Deloitte: $38 billion new Budget black hole

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From Deloitte:

Let’s cut to the chase. You are about to read another very familiar story – one in which the Budget disappoints versus the latest official forecasts. Budget deficits in the four years to 2018-19 look set to be $38 billion larger than expected.

By far the bulk of that – 90% of it – is due to the accelerating China slowdown. That continues to pummel profits, and so to tear strips off the company tax take. Company taxes in 2015-16 will be a bare 5% above their pre-GFC peak. And China’s woes have put a banana skin under sharemarkets, meaning we don’t see superannuation taxes coming within cooee of their pre-GFC peak any time at all in the next few years.

Finally, China’s move from a boom to a tricky transition means much the same is happening to Australian wages. Wages outstripped productivity gains through the glory years of the boom, but have since dropped to record lows, thereby ensuring revenue writedowns in PAYG collections – the heart of the Australian Budget.

Canberra is adding some costs of its own. China may dominate these dollars, but the gridlock in Parliament House is also making the task of Budget repair harder rather than easier. The Senate just can’t seem to bring itself to pass spending cuts, meaning the big savings from 2014-15 that are still underpinning some of the figures in this year’s Budget simply won’t happen in time for the nation’s fiscal finances to keep to its projected savings timetable.

You may think we paint a grim picture of the remaining task of Budget repair. But you’d be wrong. Among the wildly optimistic assumptions underpinning our own figuring are that the Senate passes in full the savings still before it within a year from now, the States roll over on the cuts they face and sing kumbaya, and that the Beatles get back together. Oh, wait …

Australia’s income is under pressure – meaning that the tax take is too

The world is paying less for our exports and baby boomers are retiring. The resultant pressure on our living standards (in the chart below) translates into matching pressure on the tax take.

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Some of this problem has been evident for a while. China has built too much, and relied too much on debt to do so. So its reliance on construction has to drop – a tricky transition for it. The resultant squeeze on this nation’s income growth means we forecast the economy to be 1.5 percentage points smaller than Treasury has it by 2016-17, and that shortfall blows out to being 2.5 percentage points smaller than Treasury has it by 2018-19. In turn, that says the Australian economy will be about $26 billion smaller in 2016-17 than Budget estimates, with that gap rising to be some $48 billion smaller than Treasury’s forecasts by 2018-19.

Yes, you’ve heard this tune before: Revenue writedowns …

The Budget has two drivers: China and Canberra. China keeps making Canberra’s task harder by generating revenue writedowns. Our forecasts trim official expectations on wage and job growth, and so there are shortfalls on the expected tax take on individuals of $2.0 billion in 2015-16, rising to $2.5 billion in 2016-17.

But whereas recent Budget updates saw revenue writedowns moving away from profit taxes to taxes on individuals, this time better news on jobs limits the damage on individuals taxes, whereas renewed momentum in commodity price falls and a sharemarket haircut have put profit taxes to the sword once more. We estimate writedowns on profit taxes of $4.4 billion in 2015-16, rising to an eye-watering $7.0 billion in 2016-17.

You’ll be glad to hear there’s a partial offset on spending taxes, which we estimate as being ahead of Budget forecasts by $1.5 billion in 2015-16 and $1.2 billion in 2016-17, mainly because the lower $A means higher import prices and hence more customs duties.

And the lower $A also generates another silver lining by boosting the dividend the Reserve Bank pays the government – meaning non-tax revenues are expected to outperform their official equivalents by $0.2 billion in 2015-16 and by $0.3 billion in 2016-17.

The bottom line? Don’t underestimate how tough this is. The Budget boom of the past decade continues to become a Budget bust. The mix of China’s slowdown, another downward lurch in commodity prices and weak wage growth cut total revenues by $4.6 billion in 2015-16, with that damage almost doubling to $8.0 billion in 2016-17.

… and spending increases

And while China is cutting revenues, Canberra is still adding to spending. The good news is the economy is reducing expenses. Inflation and wage growth are less than the Budget expected, and so too is the length of the dole queue. So although there are some offsets – the lower $A adds to spending, and bigger Budget deficits add to interest costs – at least the economy is doing the Budget favours by cutting spending. These ‘parameter variations’ cut spending by $0.8 billion in 2015-16 and a further $0.6 billion in 2016-17.

Yet although the economy is good news, the Senate is sitting on expenditure savings worth $67 billion over the next decade. And that bottleneck comes at a rising cost to the Budget. We’ve assumed that all those measures do still pass, but with a one year delay. That adds $1.7 billion to spending in 2015-16 and a further $1.6 billion in 2016-17. The final factor is that GST shortfalls hurt revenues, but that money – $0.4 billion in 2015-16 and $0.6 billion in 2016-17 – is clawed back as savings on money otherwise going to the States.

The upshot is that Deloitte Access Economics projects an underlying cash deficit of $40.3 billion in 2015-16. That is a substantial $5.2 billion worse than projected at Budget time and shows a worsening on the recorded deficit of $37.9 billion in 2014-15.

At least the deficit finally moves more substantially below $40 billion in 2016-17 – assuming no further policy changes (did anyone mention an election is coming?), we project a cash underlying deficit in 2016-17 of $34.2 billion. That is an ugly $8.3 billion worse than the Budget. And it also says China keeps moving the goal posts back faster than the Government can steer savings through the Senate.

The matching fiscal deficits are $38.2 billion in 2015-16 and $31.8 billion in 2016-17.

Unless Treasury downgrades the iron ore price to $30FOB next year and $20FOB the year after, this will happen again and again.

Get ahead of it or wear it, PM Turnbull.

About the author
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal. He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.