The old temporary revenue meets permanent spending trick!

There is nothing that a pollie likes more than temporary revenue recycled as permanent spending. Capital Economics with the note:

  • Treasurer Josh Frydenberg revealed in today’s Budget that the government will spend nearly all of the windfall accruing from the stronger economic recovery. That will result in a permanently larger role of the state and a sizeable structural budget deficit. But with borrowing costs still low by historical standards and net debt set to level off at manageable levels, this is unlikely to cause major problems.
  • Given the recent improvement in the monthly budget figures, it came as no surprise that the government lifted its estimate of the underlying cash deficit for the current financial year which ends in June by a huge $52bn, or around 2% of GDP, to just 7.7% of GDP. More surprising was that the government only lifted its estimate of the deficit for 2021/22 from -5.3% to -5.0% even though it expects nominal GDP to be 5% higher next year than it was forecasting in December. Our economic forecasts are very similar.
  • The extension of the low and middle income offset by another year will cost around $8bn, but that will only affect tax receipts in 2022/23. The main reason for next year’s higher deficit is that the government announced additional spending of $21bn, including on aged care and the National Disability Insurance Scheme. Coupled with the decision to extend the full expensing of capital spending by one year to June 2023, that means that the budget deficit will be around 0.5% of GDP higher in 2022/23 and 2023/24 than predicted in December.
  • Indeed, the structural deficit will still be close to 4% by 2023/24, compared to a shortfall of around 1% before the pandemic. (See Chart 1) By 2022/23, the government expects company tax revenue to be a whopping 32% lower than projected in the 2019 MYEFO and personal income tax revenue 13% lower. And it expects payments to remain well above pre-virus levels for the foreseeable future. (See Chart 2) As such, the pandemic has heralded an era of permanently larger public spending.
  • Political considerations play a role: federal elections need to be held by May next year and the Coalition government is trailing the opposition Labor party by around 3%-pts in the polls.
  • But the government’s confidence to spend a sizeable share of the budget windfall also seems to reflect the benign outlook for net debt. Despite the additional fiscal looseing announced today, the government now expects net debt to level off at a slightly lower level of around 41% of GDP, from 30% in 2020/21. And while we expect yields on 10-year government bonds to climb to 2.25% by the end of next year rather than remain around 1.75% as assumed by the government, net interest payments are unlikely to exceed 1% of GDP.
  • Fiscal policy loosening is taking a bit of pressure off the Reserve Bank of Australia but we still expect the Bank to announce another $100bn in bond purchases in July. That said, the recent improvement in the deficit means that the Bank will need to buy from a smaller pool of available bonds: we estimate that by the end of the year, it will own more than one-third of outstanding federal bonds. While that’s still low by international standards, we expect the Bank to taper its asset purchases from early-2022.
David Llewellyn-Smith
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