With a growing disparity between receipts and payments, budgeting for the medium term could prove challenging, writes AICD chief economist Mark Thirlwell MAICD.
During the onset of COVID-19, the combination of dramatic fiscal interventions — not least, the $88 billion JobKeeper wages subsidy program — and the exhaustion of conventional monetary policy after the cash rate hit 0.1 per cent, prompted declarations of a passing of the macroeconomic torch from the monetary to the fiscal authorities. As with many pandemic-era judgments, this one proved short-lived. Instead, for much of this year, the Reserve Bank has dominated the Australian macroeconomic (“macro”) agenda, having embarked on the most aggressive policy-tightening cycle of the inflation-targeting period. Yet fiscal policy has not lost its salience. After all, 2022 has brought not one, but two federal government budgets, including the first from a new government since 2014. And the most recent offering — call it Budget 2022–23: The Sequel — contributed to short-term stabilisation while also canvassing some of the medium-term fiscal challenges facing Australia.
The short-term macro objective for this October’s Budget was set by the constraints imposed by an inflation-fighting RBA. Any substantial fiscal largesse would serve only to complicate monetary policy and trigger offsetting rate increases from Martin Place. So, do no (macro) harm. The medium-term macro challenge required confronting the structural gap between budget receipts and payments. In practice, this largely entailed revising key economic and budgetary assumptions to provide an updated fiscal assessment.
Underlying cash balance
With regard to the first objective, Treasurer Jim Chalmers delivered significant reductions in the deficits on the underlying cash balance (UCB) compared to the March 2022 Budget. Over the four years of the forward estimates (2022–23 to 2025–26), the cumulative shortfall was cut by $42.9b to $181.8b. That was driven by a $53.4b improvement in the UCB due to parameter and other variations, primarily reflecting higher tax receipts thanks to high commodity prices boosting corporate profits and to higher employment lifting personal incomes. This was only partially offset by $10.5b of policy decisions increasing the deficit, allowing the Treasurer to declare that more than 90 per cent of improvements in tax receipts (excluding GST) due to parameter variations went to deficit reduction.
Importantly, this improvement is concentrated in the first two years, and especially in the current financial year, which alone delivers $41.1b of relief to the UCB. Back in March, the then government had anticipated a deficit of $78b (3.4 per cent of GDP) in 2022–23 and a $56.5b (2.4 per cent) of GDP deficit in 2023–24. Instead, Chalmers announced a $36.9b (1.5 per cent of GDP) deficit this year and a $44b billion (1.8 per cent of GDP) deficit next year. Those revisions, especially for 2022–23, meant the Budget passed the test of not complicating life for the RBA.
However, consider the final two financial years of forward estimates and the UCB deficits actually worsen relative to the March Budget, by a combined $10.7b due to “payment pressures related to higher prices, higher debt servicing costs and pressures associated with delivering essential services outweighing improved receipts”.
This is symptomatic of the larger medium- term fiscal challenges highlighted by the October Budget. In March, the assumption was that the deficit on the UCB would fall from 1.6 per cent of GDP in the final year of forward estimates, to 0.7 per cent by 2032–33, the final year of medium-term projections. Instead, the deficit is now forecast to be little changed over this period, averaging about two per cent of GDP across the medium term.
The profile for government debt has likewise altered. Previously, net debt was forecast to peak in 2025–26 at 33.1 per cent of GDP before declining to 26.9 per cent by 2032–33. Now, the ratio begins about eight percentage points lower in 2022–23, but rather than peak, it continues to grow, climbing to almost 32 per cent of GDP by 2032–33.
Three key factors
These changes are mainly driven by revisions to three key factors: increased National Disability Insurance Scheme-related expenditures, higher interest payments, and lower real GDP growth:
- Average annual growth rates for payments for programs including the age pension, medical benefits, defence, aged care, hospitals and the NDIS are all expected to grow faster than nominal GDP. The gap for NDIS payments is especially large — an average growth rate of 13.8 per cent vs average nominal GDP growth of less than five per cent. By 2032–33, that alone increases the deficit by 0.7 percentage points (ppt) of GDP and gross debt by three ppt of GDP.
- Higher borrowing costs mean interest payments are forecast to grow even faster, at an annual rate of 14.4 per cent. October’s Budget assumes a weighted average cost of borrowing for debt issuance across the forward estimates of 3.8 per cent vs 2.2 per cent in the March Budget. By 2032–33, the 10-year bond rate is expected to be 4.3 per cent vs 3.6 per cent in March. That lifts the projected deficit in 2032–33 by 0.6 ppt and gross debt by 3.7 ppt of GDP.
- Finally, the new Budget assumes lower real GDP growth (implying a reduction in the size of the tax base) because the long-run assumption for productivity growth has been trimmed from its 30-year average of 1.5 per cent to its 20-year average of 1.2 per cent. This worsens the estimated deficit by 0.3 ppt and boosts gross debt by two ppt of GDP by 2032–33.
Overall, by 2032–33, total payments as a share of GDP are now forecast to have increased to 27.9 per cent of GDP, while total receipts are expected to stand at 26 per cent (and tax receipts at 24.1 per cent, above the previous government’s cap of a tax to GDP ratio of 23.9 per cent). Closing that gap will require either much more optimism about economic growth and the future level of borrowing costs than currently seems realistic, or some difficult choices around spending and taxation against a backdrop of increased calls on government services due to factors ranging from an ageing population to a deteriorating international security environment. After using this budget to set out the scale of the problem, the next one will have to start proposing solutions.
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