No more ‘lifters and leaners’ – ‘politics and polls’ hold sway
Treasurer Scott Morrison said this morning that Budgets are about choices, and he has chosen to jettison the austerity of previous Budgets in favour of what he calls “fairness, security and opportunity”. There is none of the tough love of 2014, or any mention of “debt and deficit disaster”. There are no “lifters and leaners” here. The focus is on boosting infrastructure, easing the cost of living, improving housing affordability, and seizing the initiative on bread-and-butter issues for households like education and healthcare.
The bottom line is that the Treasurer has opted to use the cover of faster economic growth, elevated commodity prices (albeit assumed to be below current levels), and innovative accounting treatments to fund significant new spending, rather than quicken the pace of fiscal repair. The credit rating agencies consistently have warned that, without sustained remedial action to address the fiscal slippage revealed in last year’s mid-year update, a credit rating downgrade is imminent. The Treasurer seems to be calling their bluff.
The Government has responded strongly to calls for a banking Royal Commission with a series of tough measures for the sector. A new levy on big banks will raise $6.2bn for Budget repair and banking directors are also captured in a new ‘Banking Executive Accountability Regime’. This gives APRA expanded oversight of directors and executives and introduces increased civil and criminal penalties.
- The 2017 Budget uses an expected boost to revenue from faster GDP growth, higher wages growth and high commodity prices to prioritise more spending, rather than a speedier pace of fiscal repair.
- The planned return to surplus remains in the middle distance at the end of the decade, so the level of public debt will continue to climb, reaching $600 billion (more than 30 per cent of GDP) by 2019-20.
- There are substantial new spending commitments on health, education, skills, small business, defence and infrastructure, offset by savings in welfare and more efficiency dividends.
- The boost to infrastructure is welcome, but other measures to lift productivity and boost efficiency, like another round of personal income tax cuts, are notably absent.
- There is a new levy to be imposed on large banks and a planned rise in the Medicare Levy from 2019-20 to help fully-fund the National Disability Insurance Scheme (NDIS).
- At $29.4 billion (1.6 per cent of GDP), the projected Budget deficit for 2017-18 is slightly larger than was expected last year, and the subsequent improvements are premised on a sharp rebound in revenue.
- The Budget includes plausible assumptions on economic growth, but the expected rebound in wages growth leaves the nation’s finances vulnerable to disappointment.
No quickening in the pace of Budget repair
Treasurer Scott Morrison’s second Budget projects a 10th straight year of deficit, with two more shortfalls to follow before the projected move back into the black. As before, though, the belated return of the Budget to surplus is based largely on an assumed bounce in revenue as a share of the economy, which may or may not be realised. Spending, meanwhile, has been allowed to all but flat-line as a share of GDP.
The promised return to surplus, then, remains a mirage at the end of the forward estimates period, although the freshly-presented operating Budget will be in surplus a year earlier. So much for the “temporary” dip into deficit back in 2009, but at least the promised return to surplus is no longer receding ever further into the middle distance, as it has for previous Treasurers.
With Budget deficits still projected across much of the forward estimates (yielding an accumulated shortfall of $46 billion over four years), public debt will continue to climb, even if some of it now is of the “good” variety to fund much-needed infrastructure. There were tax rises announced tonight, as well as new saving measures, including another crackdown on welfare compliance. There also is the shift of some capital expenditure off Budget, a clever manoeuvre that has allowed the Government to maintain recurrent spending as a share of the economy.
Only slow progress down the road to fiscal repair
In aggregate, the accumulated deficits over the forward estimates are better than those promised last year, albeit only by around $5 billion. The slow rate of improvement is despite the tax rises announced tonight, the savings implemented earlier this year, and the further integrity measures announced tonight. These come alongside booming company profits and the improving domestic economy, both of which are powerful tailwinds for tax revenue. Weak wages growth, though, remains a material drag on tax collections, although the Budget assumes a sharp improvement. This assumption allows Treasury to assume a faster rate of improvement in the Budget’s bottom line towards the end of the forward estimates period.
The underlying Budget deficit for the fiscal year ahead is expected to be $29.4 billion (1.6 per cent of GDP), marginally worse than the estimated shortfall late last year, and still not that far removed from the record imbalances delivered in the wake of the global crisis, when the deficit reached a record $54 billion (more than 4 per cent of GDP). Commonwealth debt, which already has risen to more than $500 billion, more than was expected last year, will continue to climb, and is projected to peak at 31 per cent of GDP in 2018-19.
Infrastructure and housing affordability the main focus
Much of tonight’s Budget either was leaked or announced before tonight, meaning there were few revelations. The material surprises are the levy on the banks, expected to raise more than $6 billion, and the increase in the Medicare levy to fund the NDIS. The substantial new spending includes an infrastructure spending and financing program of $75 billion to include Sydney’s new airport, the Snowy Hydro scheme, a national rail fund, road projects in Western Australia, and the Inland Rail Link. It’s not clear, though, how much of the commitment is new funding.
The Government is committed to stop borrowing for recurrent purposes by 2019-20. Hopefully, the Treasurer avoids getting stuck in the weeds trying to explain that not all borrowing for recurrent purposes is bad (eg. education and healthcare), and that not all borrowing for infrastructure is good. Many otherwise attractive projects do not stack up on cost-benefit grounds. There are shades of grey here, with careful project selection and evaluation critical in making sure the new funding is well-spent.
There are promised measures to improve housing affordability include arrangements for first time buyers to accumulate a deposit via their Super fund at a concessional tax rate, and incentives for older people to downsize. The former measure, though, could add to demand, making affordability even worse. There also is a new fund to boost housing related infrastructure and the introduction of a levy on future foreign investors who leave their properties unoccupied for more than six months.
The Government has chosen not to tinker with the nexus between negative gearing and the capital gains tax discount, although it has tightened up on some deductions. The Government has admitted that there is no “silver bullet” on solving the housing affordability crisis – unlocking more supply is the key.
Credit rating downgrades avoided – for now
The projected improvement in the Budget bottom line probably is sufficient to prevent a credit rating downgrade for now. But, material set backs on any of the underlying assumptions on GDP growth, wages or commodity prices will quickly puncture yet another Budget strategy. The ratings agencies probably will be pacified for now, but will keep a close eye on the progress of Budget repair.
The new spending commitments mean the Budget will remain in significant structural deficit, and there is no fiscal buffer available should conditions unexpectedly deteriorate. This is what keeps the ratings agencies awake at night – the lack of flexibility should things go pear-shaped. There similarly is little room to move on monetary policy, with the RBA’s official cash rate already at a record low.
Still living beyond our means – burden of repair still falls too heavily on revenue
Unfortunately, even with tonight’s savings, we will continue to live beyond our means. Spending as a share of the economy is projected to track along at 25 per cent of GDP, well above the revenue share and only just shy of the 26 per cent of GDP spending reached during the “emergency” response during the darkest days of the GFC. That said, the projected spending share is slightly below the trajectory expected in last year’s Budget. And at least spending growth in real terms has been held just below 2 per cent, although this falls short of AICD’s preferred growth cap of 1.5 per cent.
The burden of the promised fiscal repair over time continues to fall most heavily on the revenue side of the ledger. Treasury projects that revenue as a share of the economy will spring back by more than 2 percentage points of GDP over the next four years, as spending stays broadly stable as a share of the economy. The revenue side of the accounts is where it all could go wrong if, for example if commodity prices fall faster than assumed and wages growth stays low.
Treasury projects a bounce in revenue as a share of GDP from the lowly 23.2 per cent of GDP in 2016-17, where it has languished for five years, to more than 25 per cent by 2020-21. The assumption on revenue looks ambitious. A succession of Treasurers have ended up disappointed when similarly optimistic growth and revenue expectations have proven to be well wide of the mark.
Economic growth expectations raised, but are vulnerable to disappointment
The Budget already is benefiting from the improvement in economic conditions here and overseas, which has contributed to the lift in commodity prices and, therefore, nominal GDP.
In summary, the Budget projects the following economic outcomes:
- Treasury expects Australia’s economy to grow by 3 per cent in real terms each year from 2018-19, well above the current growth rate.
- The expected growth rate of nominal GDP, a proxy for national income, has been lifted to 4.75 per cent by the end of the forward estimates.
- The jobless rate is assumed to dip to 5.25 per cent (from the current rate of 5.9 per cent), and wages growth is expected to accelerate from the current sub-2 per cent rate to 3.75 per cent.
- Employment is assumed to grow by 1.5 per cent and inflation to track in the centre of the RBA’s target zone at 2.5 per cent.
Missed opportunities – down payments on reform
This Budget is another down payment on the hard work necessary to return the Budget to surplus, but the lack of additional urgency on fiscal repair is disappointing. Indeed, more needs to be done, particularly to lift productivity. The AICD’s recommendations for broader reform and a speedier return to surplus were summarised in Governance of the Nation: A Blueprint for Growth, released in April 2017.The Budget addresses some of the issues in the Blueprint, but the bulk of the work had been left undone.
AICD’s key recommendations from the Blueprint included that:
- all marginal personal income tax rates be lowered;
- the tax rate paid by all companies be lowered progressively over time;
- the nexus between negative gearing and the CGT discount be addressed in regard to its impact on housing affordability;
- Commonwealth spending growth be restricted to 1.5 per cent in real terms;
- the rate of the GST be raised to 15 per cent and the base broadened; and
- the Government raise “good” borrowing for carefully selected and evaluated infrastructure.