A boomerang Budget

After 15 consecutive years of deficits, an Australian federal Treasurer has been able to announce a budget surplus for the first time since 2007-08 and the onset of the global financial crisis. According to the Treasurer, yesterday he delivered ‘the biggest budget turnaround on record’. And, to give him his due, there is no doubt that the pace of the fiscal shift has been substantial.

The budget bottom line – a return to surplus, for now

Back in May 2022, then Treasurer Josh Frydenberg was predicting a pandemic-driven deficit on the underlying cash balance for 2022-23 of $78 billion or about 3.4 per cent of GDP. By last October, new Treasurer Jim Chalmers was anticipating a smaller shortfall, but the Budget papers were still projecting a $36.9 billion deficit or about 1.5 per cent of GDP. Yesterday, when bringing down Budget 2023-24, Chalmers could declare that the government now expects to deliver a modest underlying cash surplus for the current financial year of about $4.2 billion or around 0.2 per cent of GDP.

The turnaround is forecast to be short-lived, however. By 2023-24, the Budget is expected to have slipped back into a small deficit to the tune of $13.9 billion or about 0.5 per cent of GDP (although note that this is $30.1 billion lower than the corresponding deficit forecast back in October 2022). The shortfall is then projected to worsen until 2025-26, with the deficit expanding first to $35.1billion in 2024-25 and then to $36.6 billion the following year.

Even so, the outperformance in 2022-23 - along with some measures to boost government revenue – still means that this new deficit path is significantly lower than the one foreseen at the time of the October 2022 budget, with a cumulative improvement in the underlying cash balance of $125.9 billion over the next five years.

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Fiscal strategy – balancing competing economic and political pressures

In setting Budget 2023-24, the government faced a similar test to one that it had to manage back in October 2022. On the one hand, there were political promises to deliver around cost-of-living relief and social spending, on boosting economic resilience, and on providing for looming future challenges ranging from the energy transition to a daunting new national security environment. On the other, the government’s macroeconomic room for manoeuvre was constrained by above-target inflation and an RBA in inflation-fighting mode that meant that any excessive fiscal stimulus would serve mainly to call forth an offsetting monetary policy tightening by the central bank.

Arguably, both of those pressures have intensified. Last month’s release of the first report of the government’s own Economic Inclusion Advisory Committee and March 2023 advice from the Women’s economic equality taskforce had each called for more generous public spending; the cost of living squeeze has continued; and the RBA’s decision last week to deliver another 25bp rate hike, resuming its tightening cycle after just a one-month pause, served as a firm reminder that Martin Place ‘remains resolute in its determination to return inflation to target and will do what is necessary to achieve that.’

Balancing those competing pressures has seen the government use this week’s budget to pledge a cumulative $14.6 billion in cost-of-living support. Key offerings here energy rebates of up to $500 for about 5.5 million eligible households and energy rebates of up to $650 for eligible small businesses. There are also boosts to welfare payments, including $1.9 billion over five years to expand access to the Single Parenting Payment, a $40/fortnight lift to base JobSeeker, Austudy and Youth Allowance payments at an estimated cost of $4.9 billion over five years, and expanded eligibility for a higher JobSeeker base rate from those aged over 60 to those aged over 55 and who have received the payment for more than nine consecutive months.

In addition, there are measures designed to lower out of pocket health costs including $3.5 billion over five years to increase bulk billing incentives along with $2.2 billion over the same period for new medicines to be listed on the PBS. government payments. The childcare subsidy that was announced in the October 2022 Budget will also begin from 1 July this year. And Budget 2023-24 also included $11.3 billion to fund a 15 per cent increase in award wages for more than 250,000 aged care workers.

At the same time, however, the government also announced that it has achieved about $17.8 billion in savings and redirected spending in this budget, in addition to the $20 billion in savings it announced last October. As a result, the Treasurer has been able to claim that over the past two budgets, the government has ‘banked’ about 87 per cent of upward revisions to revenue, including 82 per cent in this budget.

Budget 2023-24 also brought the announcement of what the Treasurer described as ‘modest but meaningful’ revenue measures including changes to the Petroleum Resource Rent Tax, tightened superannuation concessions for those with balances exceeding $3 million, a 15 per cent global and domestic minimum tax for large MNCs (in line with OECD recommendations), and increases to the excise tax on tobacco over the next three years.

That combination has allowed the Government to deliver a pretty successful balancing act, announcing both a strengthened budget bottom line including the(temporary but politically potent) return to surplus that should do enough to assuage most fiscal-related concerns at the RBA while still delivering some politically - and socially - necessary targeted spending.

Drivers of budget performance – Revenue windfalls and constrained spending

The drivers of that improved fiscal bottom line include several factors that have lifted government revenues including higher-than-budgeted commodity prices, strong nominal income growth elsewhere in the economy including an increase in wages, and higher levels of employment.

At the same time, a still-low unemployment rate has contributed to lower government expenditures. According to the Budget Papers, changes in economic parameters and other variations overall have boosted the 2022-23 fiscal position relative to the October 2022 budget estimates by $42.1 billion while new policy announcements have offset that by just $1.1 billion. Looking ahead, next year those variations will strengthen the budget position by $42.2 billion versus $12 billion of now policy commitments.

And across the five years from 2022-23 to 2026-27 as whole, the impact of changes in economic parameters and other variations is now expected to boost the budget bottom line by almost a cumulative $146.5 billion (of which $130.6 billion reflects higher receipts), while total policy decisions are expected to worsen the deficit by a much more modest $20.6 billion over the same period.

The underpinning economic forecasts – faster population growth

Treasury’s economic forecasts are little changed for the real side of the economy relative to the October 2022 budget. It still expects real GDP growth of 3.25 per cent and 1.5 per cent over this financial year and next, unchanged from October, before forecasting real growth of 2.25 per cent in 2024-25. One notable change is that projections for population growth have been upgraded on the back of higher net overseas migration, with Australia’s population now forecast to grow by two per cent in 2022-23 and 1.7 per cent in 2023-24, up from 1.4 per cent for both years in the October budget. That in turn implies a modest downgrade to forecast growth in real GDP per capita.

The unemployment rate is now expected to stand at 3.75 per cent by the June quarter of this year before rising to 4.25 per cent by the June quarter of next year and is ‘only’ forecast to hit 4.5 per cent by the June quarter 2025.

The outlook for nominal GDP growth has been lifted, with expected growth put at 10.25 per cent in 2022-23 (up from eight per cent in the October forecast) before slowing to 1.25 per cent in 2023-24 and then recovering to 2.5 per cent the following year. The rate of consumer price inflation is predicted to ease to an annual rate of six per cent by the June quarter of this year and then to fall to 3.25 per cent by June quarter 2024 and slow again to a within-target 2.75 per cent by June quarter 2025, with the government’s energy price support package estimated to directly reduce headline inflation by 0.75 percentage points in 2023-24.

Wage growth is forecast to rise from 3.75 per cent in the June quarter of this year to four per cent in June 2023-24, its fastest pace since 2009, before easing to 3.25 per cent the following year. As a result, real wages are expected to start growing again by early 2024.

The medium-term fiscal outlook – Still challenges, but much improved

Assuming no unexpected slippage before this September, the Treasurer will be able to take some justifiable pride in putting Australia’s fiscal position back in the black – a task that has eluded predecessors from both sides of politics for a decade and a half. But as already noted, the budget’s best guess is that – welcome though it is – the return to surplus will prove to be temporary. Indeed, Australia is still expected to run a cumulative deficit of $109.9 billion over the five years to 2026-27.

That persistent structural underlying deficit reflects the fact that Australia must still manage several ongoing fiscal pressures including increased spending on aged care, health care and the NDIS, and a mounting national security burden (defence spending is estimated to rise above 2.3 per cent of GDP by 2032-33). For example, payment growth on aged care is forecast to average 6.1 per cent over the projections period while growth in the latter is now expected to average 10.4 per cent, down significantly from 14.1 per cent in the October budget, but still high. In addition, for now at least, the Stage 3 Tax cuts are still due to take effect from 1 July 2024.

Still, the improvements delivered to the budget bottom line in Budget 2023-24 are significant. As a result, the cumulative deficit expected over the five years of budget forward estimates to 2026-27 is some $125.9 billion lower than expected in October. That lower deficit trajectory for the underlying cash balance translates into an improved debt position. Net debt is now estimated to be 22.3 per cent of GDP by 30 June 2024. That’s more than three percentage points lower than the October budget projections. Likewise, gross debt is now forecast to peak at 36.5 per cent of GDP in 2025-26, five years earlier and more than 10 percentage points lower than the 46.9 per cent of GDP peak predicted in the October 2022 budget.

A lower debt stock also means lower debt service payments: over the four years to 2025-26, interest payments on Australian government securities are now expected to be $9.9 billion lower than estimated last October. Expected borrowing costs have also been trimmed in line with changes in market interest rate expectations with the weighted average cost of borrowing over the forward estimates now assumed to be around 3.4 per cent instead of the 3.8 per cent used in the October budget.

Finally, the medium-term fiscal outlook has also been upgraded, with the underlying cash deficit in 2032-33 now expected to be 0.5 per cent of GDP, or 1.5 percentage points smaller than the October 2022 forecasts. Some of this reflects the stronger starting position, including lower debt service payments, as well as the projected slower rate of growth in NDIS expenditure. But it is also driven by upgrades to assumptions on the size of the labour force and the participation rate.