The 2016-17 midyear economic and fiscal outlook (Myefo) shows yet another deterioration of the budget balance due a slower than expected economic growth. But despite an extra $10bn in cumulative budget deficits over the next four years, there is little in today’s figures that should change anyone’s views over whether or not Australia should retain its AAA credit rating.
The history of budget updates since the global financial crisis has been one of reality not meeting up with hopes, and such was the case again with the 2016-17 Myefo.
While this year’s budget balance at $36.5bn is slightly improved from the May budget estimate of $37.1bn, over the four years out to 2019-20 the cumulative state of the budget is worse by a touch over $10bn.
The government still projects the budget to be back in surplus by 2020-21 – a year which, rather fortunately, is beyond the forward estimates. But a quick look at the projections of the budget balance since the 2014-15 budget suggests these things tend to slip a bit:
When the 2016-17 budget balance was first estimated back in the 2013-14 budget, the then Labor government anticipated a surplus of 0.4% of GDP. And while you might suggest that is just a perfect indicator of Labor’s inability to manage a budget, in the 2013-14 Myefo, in which Joe Hockey sought to paint as bleak a picture as he could about Labor, he projected a budget deficit for this year of 1.0% of GDP. Today Scott Morrison suggests it will be 2.1% of GDP – better than that estimated in the May budget, but the projections for 2017-18, 2018-19 and 2019-20 are all worse:
As a result government debt is expected to now peak in 2018-19 – a year later than estimated in May. It is now expected to peak at 19.0% of GDP, not 19.2% of GDP. Curiously, however, it is now expected to stay higher for longer:
And once again, as with projections of budget surpluses, you wouldn’t have a lot of confidence if you were to go by history:
The $10bn increase in the four-year cumulative budget deficit is mostly par for the course with Myefos. Over the past few years, the story is one of the budget thinking things are improving and the Myefo saying, “Yeah. Nah”:
The good news for the government is that this increase isn’t as bad as occurred in the past two updates.
As a result, it’s not surprising that the ratings agencies have for the most part suggested things haven’t changed much in their outlooks. Standard and Poor’s remains the most eager to cut our credit rating and their statement suggests this eagerness remains in place, stating that “the government’s worsening forecast fiscal position … further pressures the rating”. They “remain pessimistic about the government’s ability to close existing budget deficits and return a balanced budget by the year ending June 2021”.
Once again the big hit was due to parameter changes – changes to economic growth estimates such as nominal GDP growth, wages and consumption growth.
Since the pre-election economic and fiscal outlook (Pefo), parameter changes have reduced expected revenue of the four years of the budget by $30.5bn.
Individual income tax is now expected to be $18.3bn less over the next four years than was thought in May, and company tax, despite improvement in the export prices of iron ore and coal, is expected to be $5.9bn less over that period.
Equally, parameter changes also cause expected expenditure to fall by a total of $16.5bn over four years.
For example, slower than expected wages growth, which is tied to age pension payments, means $2.7bn less is expected to be spent on the age pension over the next four years.
Similarly, childcare has been taken up less than was expected and this will save the government a whopping $7.6bn over four years. Oddly, the Myefo papers do not actually explain why such a drop in childcare payments is expected – which is perplexing to say the least given the huge amount of money.
All up, parameter changes hit the budget bottom line over four years to the tune of $12.8bn, whereas policy decisions to raise taxes or cut spending only improve the balance by $2.5bn.
But of course the budget figures in future years will also be subject to these “parameter changes” – especially if today’s Myefo projections are too optimistic. On this score, the Treasury has been both sensible and also somewhat overly hopeful.
The big saviour of the budget for this year has been the increase in commodity prices. In May the budget was anticipating iron ore prices to be US$55 a tonne; the Myefo estimates them to be US$68 a tonne, as that is the average of the past four weeks. In previous budgets, that price would then be used to project out for the next four years. That’s a policy that works well when the price is going up, but not when it is falling; and it is very risky either way.
Very sensibly, the government has chosen assume the US$68 a tonne price will decline to US$55 a tonne from now to next June. Similarly they assume coal prices will fall from the current US$200 a tonne to US$120 a tonne by March 2018.
As such, the government now anticipates nominal GDP growth (which is strongly affected by commodity prices) to grow more strongly this year than they did in the budget, but that the next four years won’t be as strong:
That makes for budget figures that are much more believable than had they just taken the old practice and locked in the current high prices for the next four years and then hoped for the best.
But there still remain some high hopes in the figures.
The big hit to the budget this year has been on personal income tax revenue. As I noted on Sunday, lower than expected employment and wages growth coupled with low full-time employment growth has meant the amount of income tax we’re paying is less than the government thought we would.
In the budget the government was hoping to collect $196.9bn in income tax; now it estimates it will only raise $194.7bn – a 1.1% fall. And worse, next year the government expects to raise 2.5% less income tax than it did back in May.
But then somewhat oddly things improve.
As it did in the budget, the government expects wages growth to pick up strongly in 2018-19. Indeed it even expects it to improve this year from the current low of 1.9% in the 12 months to September to be 2.25% by June next year. By 2018-19, the government expects wages to be growing by 3.25% – a rate not seen for five years. But it expects this strong wages growth to occur despite employment growth remaining a tepid 1.5% for the next three years:
While the government expects wages and employment growth to be worse over the next two years than they did in the budget, from 2018-19 wages growth things are expected to be either the same or better than they were expected to be in May.
This optimism sees individual income tax growing by 6.5% and 7.2% in 2018-19 and 2019-20 – the first time two consecutive years would have seen growth that strong since 2011-12:
Thus while the projections are generally conservative, Scott Morrison will be hoping news of a wages breakout starts occurring. Because, as we have seen this year, if wages growth remains at rock bottom, then all increasing commodity prices can do is soften the blow.
With personal income tax accounting for 51% of all tax revenue, if that doesn’t reach expectations, there will be yet more announcements in the years ahead where the budget surplus is pushed out another year and the blame is put on “parameter variations” and all hope of a AAA credit rating will be gone.
