The Experts

Federal Budget: the long road to surplus

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by Craig James

Mid Year Economic and Fiscal Outlook (MYEFO)

Bigger deficit: The Federal Government is projecting a $47 billion deficit (3.0 per cent of GDP) for the current financial year. The independent Pre-Election Economic & Fiscal Outlook (PEFO) report issued in August tipped a deficit this year of $30.1 billion. A budget surplus is not expected before 2017.

Economic assumptions: There has been a slight softening of economic assumptions for 2013/14. But very conservative forecasts have been assumed for the following three financial years.

Lift in deficit: Policy decisions have had the effect of lifting the projected budget deficit by $10.3 billion out of the estimated $16.8 billion deterioration.

Spending cuts in May 2014 budget: The Government won’t release detailed spending cuts until the May 2014 Federal Budget.

What does it all mean?

The Mid-Year Budget update, like the Federal Budget itself, is an economic and a political document. There are fundamental economic assumptions. And while you can take an optimistic or pessimistic view, the assumptions are unlikely to be significantly different from the consensus. But from a political standpoint Budgets can vary markedly depending on the policy priorities adopted by the Government of the day. Still, at the end of the day, the community expects that Governments live within their means, so there must be a strategy to keep deficits and debts at sustainable levels.
 
The Government does indeed plan to implement its agenda and that lifts the budget deficit by over $10 billion this financial year. The assumption is that the deficit will be pared back over time, but no surplus is sighted through to 2017.

Of course the economic assumptions are very conservative. If growth returns to “normal” quicker than expected, the Government will be able to claim a more dramatic improvement in the budget bottom line – that is, providing it shows discipline on future spending.

Of concern is the impact of the budget update on consumer and business sentiment. The projected Budget deficit has lifted markedly but spending and saving measures aren’t to be fleshed out until next May, so this leads to a long period of community angst. This certainly isn’t in the interests of returning economic growth to more “normal” levels of around 3 per cent.
 
Interestingly, without significant budget cuts and with very conservative economic assumption, the budget deficit is expected to narrow from 3 per cent of GDP to 1 per cent of GDP in the space of three years. The Government doesn’t need to slash and burn. Rather it needs to foster strong, sustainable economic growth and apply targeted spending cuts that seek to improve productivity and efficiency.

What do the figures show?

The Federal Budget is projected to be in deficit by $47.0 billion in 2013/14 (3 per cent of GDP) with deficits falling over the following three years to $17.7 billion (1 per cent of GDP) in 2016/17.

The Government expects the economy to grow by around 2.5 per cent this year, the same rate as that assumed in August with the release of the PEFO statement. But estimated growth in 2014/15 has been revised down from 3.0 per cent to 2.5 per cent.

In nominal terms the Government is projecting receipts to lift by $13.9 billion or 4.0 per cent this year with payments to rise by $41.8 billion or 11.4 per cent. In real terms, payments are tipped to rise by 8.6 per cent in 2013/14 after falling by 3.2 per cent in 2012/13.

Policy decisions since the PEFO report have had the effect of boosting the projected 2013/14 deficit by $10 billion while “parameter variations” (basically economic assumptions) have had the effect of worsening the bottom line by $6.8 billion.

Net government debt is expected to grow from $153 billion (10 per cent) of GDP in 2012/13 to $191.5 billion (12.1 per cent of GDP) in 2013/14. Debt is expected to continuing rising in the following three years to $280.5 billion (15.7 per cent of GDP) in 2016/17.

The Government says it “is committed to returning the budget to sustainable surpluses that build to at least 1 per cent of GDP by 2023-24.”

Reasons for Budget deterioration

According to the MYEFO:

“The deterioration in the budget position since the 2013 PEFO reflects the following key facts:

Slower growth in real GDP, together with softer domestic prices and wages, have resulted in significantly lower nominal GDP, which has largely driven the reduction in tax receipts by more than $37 billion over the forward estimates.

The softer economic outlook, coupled with changes in demand-driven programmes and the revised assumption for projecting the unemployment rate, has increased total payments by $11.3 billion over the forward estimates.

Actions by the Government to address the legacy issues inherited from the former Government have impacted on the budget position over the forward estimates, with the largest of these elements being the $8.8 billion grant to the Reserve Bank of Australia.

The financial implications of the Government’s election commitments are fully incorporated in this MYEFO, with the exception of the commitment to reduce the headcount of the Australian Public Service (APS) by 12,000. This commitment will be reviewed in light of the findings of the National Commission of Audit. The Government remains committed to streamlining the public sector in the context of the expected headcount reduction implicit in the former Government’s efficiency dividends and associated measures.”


Policy decisions

“Major policy decisions since the 2013 PEFO that have increased cash payments in 2013-14 and over the four years to 2016-17 include:

A grant payment of $8.8 billion to the Reserve Bank of Australia (RBA) to increase the RBA’s capital reserve and strengthen the RBA’s financial position;

A range of measures associated with the repeal of the carbon tax, including an expected increase in payments for the buy-back of free permits in 2013-14 as well as abolishing the equivalent carbon tax applied to liquid and gaseous fuels through reductions in entitlements to fuel tax credits. These measures are expected to increase cash payments by $2.1 billion in 2013-14 ($2.8 billion over four years);

A number of land transport infrastructure projects, including the Bruce, Princes and Pacific Highway projects and the NSW F3 to M2 extension as part of the Auslink Programme for national land transport. These measures are expected to increase cash payments by $1.1 billion in 2013-14 ($5.6 billion over four years);

The implementation of the Government’s border protection policies, which is expected to increase cash payments by $904 million in 2013-14 ($2.1 billion over four years). When combined with the related $858 million reduction in the costs of the onshore detention network, this results in a $1.2 billion cost directly attributable to insufficient funding provided previously for offshore processing facilities in Papua New Guinea and Nauru; and

Additional funding for the Students First package of measures, including implementing a fairer funding agreement for schools with the Queensland, Western Australian and Northern Territory governments ($1.2 billion over four years) and committing a further $94 million to other Students First initiatives, including $70 million for the establishment of the Independent Public Schools Fund.”

Expenditure reductions

“The impact of these policy decisions has been partially offset in 2013-14, and largely offset over the four years to 2016-17, by a number of decisions that have reduced cash payments, including:

A range of measures associated with the repeal of the minerals resource rent tax, including abolishing the Schoolkids Bonus from 1 January 2014, discontinuing the Regional Infrastructure Fund and the Regional Development Australia Fund, and abolishing the Mining Tax Supplementary Allowance. These measures are expected to reduce cash payments by $1.0 billion in 2013-14 ($8.4 billion over four years);

Redirecting funding over six years under the Building Stronger Communities Fund ($528 million) and Trade Training Centres ($987 million) and other smaller portfolio savings, to broadly offset the cost of Students First — A fairer funding agreement for schools. The savings decisions for the Building Stronger Communities Fund and Trade Training Centres are expected to decrease cash payments by $104 million in 2013-14 ($841 million over four years); and

The amalgamation and rephasing of expenditure under the Restoring the Balance in the Murray-Darling Basin programme and the Sustainable Rural Water Use and Infrastructure Program over a six year period. These measures are expected to reduce cash payments by $54.2 million in 2013-14 ($650 million over four years).”

Revenue decisions

“Policy decisions since the 2013 PEFO have increased total receipts by $1.7 billion in 2013-14 and reduced total receipts by $7.6 billion over the forward estimates period.

The carbon tax and related measures will be repealed from 1 July 2014. This will reduce receipts by $6.3 billion over the forward estimates period. This includes abolishing the carbon tax as well as the equivalent carbon price applied to synthetic greenhouse gases, aviation fuels and liquid and gaseous fuels.

The minerals resource rent tax and most related measures will also be repealed by 1 July 2014. The repeal of the minerals resource rent tax reduces receipts by $3.4 billion over the forward estimates period relative to the 2013 PEFO. This is a net estimate, after allowing for the interaction between the minerals resource rent tax and other taxes, such as company tax. However, the removal and rephasing of related tax concessions that the minerals resource rent tax was intended to fund will increase receipts by $5.7 billion over the forward estimates resulting in a net increase to receipts over the forward estimates of $2.3 billion.

The Government is dealing with 92 announced but unlegislated tax and superannuation measures. The Government will proceed with 34 measures, not proceed with 55 measures and three measures will proceed with amendment. Measures that will not proceed include changes to the treatment of car fringe benefits, the removal of the provision allowing the imposition of a tax on certain superannuation earnings supporting retirement income streams and the introduction of a cap on work-related self-education expenses. Decisions not to proceed with many measures reflect the Government’s assessment that these measures are either unworkable or would be economically damaging. Collectively, these decisions will reduce receipts by $3.6 billion relative to the 2013 PEFO.”

What is the importance of the economic data?

The Mid Year Economic and Fiscal Outlook report is presented by the Government around October-December each year. The report is an update on how the Federal Budget is tracking and is therefore an update on the fiscal policy stance of the Government.

What are the implications for interest rates and investors?

Uncertainty over budget cuts will keep a lid on confidence levels and economic growth. If economic momentum eases then the Reserve Bank may be forced to cut rates again.

Published: Thursday, December 19, 2013

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