Why “bad news” Budgets are here to stay

ScreenHunter_2316 May. 08 08.13

By Leith van Onselen

Chris Richardson from Deloitte-Access Economics has penned an interesting article in The AFR explaining why the Budget has turned from a perennial ‘good news story’ during the 2000s to a ‘bad news story’ now, despite the economy seemingly being in reasonable health.

Essentially, Richardson argues that the federal government took the revenue windfall from a temporary commodity price boom and blew it on a raft of permanent promises aimed at families, pensioners and wage earners, in turn creating a large structural Budget deficit:

The resources boom of the past decade was good for the economy, but stunningly good for the budget. That’s because the boom:

  • Pushed up commodity prices…  in turn sending profits soaring. And profits are the most heavily taxed bit of our incomes.
  • Pushed up sharemarkets and underpinned earlier gains in housing prices, with those capital gains also turbocharging the tax take.
  • Encouraged families to spend, thanks to higher wealth resulting from healthy share and housing prices, boosting spending taxes…

Yet coal and iron ore prices peaked back in 2011, and capital gains remain elusive…

The bonanza delivered by the economy to the budget has gone… it turned out to be temporary.

…the nation’s politicians – both sides – took the temporary boom of the past decade and spent it all on an orgy of permanent promises such as family benefits and income tax cuts.

I have long argued the same essential points and firmly believe that without fundamental reform to both taxation and expenditure policy, the Australian Budget will remain in deficit for decades to come.

The fact is, the surpluses achieved during the Howard Government were due mostly to extreme good luck, rather than sound fiscal management. Budget revenues ballooned under the Howard Government, who presided over the most lucrative part of the resources boom when commodity prices and the terms-of-trade exploded (see next chart), not to mention rapidly rising household debt.

ScreenHunter_03 Jul. 08 10.32

The next chart tells the story. Nominal GDP is the dollar value of what’s produced and earned across the economy and is also the measure that drives federal taxation revenue. Due in part to the inexorable rise in the terms-of-trade, the Howard Government experienced ever growing nominal GDP growth as commodity prices surged, whereby it reaped the benefits of growing personal and company taxes, not to mention increased capital gains taxes as asset markets boomed.

ScreenHunter_04 Jul. 08 10.38

However, as pointed out by Richardson, much of this temporary revenue windfall was wasted. First by the Howard Government, via ballooning entitlement spending aimed at middle class families, the aged, and wealthy retirees, not to mention generous tax breaks granted for superannuation. Then augmented by the Rudd and Gillard Governments.

Now Australia faces a prolonged period where the terms-of-trade will likely trend down towards its historical norm (see next chart), crimping the nation’s disposable income and reducing the personal and company tax tax.

ScreenHunter_2317 May. 08 08.52

Added to this, demographic headwinds are building as the large baby boomer cohort retires, leaving a shrinking pool of workers to collect taxes from and rising bills for health and age-related welfare (see next chart).

ScreenHunter_2318 May. 08 08.57

Gone are the good old days of happy Budgets and widespread giveaways, soon to be replaced by an annual program of cutbacks and tax increases.

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Comments

  1. ResearchtimeMEMBER

    Given that WA was a net recipient of Federal tax distributions until 2006 – demonstrates how long it took before tax receipts from the mining boom started flowing in a big way. Dislike how people blame the Howard years, when in fact they were masterfully economic managers.

    Its all a lefty conspiracy – history revisionism. Above is factually incorrect. Data without context.

    Just realised – cannot write for shit…

    • ROFL. Stick to analysing iron ore dude. Anyone with half a brain that is not also politically partisan can see that Howard pissed away the proceeds of the boom, leaving a large structural deficit.

      • ResearchtimeMEMBER

        Given I know a little about the boom and was there from the very beginning – means that the two are inextricably linked. Your argument flawed. As is the above analysis.

      • ResearchtimeMEMBER

        That is not evidence… and I am not going down that “structural” road, its nonsensical argument, built out of ivory towers, with ideologues on either side throwing barbs. Much like the light-weight composition you call analysis above. Life is too short. Other to say if you thought that Howard didn’t do anything in his first two terms – then clearly you weren’t here.’t Heck he even fought an election on bring in a new consumption tax – decimating his own party in the process – getting less than 50% of the primary vote – just because he believed Australia needed one. he built a railway to the north of Australia, not because of economics, but for defines reasons. He supported the car industry on exactly those grounds too – that a country has to be able to make things in advent of conflict.

        He was also a pragmatist, who realised that if you pay down debt, cut taxes, and there is still a bit left over – why not spend it on a bit of right-wing social engineering. Heck the Labour Party does it all the time – and its colloquially terms progressive!!! Some of it I actually agree with. Thats the whole idea of government.

        Yes, I really appreciated those one off payments when I had my children arrive. They helped out a lot tremendously with cots, children’s clothes and even a dresser if I remember correctly. I personally like the idea of giving non-working spouses tax fee threshold to the other working spouse. Heck – I even like the idea of chaplains in schools. And yes – I don’t mind paying my taxes.

        Structural reform includes demographics. They are the biggest predictor of a countries future economic prospects. Go to Europe and have a look at what they are facing. Its (a) Demographic Nightmare, (b) Debt & (c) in the future Health Expenditure. Heaps of market commentators suggest that health care will be the next major investment theme as the baby-boomers begin to retire. I completely disagree. Inside the next decade or two, a demographic earthquake is about to shake the very foundations of modern European society, and in turn, may precipitate a crisis far greater than current agitation over increasing sovereign debt. Precipitous falls in fertility over the past three decades (resulting in a declining tax base) chasing an illusionary social contract will eventually consign the most treasured universal cradle-to-grave health care to history. Not because the populace do not want to provide it, but because they simply cannot afford it. And that is before we get to state pensions, the greatest Ponzi scheme of them all. Which thankfully the labour Government rectified here.

        Which brings me to my last point – Australia has had thirty years of pretty good government on both sides – with mistakes (no one mention the late 1980’s), to be sure.

        I suspect we are about to enter one of the greatest economic events Australia has ever seen. When China falls – Abbott’s response will define him. Will be strong – or will he take the easy Keynesian route? That term “Structural Reform” will mean nothing when Government receipts tank, hundreds of thousands lose their jobs, and those remaining will have to cope with numerous tax increases just to pay for basic necessities. Then maybe, that inevitable structural reform of not supporting the car industry, in hind-sight, may seem just a little rash…

      • “Other to say if you thought that Howard didn’t do anything in his first two terms – then clearly you weren’t here.’t Heck he even fought an election on bring in a new consumption tax – decimating his own party in the process – getting less than 50% of the primary vote – just because he believed Australia needed one. he built a railway to the north of Australia, not because of economics, but for defines reasons. He supported the car industry on exactly those grounds too – that a country has to be able to make things in advent of conflict.”

        Read my comment again, where I explicitly said “where was Howard’s structural reform after its first two terms?”. Yes, his first two terms were decent, but the rest was a giant waste. As for the railway from Adelaide to Darwin, it is my firm view that it was a misallocation of funds and will remain underutilised. Australia would have been far better off with an inland railway from Melbourne to Brisbane.

        “He was also a pragmatist, who realised that if you pay down debt, cut taxes, and there is still a bit left over – why not spend it on a bit of right-wing social engineering.”

        Except that the revenue boom was temporary, whereas much of the expenditure is permanent, which is my point.

      • ResearchtimeMEMBER

        If the north of Australia gets invaded. You need a railway. Its as simple as that. he pushed the numbers so it publicly appeared to be economic -to get it built. Thats pragmatism.

        Like him or loath him – you never got out of bed in the morning and not know what Howard stood for.

      • Researchtime – I’m with you on Howard. Saw a speech he gave in Sydney last night on APac – in fine form: erudite, entertaining and generous in response to questions (displayed a breadth of knowledge that impressed).

        He did say he wore as a badge of honour the ‘I can’t stand Howard, but at least I knew what he stood for’ refrain. There has been no PM since come anywhere near Howard – history should treat him very well and yes, repel revisionism whenever it rears.

      • The quarry monstering conservatives miss Howard like an overfed baby misses its mother’s tit. But Howard was a parochial, mealy-mouthed, grubby little worm whose legacy is a nation far more insular, mean-spirited and self-entitled than the one he inherited from the true reformers that came before him. History will slowly grind him into oblivion.

      • ResearchtimeMEMBER

        Opinion8red, be very careful. That is a gross simplification – if not a misrepresentation of the facts. You are not equating cost of debt to the debtor. If interest rates were at 17%, the capacity to carry debt is going to be substantially less if the price of that debt falls to 7%. All that graph demonstrates is a reversion to a mean.

        If a picture tells a 1000 words – maybe you need two pictures?

      • ResearchtimeMEMBER

        Not sure if you know what you are looking at Opinion8red – that graph does not demonstrate what you are claiming – interest paid as disposable income???? In fact it implies that financial wealth was the largest loser after 2007 – which must be super funds or something? Liabilities are flattish after rising in the 1990’s due to cost depreciation. And the housing line look a bit dubious – especially seeing the increasingly silly prices paid here in Sydney.

        If I had the time (I don’t) and the data (I don’t), it would be an interesting exercise net medium interest payments against medium income over two specified periods. Disposable income could work, but realistically given the tax rate is scalar, you could only apply specific analysis within certain bands. General analysis is possible though. Not sure – I would need the data in front of me and play with it for a while. Otherwise I am whistling in the wind.

        Moreover, in the late 1980’s and early 1990’s, inflation was substantially higher then than now – so you would have to apply some sort of deflator. But that could skew the analysis…

      • ResearchtimeMEMBER

        OK – gotcha.

        But given the difficulties in drawing generalisations – 2007 levels of interest rates as a percentage of disposable income appear to be lower than those in the 1980’s (not sure where the 2003 sits???).

        But a couple of things jump out at me from that graph immediately. It cannot be correct, its illogical – (a) interest rates for mortgages are not massively different from 2007 to now (yes a bit lower by only by a few percent); and more importantly (b) and neither did incomes rise during the GFC to explain why affordability rose to get that big drop in interest rates to disposable income – the (c) only other logical alternative is that house prices crashed in 2008 allowing people to buy cheap housing thus allowing them to pay far less in interest repayments????

        That graph cannot be right? Those lines must be pure fiction. How are they calculated??? Either the data they use – or the way they calculate the data is really odd !!!!

      • “2007 levels of interest rates as a percentage of disposable income…”

        The graph is interest paid as a percentage of disposable income.

      • ResearchtimeMEMBER

        AB – having bad luck, only getting one in two – or one in three posts making it at present…

        Ha ha – get you point – numbers given imply costs fall by 45%.

        However, there are a number of assumptions I think worth considering (i) people as a rule don’t flip houses, so one would expect debt for the individual to remain semi-fixed in the medium term. (ii) wages don’t vary significant (small annual increases); which implies that (iii) interest rates play a big role in debt affordability as a percentage of disposable income. I get that.

        However, the devil is in the detail. I remember interest rates around 7.5% in 2000 (last time I had a mortgage) – but the price of housing has subsequently rocketed. Putting personal debt aside (complicates the picture) – given most inputs are semi-fixed in the medium term, or at least show a substantial lag – is the reason why this graph closing matching gross movements in the share market is highly questionable.

        And given you have supplied figures above, and given the RBA graph illustrates the last major rate peak around 1989 if I remember correctly. We can do a simple comparison. Dwellings around 1989 were at 3-4x annual salary (early 80’s number, just being conservative) – average is now supposedly 6.5x annual salary in Sydney. Given this is a relative measure – assume $100 is a housing muiltiple – so they are comparable.

        $300-$400 house @ 17% (peak) is $51-68 pa in 1989 (which is approaching the majority of a persons annual wage, especially as taxes were higher then).
        $650 house @ 7% is $46 pa in 2014 terms (nominal)

        My point is – even if houses have doubled in relative income terms, interest rates are less than half of what the used to be. And given banks have not changed their guidelines lending more than 3x annual salry for a period of several decades – there is an anomaly here I cannot put my finger on. I suspect that there is something wrong with these graphs (or the person or methodology behind them).

    • WA was a net recipient of Federal tax distributions until 2006

      What you actually mean is that WA, which along with other States had been a recipient of Special Grants from the Commonwealth from the inception of the Commonwealth Grants Commission until the end of the 1960’s, had fully “repaid” these special grants by 2006 by increasing its per capita share of Commonwealth taxes.

      So what?

      Special Grants no longer exist, but Horizontal Fiscal Equalisation does. If the arse falls out of the iron ore and gas trades, WA will still be a potential beneficiary of HFE. That’s the Federation for you.

      The very real truth remains too. While we have had astonishing windfall gains, we haven’t saved and invested them. Even the resources boom itself has been financed from abroad. We’ve spent the whole lot, plus some. This extraordinary waste was enabled – even mandated – by Howard and Costello.

      We’ve been feeling the down-draft since 2011 and it’s going to get much worse before it gets better.

      • ResearchtimeMEMBER

        Thats harsh on Howard – cannot believe I have to state the bleeding obvious. [“Even the resources boom itself has been financed from abroad”] – of course those funds had to come from overseas – they always have. Until this recent boom – the UK financed every major mining boom in Australia. The massive investment phase from 2007 onwards was debt financed commodity expansion, initially the moneys came from the US (e.g. FMG, although the Chinese did take Sino Iron, but their big investments didn’t come for several more years) Those supposed economic windfalls were largely post 2007, and the benefits were largely indirect – including increased skilled migration (with many walking into high-paid jobs – massively increasing the tax base), property prices, heavy work shop construction, holidays, cars, plasma TV’s (remember those), increased super contributions to invest (much of it local) etc., etc.

        The great fallacy is that Howard was out late 2007 – his government never really saw any financial windfall, hence all the fallacious arguments above. Check out government receipts after 2006, they virtually go parabolic. Furthermore, up until mid 2006, WA was a recipient of tax receipts to equalise economic growth in addition to the GST, much like the current situation in SA, NT or Tasmania.

        By 2006 participants in the industry knew we had a big mining boom, but even we had absolutely no idea how big. China had only appeared on the radar screen 2002, and even by 2004 mining was modest – and I was asked the question, “why don’t I change into another sector” (sunset industry). In fact, some (including myself) were a bit worried that it may actually stall, and it would all be over the following year…

        This is all historical revisionism. And it does not align with the facts on the ground. East Coast Australia population didn’t even know about this investment boom until late 2007 early 2008 – when the share market topped out. And then in 2009 – investment in mining infrastructure just took off…

      • Researchtime….

        The massive investment phase from 2007 onwards was debt financed

        In fact, most of the finance came as Foreign Direct Equity, but it makes little difference.

        If fiscal receipts failed to lift until 2006 it was because Howard continued to give away tax cuts and concessions – measures which mean the budget is now chronically under-funded. Revenues have not re-built on a per capita or %/GDP basis since the GFC. This is a feature of the design of the system, largely put in place by Howard and Costello.

      • ResearchtimeMEMBER

        “briefly” – your statement [most of the finance came as Foreign Direct Equity] – is factually incorrect. Most of the finance in this mining boom came from debt outside Australia – and most of the good operations were purchased outright and funded internally by the purchaser.

        Leucadia (a well known Utah based investment company that has delivered an annual compound return in-excess of 30% since 1979, having the enviable reputation of out-performing Warren Buffet’s holding company, Berkshire Hathaway) funded FMG’s initial equity, allowing its debt to also come from the US. Paladin got a lot of its debt from the US, De Belle’s iron ore ex-Kingstream venture was purchased out-right by Sino Steel. Cliffs in the US purchased the Koolyanobbing complex, Xstrata Jubliee, Glencore Minara, and a bunch of coal assets on the East Coast by US Peabody. I could go on and on… and we shouldn’t forget the massive expansion of BHP and Rio’s balance sheets – largely on Pilbara iron ore, funded round the world, largely out of the UK.

        I have taken to posting this reply a second/third time because facts in this discussion are important. There seems to be a general lack of them.

      • I agree with (lack of) Research Time and 3dlk head. Howard was gifted a great budget and he blew it on housing bubbles and middle class welfare. Also very likely a war criminal but that’s another story. As Research Time said, we shouldn’t have revisionists labeling him as a pragmatist because that’s completely false.

  2. The Patrician

    S.T.R.U.C.T.U.R.A.L R.E.F.O.R.M.

    Bads news I can cop.

    Not dumb politically-convenient bandaids. Not half-assed temporary fixes.

  3. Pfh007MEMBER

    Recycling the boom time back taxpayers and others has merit as our pollies are not the best at applying resources productively. So to that extent putting the money into households was a reasonable objective.

    The real crime of Howard and Costello was not acting to minimise that bounty being driven into bidding up house prices.

    Had they done that our households would be less leveraged, our exchange rate lower, and the funds from the terms of trade and commodities boom directed to more productive investments locally and internationally (yes we can be a source of capital) that produced real sustainable streams of income.

    The current situation can be remedied but it requires real action to ensure that future investment in housing is directed to building new low cost dwellings and not continuing the bidding war on existing houses.

    • Excellent comment Pfh. Lazy and inattentive policy throughout those gravy years have left us with the current circumstances.

      Our leaders watched it evolve in slow motion, and never felt the need to do anything because so many of the voters were content to see their housing and associated sharemarket wealth increase. Their own conflicts of interest helped reassure them that their actions were good and righteous.

    • +1000000

      The first step is getting people to realise that expensive housing is BAD. Most people, and all of our pollies, think it’s good.

      Expensive energy is bad. Expensive food is bad. Expensive health is bad. Expensive education is bad. Expensive cars are bad. Expensive computers are bad. Expensive clothing is bad.

      … but apparently expensive houses are good.

      While our polity remains so dense that they can’t see that this thinking is absurd, we’re basically stuffed. No amount of budget fiddling will fix the stupendous misallocation of capital caused by this one rotten idea.

      Bad news budgets are here to stay indeed.

      • Ooh but you are talking about deflation now! Comrade why have you betrayed the party? You are mentally ill. Don’t worry we have a cure for that at Minilove.

  4. mine-otour in a china shop

    To unwind all the policy mistakes will take a visionary party and politician (not any of the the current “Laberals”), or a crisis.

    I go for option 2. There is more chance of option 1 happening, as there is of the next Government being led by the legendary Bad News Mock Heavy Band.

    Vote 1 – Vim Fuego!!!

    • JunkyardMEMBER

      I think ill go listen to it now to cheer up.

      “Did you ask Den to overdub my base?”

      • mine-otour in a china shop

        The great Bad News lyric “Burning, raping, looting and a shooting” might be very appropriate for next week’s budget…..

  5. I agree with (lack of) Research Time and 3dlk head. We shouldn’t have revisionists labeling Howard as a great man and a a pragmatist because that’s completely false.

  6. It’s ironic that during the temporary boom we got permanent tax cuts and welfare, and now faced with permanent structural deficits the solution we are given is… a temporary new tax to fix them!

  7. researchtime…I suspect more data would help…

    http://www.business.nsw.gov.au › … › About NSW › Trade and investment

    Foreign Direct Investment in Australia by Industry

    The mining industry had the largest level of foreign direct investment (FDI) in Australia as at the end of 2010, reflecting strong world demand for mineral commodities and the competitiveness of Australia’s resources industry. Mining also made up a quarter of FDI in-flows in 2010, along with manufacturing and finance and insurance which each also made up almost a quarter of the FDI inflows in 2010. In addition to mining, manufacturing, finance and insurance, wholesale and retail trade, and transport and communication have the largest stock of FDI in Australia.

    The level of FDI in Australia is estimated to have grown by about 60% in the five years to 2010. The largest contributors to the increase were mining ($88 billion or 138% of total FDI growth), manufacturing ($34 billion or 62%) and finance and insurance ($22 billion or 51%).

    In any case, it makes very little difference. Most of the investment in mining has originated offshore, regardless of whether it has manifested in our accounts as debt or equity.

    Foreign investment is good. But it would be good for us if we allocated less of our incomes to consumption and more to investment. Our failure to do this necessarily means that our recurrent (future) incomes will be less than they otherwise would be.

    Beyond the barest subsistence level, every single dollar of income we now receive stems from investments made in the past. It follows that if we want to increase our future incomes we have to increase our current investments. This is just not complicated. It is blindingly obvious.

    We have failed to do this in spectacular terms. Nearly all the windfall gains of the last 10-12 years have been blown on consumption goods (especially houses) and services. This was facilitated – engineered – by the fiscal settings of the Howard Government. They did this for political reasons – to achieve re-election – which really means they sacrificed our future income security for the privileges and emoluments of office.

    It’s never too late to change, though, of course, change can be exceedingly difficult to achieve. The last Government to really accomplish systemic change was Hawke’s. That was a long time ago. He did it by bringing competing forces together. There is a lesson in that record for us all.

    • ResearchtimeMEMBER

      “briefly – you might have misunderstand the term and its context. Subsequently you may have jumped to the wrong conclusion! The vast majority of mining projects were financed via debt not equity…. Smaller projects may have a 20:80 through to 40:60 for a dud project (FMG the notable exception). But overall these would be less than 5-7% of total capex spent, and even then that may be an over-estimation !!!!

      In fact the biggest investments never raised equity at all (e.g. Rio and BHP – and some of the LNG projects) and were totally funded internally. Hence the numbers you are quoting are but a tiny fraction of the massive capex bills running into hundreds and hundreds of billions of dollars.

      Try and understand what you are reading before you quote. You may also want to rethink your conclusions – they could be untenable given what I have said. Because at some stage you have to pay back that outlay!

      • “In fact the biggest investments never raised equity at all (e.g. Rio and BHP – and some of the LNG projects) and were totally funded internally. Hence the numbers you are quoting are but a tiny fraction of the massive capex bills running into hundreds and hundreds of billions of dollars.”

        …internally financed…from cash-flow or shareholders’ funds….which is to say, they were equity-financed in general….

      • ResearchtimeMEMBER

        Debt mainly – via the UK. So funds not allocated officially, internally, except via company announcements and annual reports. However, there is a kicker in the future. Assuming that all the Macrobusiness bears are correct and IO drops to $80/t, LNG drops too – depreciation and interest costs for these super projects will largely make these ventures marginally profitable.

        Where is the kicker you say? Think Federal tax receipts. Thats why I keep saying – think two or three tax hikes ahead…

      • “Try and understand what you are reading before you quote. You may also want to rethink your conclusions – they could be untenable given what I have said. Because at some stage you have to pay back that outlay!”

        Sure. The point is not lost to me or anyone else. Debt has to be repaid…though from the point of view of the borrower, debt tends to be cheaper than equity. So when rates are very low it makes sense to borrow. Nonetheless, a large part of the investments have been funded from earnings by shareholders – an equity investment if ever there was one.

        But all this is tangential to the issue….which is that we have spent our windfall gains on gazebos, toys, picnics and holidays. That is a pity, cos now we could use the income we might otherwise have had….

  8. While there has been some interesting discussion here, I’d like to pop in at the end with some pop culture irrelevance.

    “Bad News” were a quite funny fake metal band invented by the “Comic Strip Presents” crowd, who are essentially the post-Young Ones comedy clique in the UK. They did a serious of disparate half hour shows, on a range of themes, that are worth hunting down.

    While quite funny, their timing was unfortunate in that they came out at a similar time to the infinitely superior Spinal Tap.

    Bad News are worth looking up for their version of Bohemian Rhapsody in which Brian May, guitarist from Queen, plays the guitar parts. Really badly.

    Just thought I’d counterbalance my more thoughtful reply in another MB story.