In an election year, with Canberra and China seen as the biggest economic risks, and a decade of deficits forecast to end, our AICD Chief Economist Mark Thirlwell previews key points as to how next week’s federal Budget is shaping up.
In its March 2019 Budget Monitor, the key message from Deloitte Access Economics is that although the Australian economy may be getting worse, the budget is getting better, and so “a decade of deficits is drawing to a close” in 2018-19, with the first cash surplus expected since 2007-08. Here are five things directors need to know.
- Deloitte reckons that nominal GDP will be $8 billion larger than official projections both this financial year and next, that total profit taxes will be boosted by higher prices for coal and iron ore, and that strong employment growth will boost the tax take on individuals.
- As a result, Deloitte is forecasting that total revenues will beat the December MYEFO projections by $2.9 billion in 2018-19 and $3.7 billion in 2019-20.
- On the expenditure side of the equation, forecasts are for a spending undershoot relative to December’s official projections of $0.25 billion this year and $2 billion next year.
- Taken together, that implies an underlying cash deficit of just $2.1 billion this year (‘pretty much a rounding error’) and a surplus of $9.8 billion in 2019-20.
- Looking further ahead, Deloitte expects continued savings on spending will still allow underlying cash surpluses of $15 billion in 2020-21 and $20.6 billion in 2021-22. Deloitte identifies the two big risks to these projections as Canberra and China - a pre-election ‘cash splash’ and China growth-related risks to commodity prices.
With the budget position for the current financial year already running comfortably ahead of expectations from the Mid-Year Economic and Fiscal Outlook (MYEFO) as of February, that strong performance on the nominal side of the economy means that there’s more scope for upside.
If realised, the Deloitte figures would represent outcomes that were about $3.1 billion and $5.7 billion better than the respective MYEFO projections.
Fiscal space to play with
That would leave the government with quite a bit of fiscal space to play with – enough to deliver tax cuts, spending promises, and still maintain a decent-looking bottom line (albeit one that will be hostage to future trends in commodity prices and nominal income more generally). So, what might the upcoming budget deliver? Well, we already have some idea of what could be on offer:
- The government will be able to announce the imminent end of Australia’s “decade of deficits”.
- The MYEFO set aside $9.2 billion under the heading ‘decisions taken but not yet announced’, with a profile of $2.46 billion for 2019-20, $3.75 billion in 2021-22 and $3.02 billion in 2021-22. The widespread assumption is that this will be used to deliver additional tax cuts.
- One possibility is that the government could bring forward some elements of its planned personal income tax cuts. Last year, the Senate passed the government’s $144 billion, three-stage personal income tax cut measures and stage one, which focussed on low-and middle-income earners via a lift in the low-income tax offset (LITO), took effect at the start of this financial year. But stage two, which will increase income tax thresholds for middle- and higher-income earners, is currently only due to begin in 2022. And stage three, which will reduce the number of income tax brackets by eliminating the 37-cent tax bracket, is not scheduled to start until 2024.
- There have also been reports about potential one-off payments for pensioners and families, seeking to target those who wouldn’t benefit from the proposed additional rounds of income tax changes.
- Australia’s banks will be asked to contribute another $600 million to deliver an increase of $400 million over four years for the Australian Securities and Investments Commission (ASIC) and an increase of $150 million for the Australian Prudential Regulatory Authority (APRA) to help both regulators implement recommendations from the Hayne Commission. Another $35 million will underpin a commitment to expand the jurisdiction of the Federal Court to include corporate crime.
- The instant asset write-off for small businesses (with an annual turnover of less than $10 million) will have the threshold increased by $5,000 to $25,000 and be extended to June 2020.
- On energy and the environment, the Climate Solutions Fund will receive $2 billion of funding and there will be $1.4 billion for Snowy Hydro 2.0. There has also been speculation that the government will underwrite some power projects.
- Several health-related initiatives will receive funds, including $220 million for research into heart disease, $496 million for cancer research, services and facilities, and $200 million to reduce out of pocket costs for scans.
- The government will reduce the migration cap from 190,000 to 160,000 for the next four years and seek to encourage more skilled migrants to opt for regional Australia by increasing the number of regional skilled visas.
After slowing markedly through the second half of 2018, the economy’s soft patch looks to have continued into the start of this year. With markets speculating that the RBA will have to cut rates, growth, the budget offers an opportunity for fiscal policy to take some of the strain in delivering support to the economy.
Mid-Year Economic and Fiscal Outlook
Businesses, markets, and households (and of course voters) are now gearing up for the budget and, after that, what is widely expected to be a May election. A good run of budgetary outcomes over the past year suggests that the government has plenty of (short-term) fiscal room for manoeuvre, providing scope for a combined pre-election offer of tax cuts, new spending pledges and a respectable bottom line.
The MYEFO predicted that the budget surplus would approach one per cent of GDP by 2021-22 and would then stay in surplus over the medium term, with the scale of surpluses constrained by the government’s tax-to-GDP cap. At the same time, the structural budget balance was forecast to improve from a deficit of around 1.3 per cent of GDP in 2018-19 to a surplus from 2020-21 onwards.1
Bringing the fiscal story up to date, the latest (February 2019) figures from the Department of Finance show that actual outcomes for this current financial year have been tracking well even relative to the (already-upgraded) MYEFO projections. While total receipts for the financial year to end-February were $163 million lower than the MYEFO profile, total payments were almost $2.9 billion lower. As a result, the deficit on the underlying cash balance was $2.8 billion smaller than the MYEFO profile.
- Global economic growth of 3.75 per cent in 2019 and 2020;
- Real GDP growth in Australia of 2.75 per cent in 2018-19 followed by three per cent growth in 2019-20;
- The unemployment rate staying flat at five per cent across both years with employment growth running at 1.75 per cent and wage price inflation accelerating from 2.5 per cent this year to three per cent in 2019-20;
- Nominal GDP growth of 4.75 per cent and 3.5 per cent over the same period, boosted in the first year by;
- A rise of 1.25 per cent in the terms of trade in 2018-19 followed by a six per cent fall in 2019-20. That in turn assumed an iron ore spot price of US$55/tonne over the forecast period, a thermal coal price of US$93/tonne and a metallurgical coal price that was expected to have fallen to US$120/tonne by the September quarter of this year.
In the lead-up to the budget, Mark Thirlwell has provided a summary of how Australia’s fiscal footprint compares in an international perspective.
Current performance against several of these metrics on the nominal side of the economy – which is what drives government revenues by determining the size of the tax base – suggests continued scope for an even more positive outcome relative to the MYEFO:
- Nominal GDP growth has been running hotter than expected, at above five per cent;
- That reflects a stronger lift in the terms of trade. As of December 2018, they were up more than six per cent over the previous year. Prices for both iron ore (around US$86/tonne at the time of writing) and metallurgical coal (around US$200/tonne on the Singapore exchange) have been well above the MYEFO forecasts.
- Granted, the real side of the story has turned out to be a bit softer than the MYEFO forecasts, with global growth likely to be lower than forecast (back in January the IMF cut its forecasts for world GDP growth to 3.5 per cent for this calendar year and 3.6 per cent in 2020, and conditions have since softened) and Australian real GDP growth slipping to an annual rate of just 2.3 per cent in the final quarter of last year.
- The labour market has held up quite well, with the unemployment rate dipping to 4.9 per cent as of February this year. Wage growth has continued to disappoint, however, running at just 2.3 per cent in the December quarter.
- Still, taken overall, there is no doubt that the net effect of economic changes has been positive for the fiscal story.
1 Estimates of the structural balance are designed remove factors that have a temporary impact on revenues and expenditures, such as swings in commodity prices and deviations in economic output from potential, making it a useful measure of fiscal sustainability.
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