Deloitte Access Economics has issued a new warning that restoring the Federal Budget to surplus would be a “a herculean task” in light of the raft of new spending commitments in the areas of disability care, schools and parental leave, and well as increasing costs associated with medical and aged care. From the Australian:
“Federal finances risk being caught in a pincer movement, with revenues facing an extended period of underperformance as the boom-time impact of coal and iron ore prices on revenues slowly loses more hot air, and as a clutch of social policy spending increases rapidly,” the economic forecaster warns…
The Deloitte report predicts that with the budget “in trouble” the government will increase enforcement through the Australian Tax Office. It warns business its hopes for a lower tax rate “may be a bridge too far”.
While I hope to be proven wrong, I doubt that Australia will see a Budget surplus for the next 10, maybe even 20 years.
The fact remains that the revenue base is shrinking, as the large baby boomer cohort shifts into retirement. As such, the proportion of workers to non-workers is destined to shrink:
Causing the employment-to-population ratio and participation rate to trend lower:
Indeed, the ageing of Australia’s population and the growing army of retirees means more than just a shrinking tax base from having a smaller pool of workers with whom to collect taxes from. The higher proportion of retirees and older aged Australians will increase the amount of health and aged-care expenditure, significantly increasing overall Budget outlays.
Added to these demographic headwinds is the expected unwinding of Australia’s terms-of-trade, brought about by declining commodity prices.
Australia experienced the biggest commodity price boom in its history between 2003 and 2011, which saw the terms-of-trade hit all-time highs in mid-2011 (see next chart).
The Federal Budget was a direct beneficiary from the surge in commodity prices via rising personal and company taxes (think Rio and BHP), as well as via lower welfare expenditure brought about by the stronger economy.
Indeed, nominal GDP is the dollar value of what’s produced and earned across the economy and is also the measure that drives taxation revenue. Due primarily to the inexorable rise in commodity prices and the terms-of-trade between 2003 and 2011 (with the exception of a brief collapse during the GFC), the Government enjoyed strong nominal GDP growth and booming tax receipts from rising personal and company taxes, not to mention increased capital gains taxes as asset markets boomed. However, since then, the terms-of-trade has begun to trend down, meaning that nominal GDP growth has been weak, as have tax receipts (see next chart).
The problem for the Federal Government going forward is that the terms-of-trade is likely to continue to trend down towards its longer-term average, which will drag heavily on income growth and nominal GDP. As a result, personal and company tax collections will be soft relative to past experience, whereas Budget outlays could increase to the extent that weaker employment leads to higher welfare payments.
Another related headwind is the decline of mining-related capital expenditures (see next chart), which will detract from Australia’s GDP growth and employment, again placing pressure on government budgets via lower personal and company tax receipts and GST, as well higher welfare payments.
In short, without radical reforms to the way taxes are collected and fiscal expenditures, the above headwinds will likely ensure that the Federal Budget remains in deficit for many years to come.
