trump’s epic fail at dismantling Obamacare) and of bad policy too (think bonuses for babies and a submarine for every South Australian). Here at home attempts to dismantle the entitlement programs adopted during the glory years of the China boom – which spawned rivers of gold into the hands of the taxman – have occasionally been ham-fisted. But no matter how good the arguments or how well they’ve been presented (or not), it increasingly looks like this debate is done and dusted. The dollars have been in the hands of enough voters for long enough that any attempt to remove or rejig them prompts a knee to the electoral groin of any politician brave enough to have a go.
Is it time to declare that following the insanity path isn’t going to get us anywhere? The deficits we’re running up are (1) making the next recession (whenever that may hit) worse than it need be by making the Treasurer of the day less likely to use the Budget to defend against that downturn, and (2) unfairly passing the costs of this generation’s inability to come to a consensus – we’ve raised spending but not taxes – on to the taxpayers of the future.
We’ve chosen to be a high spending and low taxing nation, but that’s unsustainable: If there’s a fail on the spending debate, we’d compound that if we didn’t look at raising taxes. The maths are inexorable: if spending won’t go much lower than 26% of national income, then taxes need to lift from today’s 23.5%. That sure isn’t the best solution to our mess. But, as Sherlock Holmes neatly put it, “Once you eliminate the impossible, whatever remains, no matter how improbable, must be the truth”. If we can’t rein spending in, it’s time to tax more.
Governments can’t fix housing affordability. We risk being disappointed if we believe they can: There are things the Feds and States should do in housing, including tax reform and lifting land release. But affordability is through the floor because interest rates are through the floor. So although governments should do stuff, it worries us that elections will soon be fought on this, and that politicians are increasingly pretending to punters that “they” can do something about it. No “they” can’t: Janet Yellen and Philip Lowe can – each percentage point lift in interest rates from today’s lows would cut house prices by 7%. That’s more than double the impact on prices (and so on affordability) you’d get from cutting the CGT discount (which should be done) and winding back negative gearing (which shouldn’t– see our Mythbusting tax reform report).
And yes, reforming the National Affordable Housing Agreement between the Feds and the States is a good idea, as is redirecting some of that money to funding community housing. But if you’re wondering how much that will move the housing dial for Australia’s 9.2 million families, then ask how many families will be affected. Erm, maybe not that many??
Will the AAA rating last? And, does that matter? The lead up to December’s MYEFO was chockful of speculation as to whether the AAA credit rating would see Christmas. In the end the Budget update wasn’t that exciting: the ratings agencies blinked. In the meantime China’s recovery and the ongoing impact of the Reserve Bank’s 2016 interest rate cuts have botoxed the Budget, ironing out some of the wrinkles left by further policy rollbacks.
So it isn’t clear to us the AAA will be lost soon. Were it to happen, the initial trigger may actually be the debt of families rather than that of governments. In recent months Australian families passed those of Denmark to move into second place as the world’s most indebted. Relative to our income, our households are now pipped at the post solely by the Swiss for the world’s largest debt-to-income ratios – and we’re closing in fast on them too.
Initial impacts may be less than you’d think: Recent downgrades around the world have mostly been met with a shrug. After all, investors are desperate for safe assets. And no matter what any ratings agency says, Aussie government debt is a really safe place to be. But the pain would build: US interest rates are rising, and eventually they’ll rise all over the world. Some years from now the loss of the AAA – if it happens – would bulk larger as a cost not merely for governments (States as well as the Feds), but also for families (who think the debate over the AAA is a purely academic one, but its loss would affect bank borrowing costs, and so the mortgage payments of the punters). That combination would leave our living standards 0.5% below where they’d otherwise be.
Better Budget news – but not heaps better. This dog isn’t barking
Profits have roared baaack – boosting profit-related taxes: National income has a spring in its step for the first time in years, but that renewed vim and vigour is all about profits rather than wages. In turn, that’s good news for the profit taxes, with both company tax (thanks to profits in general) and PRRT (thanks to OPEC’s impact on energy prices) looking better than budgeted, and even the long suffering story of superannuation taxes showing some modest signs of life (courtesy of a lift in the sharemarket overcoming weakness in wages).
But we’re not talking Cartier and Tiffany. The profit taxes may beat their budgeted targets by $750 million this financial year and $2.7 billion next. That’s in the ‘nice to have’ category but, given the booming lift in profits right now, some in Canberra would’ve wished for more. However, Corporate Australia just spent a fortune on capacity: new mines and infrastructure. Rightly so, the related deductions are a headwind for collections. In addition, some of the profit winners of the moment were in the profit doghouse as recently as last year. As the Tax Office doesn’t provide payouts when companies make losses, that means the ATO has to wait for those tax liabilities to wash through before it gets the full upside of current conditions.
Families are spending, but that isn’t lifting the tax take: Average Aussie families hit a net worth of a million dollars each in Christmas 2016, and they’re taking that love to town. But, despite that, there’s mixed mostly news amid the indirect tax take (the “taxes on spending”), which doesn’t look likely to be much different from the official figures either this year or next. And the rats and mice pitch in: Interest rates are up (thanks to The Donald), and dividends are too, while ‘other taxes, fees and fines’ have lifted off the back of a better year on the farm.
But wages are a tale of woe: So the net news is good, but not as good as it’d otherwise be, because there’s some darkness in the heart of the Budget. The largest single tax – that on wage and salary earners – is disappointing official expectations. Partly that’s because wage growth is lower than a snake’s belly, and partly it is because job growth has been lacklustre, especially among full-time workers (whereas the strength has been among part-timers – and remember that lower wage earners, such as part-timers, pay lower average rates of tax). That trims $1.7 billion from official forecasts in 2016-17 and a further $600 million in 2017-18.
The bottom line is OK rather than great. Overall revenues are $550 million below MYEFO forecasts for 2016-17 and, although that jumps next year, they’re still ‘only’ $2.1 billion ahead of the official numbers for 2017-18. If you were looking for more of a tax windfall from the national income surge of the moment, you’re looking in vain. Remember the forecasts underpinning MYEFO are pretty much on the money for 2016-17. And although we forecast an even happier 2017-18 than Treasury did – more national income than official figures – the gap simply isn’t that huge. And a bit of perspective is handy here. The resources boom was a humdinger, and it set simply stunning revenue benchmarks. Yet even with the upward revisions we’ve forecast for company tax this financial year, the company tax take has only risen by 7% over the past nine years.
That’s nothing to write home about. More broadly, that says we have a revenue problem as well as an even bigger spending problem, and that revenue problem simply isn’t going away. Even today’s good news on the economy isn’t nearly enough to return revenues to anything like the strength they saw in the boom years ahead of the GFC.
As usual, our comments here all come back to our favourite four word summary of what happened to the Budget over the past decade-and-a-half: temporary boom, permanent promises. The last decade-and-a-half saw a temporary boom in revenues – notably profit taxes – that subsequently tanked. But whereas the impact of China and the resources boom on the Budget came and went, the impact of politicians’ promises has lingered.
Meantime the butcher’s bill from another six months’ of further Senate dithering plus new decisions ($730 million to hand the Mersey Hospital back to Tassie and $260 million in one-off payments to secure NXT Senate support for some measures) adds $1.1 billion to spending in 2016-17 and $820 million in 2017-18. Those extra costs aren’t due to the economy: current conditions aren’t changing spending much. This is policy – our decisions. Total spending in 2016-17 may be a net $1.2 billion higher than expected in MYEFO, with that difference running at $840 million higher in 2017-18 – with policy decisions (or non-decisions – hello Senate, we’re looking at you) continuing to add to costs.
The upshot is we project an underlying cash deficit of $38.3 billion in 2016-17. That is $1.8 billion worse than projected in MYEFO, although it is a smidgen better than 2015-16. Assuming no further policy changes, we project an underlying cash deficit in 2017 18 of $27.5 billion. Happily, that’s $1.2 billion better than projected in Mid-Year Economic and Fiscal Outlook – but that improvement comes thanks to China and to the Reserve Bank’s interest rate cuts last year, not to decisions taken by a courageous Canberra.
The matching fiscal deficits weigh in at $43.3 billion in 2016-17 and $21.0 billion in 2017-18.
What about 2018-19 and 2019-20?
Perspective, peoples: Official forecasts are for the sharpest lift in revenue as a share of the economy in almost two decades. Our forecasts are just that little bit less. Remember that as we tiptoe through the tulips of 2018-19 and 2019-20: we aren’t grumpy curmudgeons, we’re slightly-less-crazy optimists. Different views drive the gap: Treasury assumes an autopilot economy, with growth in key drivers at trend (true of their views of economic growth and job gains) or accelerating back towards trend (true of wages, prices and national income growth).
We’re more cautious than that. It’s true there are hints of an acceleration in global inflation. And we’ve long believed global and Australian inflation would lift: that’s in our forecasts. But we doubt The Donald in the White House will keep global growth accelerating, so we just aren’t as big a believer as Treasury on the pace of return to “normal” inflation. And, related to our view on inflation, we see wage gains on a slower path to recovery. Lastly, we remain China sceptics, which means we remain commodity price sceptics. The upshot of all that?
- For the last seven years total revenues averaged gains of less than $17 billion a year.
- For the next three years official estimates have revenues growing over $30 billion a year.
- For those same three years we have revenues growing an average of $29 billion a year.
Does that really make us pessimists? It does mean a turnaround in our forecasts versus official views. We saw revenues running ahead of official figures by $2.1 billion in 2017-18. But that turns into shortfalls of $1.6 billion in 2018-19 and (sigh) $4.6 billion in 2019-20. Part of that is a worsening shortfall in taxes on individuals (with wages picking up more slowly than official views), but profit taxes see the most ground lost (as commodity prices ease).
Again, be clear: this is still tax on steroids, with revenue climbing by 1.7 percentage points of national income over the three years to 2019-20 – the best such performance since 2000-01. The lack of tax cuts helps that (yes, there’s some company tax cuts, but they’re smaller than you think, subtracting just 0.1% of national income from this calculation). And although a lack of tax cuts helps, don’t forget a lack of fiscal drag hurts. Fiscal drag is a function of wage growth, and wage growth has been going lower than a limbo dancer.
That still leaves revenues climbing very fast. Why? One reason is Treasury keeps pencilling in a sharp lift in capital gains taxes (an extra $5.5 billion in 2019-20 versus 2016-17). Surging housing prices says that’s sensible, but progress here has been disappointing for many years now – so that’s a continuing question mark on the official numbers, and ours too.
Wondering why there aren’t bigger impacts around company tax? There are two reasons. The simple reason is that the government remains committed to tax cuts for all companies, rather than just some companies. Given how unpopular that policy is, we dips our lid to the government for holding its nerve. (The thing that makes company tax cuts work in boosting prosperity is the same thing that make them easy to demonise: those cuts go to foreigners.)
The related point is that, even if the government did back away from company tax cuts for all, that wouldn’t save a cent. Confused? The Budget assumes society won’t let tax receipts go higher than 23.9% of national income. That means the only issue is the relative shares of tax within the cap. Less company tax simply means more other taxes, including personal taxes.
And don’t forget what the modelling finds – both ours and Treasury’s: less company tax would mean a bigger pie, because company tax hits the economy harder than any other Federal tax.
There’s not much excitement happening on spending, though new policy costs add another billion dollars to the 2016-17 deficit, and continuing Senate delays add another billion to the 2017-18 deficit. Absent further policy changes, we forecast cash underlying deficits of $20.9 billion in 2018-19 and $14.3 billion in 2019-20 (with matching fiscal deficits at $16.5 billion and $10.7 billion).
That is some $1.2 billion and $4.3 billion worse, respectively, than Treasury projected last December.
Bracket creep is crawling
Inflation keeps pushing people into higher tax brackets – and that’s an ungainly and unfair way to raise taxes. But with wages stuck at record lows, creep is crawling. PAYG collections in 2016-17 would be $3.9 billion lower this year if the 2014-15 thresholds were indexed (note we ignore the ‘temporary Budget repair levy’ – we assume a top rate of 45%).
Bracket creep grows only slightly to $4.1 billion in 2017-18, held back by the tax cut for those earning over $80,000, but then resumes its inexorable rise, lifting to an estimated $6.3 billion in 2018-19, and to $8.8 billion in 2019-20 (meaning the tax paid by taxpayers in 2019-20 will be $8.8 billion more in that year than if they faced indexed 2014-15 rate scales).
Yet, as we keep saying, weak wage growth means that, at an average of just $1.8 billion extra per year, bracket creep in Australia is a problem rather than a disaster.
Debts and deficits
The longer term Budget outlook is covered in caveats:
- First, a swag of existing programs become more expensive further out in time – the NDIS, child care and paid parental leave, hospital and school funding, carer support, aged care, Medicare and the PBS, disability pensions, age pensions, universities and Defence. That means much of the Budget is already promised to grow fast, with the bulk of that pain falling just beyond the current forward estimates.
- Second, a raft of savings are in trouble, with both the Senate and the States showing little appetite to accept the savings options in front of them. In particular, spending on the States has been placed on a diet that may be hard to keep.
- Finally, the set of longer term costs posed by an ageing population and rapid health cost growth continue to threaten the longer term health of the Budget.
And to make one more unhappy point, we are currently a dysfunctional family: our elected representatives couldn’t agree on the day of the week. That leaves us unhappily equipped to rise to the challenge of getting our house in order. Heaven forbid a genuine crisis rocks up...
The chart above shows two sets of downgrades to official net debt estimates. The first adopts our forecasts, and then allows for a structural deficit that continues at the level we estimate for 2019-20 (the last year we examine in detail). The final line then assumes that the savings stuck before the Senate – yet still factored into the official forecasts – don’t occur. Our forecasts imply that net debt stays stuck at just under 20% of annual national income, and then only edges ever so slowly down in the next decade – across a period in which Australia will have racked up a third of a century without a recession. And adding in Senate constipation means that debt rises to 20%, and essentially just sits there forever. Make no mistake: continuing deficits aren’t the result of big investments in our future. They’re the result of pretending to the punters that the boom is rolling on.
And the changing direction of policy doesn’t bode well. Politicians of all stripes are busily channelling King Canute, pretending to the punters that they can fix housing affordability.
Similarly, while recent changes to migrant visas aren’t as dramatic as they sound, this nation is again – as it did with Julia Gillard in 2013 – seeing a PM pander to the myth that migrants steal jobs. Yet we had this debate in the 1970s, back when the evil people stealing jobs were, umm, married women. And no, they didn’t. Someone who puts up their hand to do a job not only earns an income, they also spend it. And by spending their income, they thereby create the next job. We don’t simply ‘steal’ jobs from each other in some Game of Thrones episode. After all, if we did, then we should never have children, because the little blighters would grow up and steal all our jobs ...
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