Deloitte Access Economics Budget Monitor

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Deloitte Access Economics Budget Monitor

Red hot recovery drives budget repair

3 May 2021:  Australia’s recovery is red hot. Deloitte Access Economics has said for some time that, if our economy gets better, our budget will too.  So it’s no surprise that our red hot recovery is helping the budget get better.

And yes, it is a red hot recovery:  it still seems to come as a surprise to many that global growth is recovering fast, that Australia’s world class defence against the virus has us near the front of that pack, that Australian living standards grew faster than their decade average through 2020, that we are the first (and so far only) advanced nation to have more jobs now than before the pandemic, and that overall job momentum is set to be only temporarily disrupted by the end to JobKeeper.

That’s a pretty good backdrop for the upcoming budget.  How good?  Three things stand out:

  • First, jobs have returned much faster than Treasury assumed.  That’s even more central to the economic outlook than usual, because COVID’s economic pain has centred on jobs.
  • Second, the world is giving us a much larger pay rise than Treasury forecast – iron ore prices are as high as Nimbin on a sunny Sunday, and other export prices are looking healthier too.
  • Third, families have been happier to open their purses and wallets than Treasury had forecast.

To be clear, the economy remains under a lot of pressure.  But that pressure is much less than the official forecasts had factored in.  Compared with Treasury’s latest forecasts, national income is set to be 1.6% ($31 billion) stronger in 2020-21, rising to 4.2% ($85 billion) in 2021-22, 4.9% ($102 billion) in 2022-23, and a mighty 5.2% (or $114 billion) better in 2023-24.  That drives beautiful momentum across all the key drivers of the tax take – jobs, profits and spending.

So revenues are recovering

The personal tax take is a big beneficiary of the outperformance on jobs, even if wages are stuck in the slow lane for some time.  That good news on jobs also makes refunds smaller than otherwise.  And better-than-expected business profits, dividends and farm incomes all show up here too, leaving the total personal tax take running ahead of the most recent Treasury forecast by almost $5 billion this financial year, and by a hefty $14 billion next year.  Them’s big bucks.

And it is big bucks on profit taxes too.  They’ll also outperform the low bar set for them by Treasury.  The upfront damage to profits from COVID was smaller than expected, and prices for key exports are healthy.  Prices for iron ore in particular are miles ahead of where Treasury had them, with that mix driving up the company tax take.  Even better, healthy sharemarkets underpin super taxes, while recovering gas prices limit the damage on resource rent taxes.  Add all that together, and it says the Treasurer will trouser an extra $9 billion in profit taxes both this financial year and next.

Confident families are also spending up a storm, adding dollars to spending taxes.  The GST take is soaring ahead of official forecasts, and there’s some good news in excises and customs duties as well.  That adds up to a further revenue boost of $6 billion this year and $5 billion next.

So 2020-21 revenues may end up ahead of the forecast in the 17 December 2020 budget update by $21 billion, or 4.2%, and that good news gets even better in 2021-22, beating the latest official forecasts by $28 billion (5.6%).

And what about spending?

Our defence of lives and livelihoods cost heaps, but the big bucks are already in the rear view mirror.  The cost of JobKeeper, the Coronavirus Supplement and other programs peaked back in mid-2020, and they’ve now mostly wrapped up.

The economy is a lot happier.  The remarkable recovery has left official forecasts well behind.  Compared to Treasury, we see the economy in 2020-21 and 2021-22 as having much lower unemployment, but stronger inflation, a higher currency and higher long term interest rates.

By the way, those differences have a common theme – they’re all the result of a happier economy.  In total, that saves money.  But it is the sheer size of that saving that stands out, because better job and joblessness news saved much more than usual, boosting the budget bottom line by a mammoth
$17 billion in 2020-21, and then by a further $3 billion in 2021-22.

Interest costs remain cheap as chips.  Within that latter saving, expected interest costs are a little higher than official forecasts have them this year (as Australian borrowing costs have risen alongside their global counterparts), but that swings back into a saving next year (as deficits are so much smaller than expected – more than compensating for the cost impact of higher interest rates).

Happiness is a double-edged sword.  The economy’s happiness is widespread.  Notably, families are relaxed, comfortable and cashed up – which is why GST receipts are roaring along.  But those dollars get passed straight to the states, meaning that, relative to the latest official forecasts, some $5 billion more will be added to spending this financial year, followed by $2 billion next.

The purse strings have been loosened … a little.  Vaccines, tourism, housing, aged care – there’s been extra policy support where it’s been needed most.  And, speaking of help where it is needed most, there’s the cost of a higher unemployment benefit too.  That was costed using what are now outdated expectations of where unemployment would go.  The official costing is $9 billion over the forward estimates, but we see a direct cost of $8 billion.  Even better still, our analysis shows that the net cost to the budget will eventually be only a third of that direct cost.

The bottom line is spending in 2020-21 may be $9.8 billion less than in the official figures – mainly because the sharper-than-forecast recovery means JobKeeper and the Coronavirus Supplement were less costly than feared, but also because JobMaker … isn’t making jobs.

Thereafter the spending impact goes the other way.  Savings on the big emergency programs drop out of the equation, and spending rises above official estimates partly due to extra GST grants to the states, and partly due to new decisions such as the increased spending on aged care and unemployment benefits.  That adds $6.6 billion to overall spending totals in 2021-22.

That points to savings on spending this year thanks to a red hot recovery saving money on emergency programs.  But spending may be back up above official forecasts next year off the back of new spending.

Adding all that together, Deloitte Access Economics estimates underlying cash deficits of $167 billion this financial year and $87 billion next year.

These are $31 billion and $22 billion, respectively, better than Treasury forecast, with that improvement dominated by better news on profit taxes and personal taxes.  Our matching fiscal deficits are $163 billion and $86 billion, respectively.

That’s stunningly good news.  The budget is getting better rapidly because the economy is getting better rapidly.  Yet a bit of perspective is handy here.  Yes, things are getting a lot better.  But they are getting better from a starting point in which the proverbial had hit the budgetary fan.  So although our forecasts are way ahead of Treasury’s latest, that still leaves them heaps less happy than they were – as an example, the deficit is an eye-wateringly $95 billion larger than the matching projections for 2021-22 that Treasury issued in late 2019.

To be clear, the tax take is weaker because, when we crashed into the brick wall that is COVID, the airbag built into our tax system took a stunning share of the blow that would otherwise have fallen on the finances of families and businesses.  The system is doing what it should.

Future deficits are already looking much less scary

But wait, there’s more.  Recessions usually leave gigantic hangovers for the tax take.  That’s because businesses lose money in recessions, and those losses can be offset against tax bills in later years.  That’s why Treasury has built a phase of sackcloth and ashes into its tax projections.

Yet our red hot recovery means we mostly dodged that bullet – far fewer businesses made losses than Treasury expected, and that means heaps more money in the door in 2022-23 in particular.  In that year we see profit taxes outperforming their official counterparts by a gobsmacking $19 billion, followed by further outperformance of $6 billion in 2023-24.

There’s plenty on offer in personal taxes too, beating official equivalents by $7 billion in 2022-23 (even though we’ve allowed for the mooted extra year of tax cuts, costing $7 billion more in refunds in that year) and then $10 billion in 2023-24.  Given the sheer size of the personal tax bucket, those gains could have been bigger still, but we forecast wages to bring up the caboose of the economic recovery from COVID.  Although we see jobs easily besting the official forecasts, wages may merely level peg or even fall behind a little, and that limits the upside here.

Cashed up customers will also keep the tills turning over, adding $6 billion to the take from spending taxes in 2022-23, followed by $8 billion in 2023-24.  Add in the odds and sods, and total revenues are on a path to beat the latest official projections by $33 billion in 2022-23 and by $24 billion in 2023-24.  And yes, that’s a whole lot of money.

The expenditure story is much more modest.  The last handful of months saw big savings on spending, because our remarkable recovery ate into the cost of emergency programs such as JobKeeper and the Coronavirus Supplement.  But those emergency programs are no longer there to make savings from.  The good news is that there are savings on interest payments from the markedly lower deficits we are forecasting, and there are still savings generated by fewer unemployed than the official view.  But the bad news is that higher prices add to program costs, plus the ongoing outperformance on the GST gets passed to the states, while there have been some spending decisions (notably in aged care and on unemployment benefits).  The net outcome there is an addition to spending of $5 billion in 2022-23 and $7 billion in 2023-24.

Add that together, and we forecast cash underlying deficits of $56 billion in 2022-23 and
$49 billion in 2023-24 (with matching fiscal deficits of $64 billion and $50 billion)
.  That is better than the official forecast in 2022-23 by a hefty $28 billion, followed by a welcome improvement of $17 billion in 2023-24.

Almost $100 billion better off over the four years to 2023-24

For those playing along at home, our deficits in the four years to 2023-24 are $98 billion less than Treasury estimated just a few month ago.

Meantime our conclusion remains the same:  the defence against the virus is cheap as chips.  Interest rates have been more frisky of late, but they still remain miles below where they were.  So despite loads more debt, we estimate federal interest costs on government securities at $0.3 billion lower in 2023-24 than they were in 2018-19.  Yep, lower.  Pretty good, huh?

Less creepy

The tax cuts of recent years have more than paid back bracket creep:  The collapse of wage growth and the shift to an earlier start to Stage 2 of the tax cuts means that these long planned cuts are now more generous than originally envisaged.  If taxpayers were being taxed at 2014-15 rates and thresholds (but those thresholds had been adjusted for inflation), then families would be paying much more in tax than they actually are.

Taxes are lower to the tune of more than $19 billion this year, with the ‘overpayment’ of bracket creep soaring that high as the fight against the COVID hit to the economy saw Stage 2 tax cuts were brought forward and Stage 1 tax cuts kept for longer.  The overpayment of bracket creep then gets pegged back over the remaining years of the forward estimates, easing to $7 billion in 2023-24.  The arrival of the Stage 3 tax cuts – if they ever do see the light of day – would leave families paying $20 billion less in taxes in 2024-25 than if the 2014-15 tax system had been indexed over time.

So far, so very beautiful.  But …

There’s a few problems ahead – some driven by the economy, and others driven by politics:

  • The first problem is that our basic recommendation (aiming to repair the budget by repairing the economy) has its limitations.
  • And the second problem is that the politics of personal tax is getting problematic.  ’Twas ever thus.

Let’s have a look at both these problems.

… we need a tougher target

OK, we’re repairing the budget by repairing the economy.  Yippee.  But how do we know when the economy is ‘repaired’?  We need the right target for that.  And the current one isn’t tough enough.  The Reserve Bank has made it clear unemployment needs to fall to the “low 4s” or “high 3s” before it raises interest rates.  That’s more in line with the consensus among economists that the ‘natural’ rate of unemployment is near 4½%.  That says that the fastest and smartest way to repair the budget will be to avoid attempts at budget repair until unemployment is comfortably under 5% – not the current target of comfortably under 6%.

Attempting budget repair too early would risk hurting the economy – and therefore hurting the budget.  The good news is that appears to be the way the government is thinking.  The Treasurer, quite correctly, continues to emphasise “the best way to repair the budget is to repair the economy”.  And the smoke signals from Canberra indicate “Treasurer Josh Frydenberg has decided to maintain the momentum and keep spending on job creation to drive the rate below the pre-pandemic level of 5.1 per cent”.  You should hope that happens:  it would make good sense.

… there’s a further repair task down the track

And now for some sad news.  Even once the economy is repaired – and unemployment is comfortably under 5% – the budget still won’t be quite as healthy as we’d like it to be.

To be clear, repairing the economy does indeed do the vast bulk of the heavy lifting.  But there’s still a budget repair task even with a repaired economy.  That’s because:

  • Years of weak wage and price growth are unlikely to be followed by a period of catch up, and weaker wages and prices weigh on the ability of an income tax system to raise revenue.
  • At the same time weaker population growth and business investment spending as a result of the coronavirus crisis mean the future size of the economy is also smaller than pre-COVID forecasts for it.  That hurts the budget too, partly as migrants tend to be younger and more skilled than the average Australian worker – which is why we welcome them as migrants.
  • Finally, COVID means more debt, and overall interest payments are higher than what would have been seen if the virus hadn’t hit.

Our analysis shows that we may eventually need to save the equivalent of $40 billion a year to get the budget back into balance.  Australians do need to realise that there’s an eventual bill to pay – it isn’t nearly as large as many seem to fear, but nor is it nothing.  And the politics here are horrendous.  If you’d like a yardstick, the last budget that tried to save a similar share of national income was in 2014, and it is widely seen as having torpedoed the fortunes of Tony Abbott and Joe Hockey.

That’s a challenge.  To be clear, budget repair shouldn’t start soon.  And it can – and should – be slow.  But it won’t be fun.

… that repair task doesn’t mean no more for aged care or the unemployed

In the meantime, the government is spending more.  Sometimes that’s just a temporary spend, such as on much needed vaccines.  And sometimes it is on vital long term priorities – such as a better deal for the unemployed (though what was done was too little by far) and those in aged care.

So to say that there’s an eventual budget repair task doesn’t say that the government can’t do more in areas where that’s needed.  But it does say that Australia needs a national discussion around our post-COVID priorities.  Whether we like it or not, we’ll need to cut some spending and raise some taxes.  And we’ll probably need to start doing that – slowly so – just a few years from now.

… but beware politics

Doing what we’ll eventually need to do will require Australia’s politicians to pull together in a way they never completely succeeded in doing through COVID.  We’re not enormously optimistic that they’ll do it post-COVID either.

And the political challenges are already lining up ...  Take what’s happening on tax cuts.

Some years ago the current government came up with a three stage plan to deliver tax cuts that simplified the rate scale, kept shares of tax paid mostly unchanged, and addressed bracket creep.

But then events intervened:  the third phase of those tax cuts got terrible press, wage growth collapsed, and COVID led to the second phase tax cuts being brought forward and the first phase (which was meant to be being folded into the second phase) being kept for a further year.

The upshot was that lower income earners got two tax cuts, middle income earners got one, and higher income earners got none.  And politics may lead to the tax system staying like it looks this year, otherwise:

  • Unless the government acts on budget night – and there’s a lot of speculation that it will – then low-to-middle income earners will see their tax refunds in August and September 2022 slashed by somewhere between $255 and $1,080:  a bad look ahead of an election, and
  • Budget repair would go backwards in 2024-25 as the government’s forecasts extend to that year for the first time – meaning that they’ll reflect the $17 billion cost of the phase three tax cuts.

So that’s where the politics may lead.

Yet what would our personal tax system look like if it stays stuck where it is?

  • The overall cost of the tax cuts would be lower.  And that’s a good thing:  we at Deloitte Access Economics have always been worried that they’re too big – that they promised too much too soon.  And that was even before COVID-19 hit.
  • But stopping now would leave the worst features of the system in place.  Remember why the nation went down this path in the first place:  we did it because (1) Australia relies much more on personal tax than other developed countries do, because (2) we have a high top marginal rate of tax, and because (3) that top rate cuts in at relatively low levels of income.  Yet if the tax system skids to a halt with its current features cemented in place, then we will have made very little progress on (1), no progress on (2), and we will see a further worsening in (3).
  • The system would be more complicated and less fair.  A key aim of the reform was to simplify the tax scale without affecting fairness.  But if we stay stuck where we are today, then we’ll have added complexity and worsened fairness.  The added complexity is thanks to the first stage – designed as a temporary lean to at the back of the tax system, it would be an unfortunate feature if made permanent.  And the worsening fairness is because what’s happening is the exact opposite of what Twitter thinks is happening.  As the table below shows, the notable over-reliance of our tax system on the nation’s highest income earners continues to become more marked.  Quite correctly, many low income Australians pay nothing in personal tax.  But it isn’t clear that the public realises that this year the top 1% of personal taxpayers will pay the same total dollars in personal tax as the lowest earning 16.5 million adult Australians.

Table i: Shares of personal income tax paid by taxpayer group

Source:  ATO, Deloitte Access Economics

To be clear, it’s not the end of the world if that’s where we do end up.  At least it would help with budget repair.  And although it would cement complexity into the tax system and be unfair to high income earners, it isn’t clear that would make high income earners work any less than they already do. But it is already clear that the politics of budget repair will be tricky. 

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