Budget deficits “as far as the eye can see”

By Leith van Onselen

Deloitte Access Economics has released its Budget Monitor, which assesses the Federal Budget over the forward estimates, forecasting a $2.3 billion revenue shortfall in 2014-15, increasing to a $7 billion shortfall versus official estimates in 2015-16, due mostly to the July 2015 income tax cut to compensate for a carbon tax that no longer exists.

Overall, the report is a sobering reminder of what happens when governments rely on windfall gains from a temporary mining boom and use those revenues to fund permanent promises:

…the first decade of the rise of emerging Asia was marvellous for Australia’s miners, and wonderful for Western Australia … but the biggest beneficiary of all was the Budget. China’s surge led to a matching surge in commodity prices and an even bigger boom in tax revenues. That peaked ahead of the GFC. These are Canberra numbers, so they’re four year figures, but even allowing for that the pre-GFC Budget boost was $80 billion in 2007-08.

The GFC then saw that windfall halve before China’s stimulus once more sent coal and iron ore prices stratospheric. The recovery that period produced in the Budget outlook encouraged then Treasurer Wayne Swan to announce that there’d be a surplus in 2012-13.

That promise didn’t end well, because a tsunami of revenue writedowns out of Treasury soon came as commodities finally cooled…

No previous boom in economic history has been permanent.

Yet for all too long – even well after the GFC – official forecasts of the Budget assumed that, at best, there would be a slow hissing sound as the commodity boom only partly deflated.

Deloitte Access Economics also goes on to explain why news since late-2011 (when the terms-of-trade peaked) has been almost universally bad:

The iron ore price (as good a budgetary indicator as any) is certainly whimpering… Those falls are taking the grandiose hopes and plans of Australia’s politicians along with them…

In brief, falling commodity prices and weak wages are doing to the Budget pretty much what Sherman did to Atlanta. At least the more recent fall in the $A is an offset. But ‘offset’ is all – the renewed damage from the economy is still severe.

Deloitte Access Economics projects revenues to fall short of the Budget forecast by $2.3 billion in 2014-15, and for that to turn into a rout in 2015-16 – down $7 billion versus official estimates (with all but a few hundred million due to the economy, and the rest due to a July 2015 income tax cut to compensate for a carbon tax that no longer exists)…

The bad news of recent years was mostly felt in profit taxes, and that remains a source of red ink. We estimate that each of company taxes, superannuation taxes and resource rent taxes will disappoint relative to the Budget forecasts, dragging down the tax take by $1.9 billion in 2014-15. With the latest round of commodity price falls hitting taxes with a lag, that shortfall in profit taxes then worsens to reach $5.4 billion in 2015-16.

However, the source of the budgetary pain is now spreading. Whereas once the red ink was mostly confined to the profit taxes, the combination of wobbly job growth and (even more importantly) an extended period of weak wage gains now looks like being just as big a Budget buster – with total income taxes on individuals falling short of Budget estimates by $2.9 billion in 2014-15. That shortfall reaches an unhappy $4.2 billion in 2015-16.

The report then maps out the impacts of politicians’ (both Labor and Liberal) policy promises, which were made without due regard to the mining boom being temporary, and are now exacerbating the pain from the ongoing revenue downgrades:

…the economy spent a decade throwing kisses at the Budget, but that boom turned out to be temporary.

What weren’t temporary were politicians’ promises – they turned out to be permanent.

May’s Budget was Australia’s toughest since 1997, yet its upfront policy savings were small, amounting to less than $2 billion in 2014-15, and less than $6 billion in 2015-16…

However, since the Budget, Australian policy has barely budged. Many measures didn’t make it through the Senate. Others clearly won’t.

And at the same time the Government has announced new money to (1) support its key priorities, as well as to (2) respond to ongoing national security developments, and to (3) do deals with the Senate so as to pass a slowly rising proportion of its policy program…

All up, these and other new policy costs announced since Budget night add to spending by $2.5 billion in 2014-15, and by $2.9 billion in 2015-16. These generate the circled element of the chart above. The circle shows the cost of compromising with Clive (plus new Iraq commitments) mean that politicians’ promises are still adding to the budgetary mountain…

Deloitte Access Economics then sums up the Budget situation as follows:

,,,red ink will once again be the new black when it comes time to update the bottom line in MYEFO. As usual, that is mostly due to revenue woes, with the heavy hitters of income tax and company tax both showing a new round of major writedowns. Yet this time the bad news will also be coming on the spending side too, as national security fears combine with deals done in the Senate to undo a bunch of the heavy lifting in terms of the cuts to projected spending presented in the May Budget.

That is an unwelcome combination of factors for a Government hoping for Budget repair.

Accordingly, we project a “no policy change” cash underlying deficit of $34.7 billion in 2014-15. That is $5.0 billion worse than projected at Budget time.

We then see a cash underlying deficit of $27.2 billion in 2015-16. The lagged impact of falling commodity prices plus the rising cost of compromising with Clive means that year is an eye-watering $10.1 billion worse than the official figure in the May Budget…

It is important to note that Deloitte Access Economics‘ forecasts do not include saving measures that are likely to be or are already stuck in the Senate (since they are attempting to mirror how MYEFO will treat them), some of which have very little chance of seeing the light of day. This means that actual Budget outcomes are likely to be much worse.

Finally, the report has some stern words for both the Senate and the electorate, which seem to be in a state of Budget delusion about the challenges facing the nation:

It looks to us like a nation that can’t handle the truth. The truth is that a temporary boom has come and gone, and that a sustainable path for our national social compact requires some tough decisions. When even the Greens oppose sensible fuel tax policy – the restoration of indexation to fuel excise – it is clear something is wrong with Australia’s political processes. If our nation can’t make the easy choices, how are we going to make the hard ones?.

…were China to tremble more than we have allowed, sending commodity prices into even more of a tailspin, then the fiscal follies of the last decade would show up in an even worse light than already seen. As Warren Buffett put it, “you don’t know who’s been swimming naked until the tide goes out”.

The tide continues to recede, but the Senate still refuses to start getting dressed…

Just as it did ahead of the May Budget, Australia faces deficits as far as the eye can see – the economic backdrop is once more ringbarking revenue, and Government attempts to wind back future deficits have been largely rebuffed in the Senate…

We didn’t love everything in May’s Budget. Making the under-30s wait six months to get unemployment benefits never made sense: it didn’t save big bucks, and it ignores the fact that unemployment runs in families in ordinary times, a trend which intensifies in recessions.

Yet May’s Budget is the only roadmap to structural fiscal repair Australia has – the Opposition and minor parties washed their hands of setting out detailed alternatives, preferring populist posturing.

Overall, it’s a very good report by Deloitte Access Economics, which highlights the immense fiscal challenges facing the nation, as well as the dire need to reform both the revenue and expenditure sides of the Budget in order to place it on a more sustainable footing and improve productivity and growth.

My preference for Budget repair is to see some of Australia’s poorly targeted, inefficient and inequitable tax expenditures plugged (including superannuation concessions for the well-off, negative gearing and the capital gains tax discount), tighter means testing for the aged pension (one of the fastest growing areas of expenditure, along with superannuation concessions), as well as fundamental tax reform that shifts the tax base away from productive effort (e.g. labour income) towards more efficient sources, such as land, resources and consumption.

To once again quote Treasury head, Martin Parkinson: “genuine tax reform… requires more than an across the board cut in tax rates – it is about improving the structure of the tax system to reduce the cost that raising revenue imposes on the economy. In other words, it is as much about how much revenue is raised, as how it is raised“.

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