Here comes the budget pain

Last week’s article, Hooked on property, provided some detailed facts and figures from RP Data highlighting how Australia’s state and local governments are addicted to property-related taxes, and discussed how these revenues are expected to fall precipitously as housing sales decline and prices stagnate. The article concluded with the following statement:

Over the past decade, Australia’s state and local governments have rode on the back of skyrocketing property prices. The revenues received have funded all kinds of expenditure – from public servants’ salaries to health care, schools and infrastructure.

The story is similar at the federal level, where tax collections have surged on the back of growing property values and rising debt levels, which have boosted consumer spending, employment and the economy more generally.

Should Australia’s housing market encounter a significant correction, rather than the price stagnation and falling volumes experienced currently, then government finances will likely take a hammering as consumer spending dries-up, unemployment rises, tax collections haemorrhage, and welfare payments rise.

Wednesday’s Australian Financial Review (AFR) provided further insight into the revenue squeeze being experienced by both the state and federal governments from the fall in household consumption expenditure amid slowing credit growth (‘disleveraging’).

According to the AFR article, States peer into GST budget abyss, the state governments are facing a $6 billion hit to their GST revenues as the Federal Government adjusts its national economic forecasts in the face of weaker consumer spending:

Several states preparing their budgets have now warned that slower than expected economic activity will slash their GST receipts.

NSW Treasurer Mike Baird admitted yesterday that his state’s Treasury department had warned the new Coalition government that plummeting GST income could help produce several operating deficits worth $4 billion. West Australian Treasurer Christian Porter said his state was facing a $550 million black hole…

It emerged this week that the Victorian Treasury expects GST receipts to be $1.5 billion lower over the forward estimates as a result of lower GST income to the Commonwealth…

Asked whether he was concerned about the economic outlook, Mr Baird said: “I don’t think any treasurer is being genuine unless they said that they were worried”.

“It’s very clear that households are starting to hang on to their money, which is having a knock-on impact into the retail sector and affects the state budget”…

It is becoming clear that the state governments will be hit hard from the combined slowing of the housing market, credit growth, and household expenditure, which will significantly lower both GST revenues and stamp duty receipts.

But it’s not just the state governments that are feeling the pinch. The Federal Treasurer, Wayne Swan, is also forecasting slower revenue growth due to household disleveraging. From Wednesday’s AFR article, Swan talks down ‘rivers of gold’ resources boom:

The Government says tax revenues were revised up by a massive $334 billion over the budget estimates between 2004 and 2007, boosted by a sharply rising terms-of-trade, rapid asset price growth, and solid corporate profitability across the board…

[However] while personal credit rose by almost 60% in the four years preceding the GFC, it has fallen by more than 5% since the crisis.

“Growth in household consumption is expected to be almost a full percentage point lower over the budget forecast horizon than it was during Mark I [the 2004 to 2007 mining boom]”…

All these factors mean Australia will not experience the growth in nominal GDP “at anything like the rates we saw in the first boom”, Mr Swan will say. “And that means revenues won’t grow at the sorts of rates we saw during the previous boom”.

I have explained in detail the link between credit/house price growth, consumption expenditure and economic growth previously (most recently here), so I won’t bore you with another sermon.

Instead, I will let Business Spectator’s Rob Burgess explain the disleveraging forces at play:

…while in aggregate the economy seems to be rocketing along, out in the mortgage belt voters are having a hard time believing “they’ve never had it so good” (as John Howard put it during the first phase of this boom).

How do we know this?

Well firstly, they’re not shopping like they used to. Retailers are growing increasingly desperate to shift stock and are slashing prices – December quarter CPI figures showed clothing and footwear prices falling by 4.8 per cent.

Secondly, though the miners and unions are battling over wages blowouts… wages growth in other sectors is not following suit…

But perhaps the biggest reason… is found hidden in the RBA’s credit aggregates data, where the end of a house-price linked ‘wealth effect’ is becoming clearer by the day.

While there are conflicting stories in the media about what’s happening to median house prices, price-to-income ratios or auction clearance rates, the RBA’s aggregate data is harder to argue with. And it shows a dramatic and continuing decline in a long-standing component on Australian income – namely, the debt we took on via housing finance to spend on consumption over the past decade.

Readers may remember Steve Keen’s sage warning of a year ago, that the then-emerging trend towards borrowing less and saving more would have a dramatic effect on the apparent wealth of Australians (Why a fifth of our income is vanishing, May 25, 2010).

Well that vanishing is continuing apace as the chart below shows. The short version of Keen’s argument is that when the housing market is rising, it’s relatively easy to extract equity from one’s home and fritter it away as ‘income’. We still have the shiny cars and overseas holiday snaps to prove it.

But when house prices stall – and though they may not be falling, I don’t think anyone is predicting any substantial growth in the years ahead – both consumers and banks start to see such borrowing and spending as reckless.

And so while the housing credit extended to owner-occupiers and investors is still growing, currently at just under 5 per cent in real terms or 7 per cent nominal, it is in dangerously low territory. As the chart shows, it has broken below 5 per cent in real terms for only the third time since 1980.

In the mortgage belt [households] are increasingly aware that their houses are no longer appreciating as they used to, and in cities such as Perth and Brisbane they may well be depreciating. Equity withdrawal and the wealth effect that flowed from it are all but over.

For Australia’s governments, the golden era of credit-fuelled revenue growth that was 2000 to 2007 appears over, replaced by an age of frugality. And the headwinds facing government revenues will only intensify as the baby boomers retire and pare back their spending; or if commodity prices fall.

Cheers Leith

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Unconventional Economist
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  1. On 2nd May it will be exactly one year since the last time we activated a redraw on the house.
    We’ve deleveraged big time and changed our spending habits. It’s been a year of hard lessons.

  2. Thanks Leith. Another “shock” to precipitate the downward spiral in house prices and the general economy. Reductions in govt revenue resulting in reduced spending will impact families and the economy further.

    In my mind, this is underlines the fact that unemployment (often cited as the reason prices will stagnate) is defined to rise as a result of unsustainable levels of household debt. With retail, manufacturing and retail already hurting, the public service seems destined for cutbacks.

    Unless we all move to WA I struggle to see what will step in and save us.

    • Forget moving West. As a small businessman I can tell you, its been ugly here for months but few seem to be willing to acknowledge it.

      • The business I work at in Perth, in healthcare is growing, as the baby boomers are getting older and the population rises 🙂

        • Vince..Should you have a problem with population growth…or,And if you ever run-out of retiring Baby,
          Boomers ..that would like to live to 100..
          Just let me know…cheers JR

          • Hi Jason,

            Thanks for the reply. 🙂

            My place of employment just doesn’t rely on population growth or baby boomers to grow. We have a range of consumers that we service to allow us to grow well in to the future including children, teenagers, Generation X, Y etc. As people go through different stages of their life, we accommodate for all their needs to enhance their health and quality of life. 🙂

  3. Dunce a Jolly Bagman
    Ramped by a Rivers Rise
    Under the shade of a cool-aid Tree
    Planned,he sang as he watched or weighted, un-till his froggie’s Toiled
    You’ll come a ‘whats in the Tillda’ ,with me……
    Happy Easter..Cheers JR

  4. The_Mainlander

    Steve Keen was never wrong… this is the correction we were supposed ot have but was delayed by a last gasp vendors home boost.

    It is all over now bar the shouting and tear over red rover and “equity mate” err make that negative equity mate… elcome to 1980.

    Got cycle?

    • The only reason why Keen got it wrong was Homes owners grant and Rudds 900 stimilus. If the govt would have stayed out of it then Australia would have suffered the GFC. Now its time to pay the dues and go through the correction that should have happened 2 years ago with every other country.

      • Everybody thinks that the FOHG and the stimulus was to push up property prices and boost the economy. My guess is that it was a way for our government to indirectly bailout our banks. Westpac Chief said something along the lines that the banks now had the ability to handle a 20, 30 or even 40% drop in house prices. I wonder how many people used the $900 to pay off debts and that $7000+ on top of the FOHG would have gone straight into the banks kitty as a deposit to help them deleverage. Who cops it in the end? The little guy, inflation is not linear. It’s a % quarterly increase on the previous quarterly increase so it accelerates. CPI-Jun88_88.5, CPI-Dec10_174.0. A doubling every 23yrs. Not linear doubling, compounded doubling. Got a mate who swears by inflation and backs Bernancke. Keynesians, experts at Economics, hopeless at Mathematics (and reality).

  5. The Ancient Investor

    The negative feedback loop will be vicious and surprise all the conventional economists and politicians who rely on their hopeless forecasting. The key question is how will the various governments react? If we look to overseas examples, the various US municipalities and cities have mostly attempted to raise sales tax rates and increased property taxes (akin to our council rates but much higher). Even with property prices falling, total property tax revenues have actually held up well or even increased in some US areas due to those higher rates. In Australia State governments are going to have a devil of a job as even if they raise stamp duty rates it will not help much, the number of tranasactions will be down significantly and the median/average amount will be lower as well leading to sharply reduced stamp duties especially as falling property prices lead to “downwards” bracket creep. WA will be one of the worst affected areas as stamp duties provide nearly half of State government revenues. The property market here is already turning nasty so the 2011 budget will show a gaping hole and the 2012 budget a chasm.

    I would expect State government impetus for a new GST deal ie a higher GST rate, applied to everything (goodbye food exclusion) and a clamouring for more GST to be given to the States. Governments are hopeless at cutting spending so infrastructure projects will be binned/slowed and a raft of charges, duties and levies will be increased. I would have tipped utility charges to increase markedly but they are already on a tear around the country, too much heavy handedness here will lead to a lot of public moaning.

  6. …and what fraction of GDP is current total govt spending?

    Would be good to get an idea of how cuts in govt spending (at all levels) might affect nominal GDP…?

  7. One article on SMH about the ‘folly of first home grants’ and another by Saul Eslake about the inequity of negative gearing.

    Is it an aberration or have they turned on the property industry?

    Maybe negative gearing really will be reigned-in in the budget..

  8. An unfairness with ng is that it discourages investment (and initiative) from lower income earners. We have done quite well from our ips and always had mainly cash positive investments (a ng loss is still a loss). I suppose the old saying it takes money to make money will always hold true.

  9. ms gillard can give every 1 500K, problem solved. then after that 1 million, the 2 million…..

  10. Unfortunately the system is fundamentally busted. In real value, every dollar of debt put into the financial system in the 1960’s generated about twenty dollars worth of returns. Today every dollar of debt returns less than ten cents. We are at a mathematical peak. The economic canery in this ‘produce and consume’ system is retail sales.

  11. Great story except for 1 point. Local Councils do their accounting backwards. They work out their expenses and then adjust their Rate notices accordingly. If prices start to go down and by a miracle they adjust the values of the properties, they simply increase the % they work off. Bobs your uncle, lower house prices but Rates notices stay the same.

    Its going to take Jesus walking through a City Hall before those clowns actually cut any of their expenditure or money wasting programs back.

    (PS I’m a scorn man when it comes to local councils, my rates have gone from $1100 in 2007 to $2600 in 2010)

  12. The guys talking about feedback loops are exactly right.

    Bubbling prices = equity cashouts = higher consumer spending = greater tax revenue = irresponsible levels of government spending committed to.

    What is the reverse of this? The government AND households simultaneously needing to pay off debt, AND the government having to axe unsustainable spending programs and/or borrow big time; AND households going into negative equity as their house price goes back to reality; AND mortgagee sales boosting “market supply”; AND land speculators having to cut their losses and sell up…….

    Note that a distorted, inelastic land supply curve will lead to rapid price falls when demand collapses, as well as rapid price rises while demand holds up. As California confirms.