Time for Christmas Budget Cheer

Posted: Thursday 18 January, 2018

With the Government’s 2017-18 Mid-year Economic and Fiscal Outlook (MYEFO) due Monday, a review into the likely national bottom-line is timely. Certainly the domestic economy is likely to achieve respectable growth in 2018 and it appears that non-mining business investment is recovering nicely. All this is good news. Surely the Treasurer can finally back in a return to surplus in 2020-21?

No so fast.

Recall that if the 2017-18 Budget outlook was ‘adjusted’ ever so slightly to reflect the evident slowdown in household and small business incomes and historic payments growth, the projected cash surplus in 2020-21 was more like a deficit in the order of $20 to $30 billion. Much of the upswing in the domestic economy in 2017 has been driven in large part by publicly funded employment (disability support, education and health) and infrastructure investment that will certainly not reduce budget pressures.

Indeed, without a more deliberate budget strategy than relying on fiscal drag, it is unlikely that the Commonwealth will achieve a return to surplus over the next decade. Into this sea of red ink it seems the Government wants to announce personal income tax cuts in the 2018-19 Budget to address fiscal drag which is currently adding around $5 billion dollars to revenue each year. Without this Clayton’s fiscal consolidation the fiscal strategy is sunk. Nor is the permanent cost of the Government’s $15 billion annual company tax cuts factored into the Budget outlook.

Another problem for the Government is the reality that beyond the forward estimates, spending growth is likely to run away from revenue potential. The Budget parameters do not reflect the low productivity growth in the Australian economy.  Nor are program parameters accurately calibrated to reflect spending associated with the NDIS, population ageing, long term infrastructure needs, defense industry priorities, and political largesse. 

Put it all together and you have a recipe for persistent and rising public budget deficits over the 2020s and beyond. This is our best case scenario. It assumes the nation will also continue to clock up unbroken economic growth (26 years plus so far without a recession). It ignores other major structural weaknesses including having the second highest level of private indebtedness via households in the OECD. Nor does the Treasurer or Treasury make any allowance in its figuring for the external vulnerabilities of the Australian economy. There is still a massive ‘made in China’ boom built via the terms of trade forecast underpinning the Budget.

Certainly the news is not all bad. After years on Struggle Street, many advanced economies are experiencing what appears to be stronger and synchronous growth for the first since before the GFC – the so called Goldilocks economy. Hopefully stronger and accelerating global growth is a tailwind for the Australian economy, especially through Asian commodity flows. 

Domestic economic activity seems to be picking up in late 2017. But is this via productivity enhancing business investment or the substitution of low cost labor for greater investment in new hard assets? Probably a bit of both. Certainly workers have moderated their wage claims in the face of sectoral disruption and globalisation.

Overall, a sober assessment would suggest a bottom-line staying in deficit by around 1 to 2 per cent of GDP in structural terms.

Approaching Christmas 2017, Treasurer Scott Morrison’s objective in framing MYEFO must do everything reasonable to support household and business confidence, avoiding policy “own goals” and partisan politics, whilst forging a path back to surplus in the medium term.

The Government could start by announcing a package of revenue neutral and efficiency-enhancing tax reforms (such as those proposed in the Henry Tax Review) funded by targeted cuts in lower value social transfer and industry assistance spending programs. Government should gradually target a size of government closer to the thirty to fifty year average, not the high point of the GFC stimulus.

Second, it could establish a more consistent and strategic stream of infrastructure projects year to year via a pipeline of high value projects with large benefit-cost ratios. This would be coordinated by an independent Parliamentary Infrastructure Office, with funding drawn from public auctions to identify long term private equity partners.

Third, it could eliminate all tax concessions that encourage investment in existing property assets in favor of accelerated depreciation of new property assets, potentially tapping institutional sector debt and equity.

Fourth, it should mandate uniform IT systems across all Commonwealth and State social spending programs, allowing a client’s entire service history to be tracked. Bingo! Accountability at last.

The great hope is that MYEFO will help focus a more strategic, transactional approach to policy-making across the Federal Parliament, to allow significant good policy measures passage through both houses. The best approach to this is to spread the adjustment pain from a reformist budget as widely as possible and to impose the largest share of adjustment burden on those most likely to benefit from resultant strong growth.  

This article first ran in the Australian Financial Review in December 2017.