Budget 2019 promises to deliver an almost magical trifecta of tax cuts, spending initiatives and a series of projected budget surpluses, a combination designed to gladden the heart of any Treasurer. But the longevity of Budget 2019 is even more hostage to fortune than most of its predecessors. With an election already imminent (18 May) at its inception, this was as much a campaign launch as a fiscal plan. And just as the budget’s pitch is shaped by that campaign, its fate is tied to the campaign’s outcome. Much of the budget content and messaging can be captured by four main factors.
Need for a compelling political narrative
This requires a payoff to long-standing messaging about sound economic management through ending the era of more than “a decade of deficits” via a return to surpluses and paying down government debt. It also requires a voter-friendly offer to Australian households, which have not only experienced a steady rise in their tax-to-income ratios, but which are also being squeezed by an uncomfortable combination of sluggish income growth and falling house prices.
Here, the budget mostly meets its objectives in terms of the fiscal responsibility story, targeting an underlying cash surplus of $7.1b (0.4 per cent of GDP) in 2019–20, followed by more surpluses across the forward estimates period. “Mostly” because the promised surpluses are still in the future and modest enough to remain hostage to any severe adverse shock. That trajectory sees net debt peaking at 19.2 per cent of GDP in 2018–19 before falling to 18 per cent of GDP in 2019–20 and 16.8 per cent the following year.
Helpful fiscal starting point
High commodity prices for some of our leading resources, including coal and iron ore, have pushed up export earnings, corporate profits and nominal GDP. Strong employment growth has helped bolster receipts, too. Meanwhile, payments have been limited by low inflation, low wage growth and low interest rates. That helpful mix is what allows the budget maths behind the trifecta to add up.
Weak real economy
Despite that positive story on the nominal side of the economy, the real economy looks relatively weak. While the budget papers boast an economy “in fundamentally good shape”, the reality is more complex. Granted, unemployment is low, exports are doing well and we’ve finally negotiated our descent down the mining investment cliff. But economic activity has softened. Real GDP growth for 2018 may have come in at a respectable 2.8 per cent, but last year was very much a story of two halves. While the first one saw annualised growth roaring along at close to four per cent, the second saw it slump to less than one per cent, accompanied by headlines proclaiming a “per capita recession”. That economic weakness continued into the opening months of this year, prompting financial markets to begin pricing in RBA rate cuts. With the cash rate already at record lows and the supply of conventional monetary policy ammunition running low, those same circumstances also make a compelling case for fiscal stimulus.
This is where the politics and economics of the budget intersect quite helpfully. Households have been suffering from low wage growth and falling wealth, squeezing consumption. At the same time, taxes have been compounding matters by taking a rising share of income just when that income growth has been uncomfortably slow. That combination is problematic economically — private consumption is a key driver of the economy — and unattractive politically. The budget sets out to tackle both by delivering lower taxes via increasing the non-refundable lower and middle income tax offset from a maximum amount of $530 to $1080, along with a hike in the base amount from $200 to $255.
The compelling political and economic logic here saw the policy adopted promptly in the Labor opposition’s budget response, albeit with the pledge of additional payments to those on low incomes.
Other major tax measures in the budget were largely confined to the medium term and therefore hostage to at least two more election outcomes. An important exception to this was increased support to small and medium-sized businesses, combining a $5000 increase in the instant asset write-off threshold with expanded access to the same for medium-sized businesses. The budget also proposed to bring forward by five years — to 2021–22 — the promised cut in the small business company tax rate to 25 per cent.
Budget 2018 saw the government deliver a significant increase in infrastructure spending to help close Australia’s infrastructure gap. Budget 2019 seeks to build on this, increasing planned investment to a total (including existing commitments) of $100b during the next decade, with an emphasis on “busting” congestion and enhancing connectivity. This has the twin advantages of sustaining current support to near-term growth — remember, the infrastructure program is already underway — while also enhancing the medium-term productivity outlook, assuming politics doesn’t distort project allocation too much.
The main risk to implementation of the budget measures remains the election outcome. In addition, budget outcomes, as always, remain vulnerable to economic ones. The global economy also suffered a tough start to this year, and the levels of policy uncertainty remain worryingly high. The budget assumes that growth in Australia’s major trading partners will remain relatively solid, but there are clearly substantial risks around the international environment.
That also holds true for the domestic economy. Current conditions look fragile in several respects, and the risky nexus of a housing market correction, stretched household balance sheets and weak household income growth represents a big downside risk. The planned boost to incomes is welcome in this context, but whether it will be enough to restore household confidence remains to be seen.
Further ahead is the recurring challenge for Australian treasurers of basing revenue and spending commitments around reversible commodity price swings. Projections suggest the near-term outlook remains positive and the underlying forecasts seem reasonable. But any big shift in the global economy would rapidly call those same projections into question. Finally, the budget position will continue to face long-term challenges reflecting structural factors such as the relatively disappointing pace of productivity growth and shifting demographic trends — factors Budget 2019 makes only limited efforts to address.