Budget Monitor November 2018
Close… but no cigar for 2018-19
26 November 2018: The rivers of gold are running, with the good news for revenues coming thick and fast:
- The world is growing at the fastest rate seen since 2011. And although China continues to slow, it also continues to pump out stimulus – meaning that world prices for what Australia sells (such as coal and iron ore) are doing better-than-budgeted
- At the same time, Australia is growing at the fastest rate seen since 2012, allowing unemployment rates here have also dropped to their lowest since 2012.
Relative to the official Budget forecasts, there’s good news galore in profits and jobs. How big are the bucks? We forecast the economy to be $27 billion dollars bigger this year than official projections had it. And that gap is only slowly eroded. By 2021-22, we still forecast the level of nominal GDP to be $5 billion dollars above the official figures.
And when the economy smiles, the Budget beams. Nominal GDP may be growing at 5%, but current revenue growth is a perfect 10, up more than 10% above year-ago levels, pumped up by surge in profits. In turn, that’s generating a matching surge towards surplus.
Revenues are turbocharged. Federal revenues are a quarter of national income. But the tax system really outperforms in upswings: a stunning 47% of the entire increase in national income this financial year and last is going into Canberra’s pockets. So almost every second dollar has gone to the taxman rather than staying in the hands of families and businesses.
2018-19 looks sweet
Most of the good news is in profit taxes. Company tax will raise almost $100 billion this year, more than half as much again as it raised in the year to March 2016, and up by a huge $8.4 billion on the Budget forecast. The superannuation tax take is similarly supersized, up by $1.0 billion on Treasury forecasts – with both the company and super tax takes benefiting too from firms and funds having run out of tax losses to offset against current tax payments.
But one profit tax isn’t dazzling. PRRT dollars are dire. Oil prices are at a seven-month low, but tax collections have been stuck in first gear even though Oz is now the world’s second largest gas exporter. The PRRT’s design was no longer fit for purpose, as we now sell gas rather than oil, and as interest rates are lower. The Callaghan review recommendations have now been adopted, but they’ll be a slow and partial repair, and we see a $0.5 billion shortfall.
And the outlook is only so-so on the biggest tax of all, PAYG. The news is good on jobs but bad on wages, and we see PAYG outperformance at ‘only’ $1.6 billion this year – $1.2 billion of which may well get eaten up as the drought cuts into collections from ‘other individuals’.
GST collections may disappoint amid consumer caution as house prices discover the laws of gravity, interest earnings may fall short as rates rise slower than Treasury expected, while the FBT take is struggling too. Even so, the bottom line is 2018-19 revenues are forecast to be $9.2 billion above where Treasury estimated them. Yippee! Them’s big bucks.
But don’t count your budgetary chickens before they hatch
The news may be less sweet next financial year:
- Coal and iron ore prices aren’t better-than-budgeted because China is better-than-expected. Rather, they’re looking good precisely because China’s growth is weakening, leading that nation to pump more stimulus into construction markets. That plays perfectly to the sweet spot of company profits and hence of company tax, but it shouldn’t lull you into a false sense of security as to where Budget revenues head over the medium term.
- Similarly, bank profits are already weakening here at home as the big banks tighten up on their lending criteria, and as rising global interest rates eat into their loan margins.
That combo could be kryptonite for company tax, whose 2019-20 outperformance may fade to ‘just’ $3.9 billion. And the slow speed of the recovery in wages will start to overwhelm the good news on jobs, leading PAYG taxes to drop $1.3 billion behind official expectations.
That still leaves total Federal revenues in 2019-20 some $2.1 billion ahead of Treasury’s projections, though that’s a fraction of what we see as the write-ups for 2018-19.
What’s the story on spending?
While the economy is shovelling money in the front door of the Tax Office, the approaching election means some of that windfall is being promptly shovelled out the back door. The new PM is putting out brushfires: getting WA back on side via a GST deal (requiring new funds to be tipped in), more money for Catholic schools (so the thunder from the pulpit lessens), plus a Royal Commission into aged care. And there’s taking care of the flock in the bush, with the drought accelerating the risks that regional voters further desert the Coalition for One Nation. Policies announced since the Budget have already cost more than $0.4 billion this financial year, rising to a $1.4 billion hit to the 2019-20 bottom line.
So it’s good news that the economy is restraining spending at the same time it is boosting revenues. The dominant factors are lower wages and a smaller deficit, leaving overall savings on spending from these ‘economic effects’ at $0.4 billion in 2018-19. And those savings leap to more than $1.1 billion next year. Weak wages are bad news for the Budget, but that bad news is in revenues, and there’s a partial offset via some savings on spending.
Total spending may be $360 million less than expected at Budget-time this year, and then $140 million more next year, with the cost of new policy promises being – to date – paid for by the savings to spending thanks to good news on the economy.
Soooo… when do we look likely to hit surplus?
These numbers say we’re well advanced on the strategy unveiled in the 2017 Budget, with the return to surplus financed by a lift in revenues rather than spending restraint.
To be fair, spending has been on a tight leash, and the Government deserves a lot of credit for that. But policy discipline is being aided by the tailwinds from a strong economy.
Meanwhile, the heavy lifting of Budget repair lies in revenues, which continue to climb from their 2010-11 low. This year revenues – most of which are taxes – will account for 25.7% of national income, almost 4 cents in the dollar higher than they were in 2010-11.
Importantly, revenues aren’t roaring because the Government has been raising tax rates. They’re on the up because the economy is on the up. Yet that painless way to get closer to surplus also says revenues are vulnerable to any future bout of weakness.
Our different dollars on spending are rounding errors versus our revenue write-ups, thereby placing the long sought after surplus nearly within reach. Yet, for 2018-19, it’s close but no cigar, though we do see the Budget bottom line as better than the official forecasts by a happy $9.6 billion this financial year, followed by a further $2.0 billion in 2019-20.
That translates into a modest underlying cash deficit of $4.9 billion in 2018-19 (the smallest since the GFC), followed by a small surplus of $4.2 billion in 2019-20. The matching fiscal balances are surpluses of $2.1 billion and $5.7 billion, respectively. The shift back into the black remains elusive for 2018-19. It has taken the current virtuous cycle of surging revenues and some modest spending restraint to get us this close. But we really are close. In fact the accrual measure of the Budget balance looks set to be in surplus this year, and both measures – accrual and cash – are headed for the black in 2019-20.
Could the Budget squeak into surplus in 2018-19?
Yes. On our forecasts it will fall short on the underlying cash measure, but be in surplus on the fiscal balance. Yet it wouldn’t fall short by all that much on cash. And although it would be a stretch, there’d be a few options open to get across the line – such as help from a larger Reserve Bank dividend – if the politics were sufficiently compelling.
Then again, the most compelling politics may be more likely to lie in spending in marginal electorates. And, either way, on current trajectory surplus will be reached next year anyway.
What of 2020-21 and 2021-22?
The oldest mistake in the budgetary book is to take the good fortune of the moment – with revenues sprinting much faster than the economy – and assume that will keep happening. Commodity prices look good today in part as China is responding to a slowing economy by rolling out stimulus that boosts construction. That won’t be permanent. And bank profits are already falling. That says the high water mark for the stupendous cycle in profit taxes evident today may not be far off. We see profit taxes still outperforming the official forecasts, but by relatively steady amounts: $3.7 billion in 2020-21 and $2.7 billion in 2021-22.
We also see a slow baton change out of job gains into wage growth, leaving the nation’s total wage bill smaller than official forecasts. That’s a problem for personal taxes, seeing them fall $0.9 billion shy of official forecasts in 2020-21, and then $3.3 billion shy in 2021-22. We don’t expect much action on indirect taxes (down a bit, mostly thanks to consumer caution reining in GST collections), while weak interest rates may weigh on interest earnings.
So whereas we see revenues beating official forecasts by $9.2 billion in 2018-19 and $2.1 billion in 2019-20, we forecast revenue outperformance to ease to $1.6 billion in 2019-20, and then to drop south of officialdom by $1.6 billion in 2021-22. Easy come, easy go.
There’s not heaps happening on spending, although weak wage and price growth generate some savings (versus the rather larger pain for the Budget that combo causes the tax take). Interest costs will be lower thanks to better Budget balances, and also because we foresee lower interest rates than Treasury assumes. And GST payments to the States may be lower too (as our weaker wage trajectory shows up as weaker spending in the shops).
All up, and absent further policy changes (such as extra personal tax cuts announced ahead of the election), we forecast cash underlying surpluses of $14.1 billion in 2020-21 and $16.1 billion in 2021-22 (with matching fiscal surpluses of $16.0 billion and $18.9 billion, respectively). That is $3.1 billion better (in 2020-21) and $0.5 billion worse (in 2021-22) than Treasury had projected on Budget night back in May.
It’s time to take a moment to smell the roses…
Australia’s decade of deficits is drawing to a close. The toxic politics of Budget repair were a torment for all involved. Everybody wanted everybody else to wear the pain of Budget repair, except for the Senate, which never saw a spending cut it liked. But luck’s a fortune, and a better economy – and rather better company profits – are helping us come home with a wet sail. Just remember that it may not last: the deficit was stuck close to $40 billion a year for many years, including as recently as 2015-16, until a whole heap of good fortune suddenly dropped in our lap. Yet that good fortune could evaporate just as fast as it arrived.
The newly legislated tax cuts will largely address bracket creep – eventually
Inflation pushes people into higher tax brackets, and that’s an ungainly and unfair way to raise taxes. Yes, big tax cuts are in play. Yet despite the first stage of those tax cuts already being here, PAYG collections this year would have been $1.9 billion lower if the 2014-15 thresholds had simply been indexed. And the later stages of the tax cuts – which are substantial – don’t arrive until a few years from now, which is why the punters would be paying less tax had we merely indexed 2014-15 thresholds to inflation.
Bracket creep lifts to $4.6 billion in 2019-20, $7.8 billion in 2020-21, and then reaches $11.2 billion by 2021-22. So even though weak wage growth means bracket creep is only creeping along, it is still enough to mean the taxman will grab a bigger slice of paypackets. The twenty cents in the dollar of wages and salaries set to be paid in personal tax in 2021-22 has only been beaten once in history – in 1999-00, just before the GST first came in. So chances are we haven’t heard the last of tax cuts ahead of the coming federal election…
Oh yeah…what Ken said
The current surge for surplus is both wonderful and dangerous, in equal parts. The danger is that official methodologies tend to lock in temporary good news into permanently better budgetary forecasts.
With an election looming, both sides will therefore wave cash in your face while crossing their hearts and reverently assuring you that “Treasury says the money is there”. You should trust that as much as you trust a used car salesman who says “it’s only been driven by a little old lady”.
And there are questions not merely as to the quantity of dollars that’ll be promised, but also their quality. It’s time to dust off Ken Henry’s prescient warning. In similar conditions back in 2007, with the economy handing the Budget money and an election in the offing, Ken said that there was a “greater than usual risk of the development of policy proposals that are, frankly, bad”. Umm, yes. At the risk of stating the obvious, you’ll need to keep your wits during election season. Chances are that both sides will be breaking bad on the policy front.
But wait, won’t Treasury and Finance have a chance to warn the electorate about such risks in the Pre-Election Fiscal Outlook?
Probably not. History suggests the government will issue an Economic Statement in (say) April, just before the election is called. For example, that’s what Kevin Rudd did in 2013, just nine days before PEFO was released. That then limited the flexibility of Treasury and Finance to say anything much different to what they’d said (under the watchful eye of the government) a few days before.
PS: let’s fix that epic fail
Finally, we’d remind you that the Budget – this nation’s social compact with itself – is about far more than deficits or surpluses. We need taxes that don’t hurt prosperity and spending that ensures fairness.
On the latter front, this nation has one epic fairness fail – the continuing crush we’re putting on the living standards of the unemployed. History won’t judge our record kindly.
We can do better than that. Please check this out: https://www.acoss.org.au