This Mid-Year review of the economic and fiscal outlook contains no new surprises. However, the balance of risks is that the outcomes will be worse than predicted. Clearly on the Government’s own projections, the nation cannot afford income tax cuts in the foreseeable future. Instead what this review reminds us, is just how threadbare this Government’s economic and fiscal strategies actually are.
The Economic and Fiscal Forecasts
The Government’s Mid-Year and Economic and Fiscal Outlook suggests no significant change in that outlook since the last Budget. The economic outlook has been marked down slightly for this financial year and the next, but there has been a slight improvement in the forecast cash deficit. Most importantly the projected return to Budget balance continues to be expected in 2020-21.
My personal assessment is that the Government’s latest economic and fiscal forecasts and projections are plausible. In addition, the projected path of the return to a Budget surplus over another three years seems to me to be appropriate. Nevertheless, the risks are on the downside, especially as aggregate demand in the economy may not rise as fast as expected by the Government.
Many commentators have pointed particularly to what they consider to be optimistic forecasts for future wage growth, and consequently future consumption growth. As a recent Treasury analysis shows, wage growth in Australia has been low across all industries for the last five years. It has also been low in other countries; in the US for example, ‘the typical American man makes less than he did 45 years ago (after adjusting for the effects of inflation’ (Stiglitz, 2015).
We don’t really know the reasons for this widespread low wage growth. The Treasury, in a recent analysis of low wage growth, acknowledges that productivity growth has been low in other countries, and that could help explain low wage growth there. However, Treasury claims that Australian productivity growth has held up better. Although, in fact Australian productivity did not grow last year, in 2016-17, and the Treasury forecasts only very modest productivity growth this year in 2017-18. But then for no clear reason, Treasury projects that productivity growth will resume increasing at annual rate of 1½ and 1¾ per cent in the following three years ending in 2020-21. This projected recovery in productivity growth seems to be the basis for assuming that wage growth will also accelerate, notwithstanding that this projection seems to be contradicted by the experience over a decade or more in most other advanced economies.
Stephen Bell and I in our forthcoming book, Fair Share, to be released early next year, argue that the evidence shows that in fact the causality in the relationship between inequality and productivity tends to run the other way than that assumed by the Treasury. Thus, the low rate of wage growth and increasing inequality of earnings are at least part of the explanation for the slower rate of productivity growth in the last decade or more. Indeed, both the IMF and OECD have found that increasing inequality is bad for economic growth, but that has not yet registered with the Australian government.
Future Tax Cuts
The other key feature of this economic and fiscal update is how little support it provides for the Prime Minister’s attempt to divert our attention by promising tax cuts. The Mid-Year Update makes it quite clear that the priority is repairing the Budget, but that will not be accomplished on the Government’s own reckoning before 2020-21. Furthermore, as I have just argued, even that projection may prove to be optimistic.
Thus, tax cuts would therefore only be possible in the next four years or more if expenditure could be cut substantially. But budget outlays are projected to grow quite fast over the current fiscal year and as a percent of GDP they will still be around their long-term average in 2020-21.
What government rhetoric fails to recognise is that Australia already has the most tightly targeted welfare system in the world, and there are really no opportunities for making significant savings by further tightening eligibility. True to form, however, the Government has announced plans in this Mid-Year Budget Review to tighten debt recovery arrangements, payments to migrants, family day care services, and family payments. The savings involved are almost irrelevant to the size of the Budget repair task, let alone covering the cost of a tax cut. Instead, what these savings measures signify is a mean vindictiveness, rather than a coherent economic strategy.
Furthermore, if inequality is bad for growth, then public expenditures on education and health represent some of the best ways of insuring against increasing inequality and lower economic growth. For example, Stephen Bell and I in our forthcoming book, Fair Share, explore why inequality has risen so much less in Australia than in America over the last forty years, and we find that education is the key. Both the US and Australia have been very similarly impacted by the main causes of inequality – technology and globalisation – but the cost of higher education in the US has made it impossible to access by most young people. Whereas in Australia, and because of the increase in government support, the access to higher education has increased enormously over the last forty years. As a result of these different policies for higher education, the wage premium for US college graduates has more than doubled since the late 1970s, whereas in Australia it has stayed remarkably stable, notwithstanding the large increase in the demand for university graduates in the workplace. In short, support for public education has been critical to encouraging income equality and economic growth, and represents much better value than a company tax cut.
In the longer run, as the Government has pointed out, there will be a case for tax cuts to offset the increase in average personal income tax rates that is occurring through bracket creep, as taxpayers move into a higher tax bracket through inflation. Indeed, the Government has implied that this extra revenue generated through bracket creep can be used to pay for the tax cuts. However, the Government’s self-imposed revenue ceiling whereby revenue is capped at 23.9 per cent of GDP is not expected to be reached until 2022-23. Thus, there will be no scope (or even necessity according to the Government’s reckoning) to introduce income tax cuts for middle Australia before 2022-23; much too late to be credible at the next Federal election.
Conclusion
This mid-year review of the economic and fiscal outlook contains no new surprises. In principle, that is a good outcome. However, more importantly the review reminds us how threadbare the government’s economic and welfare strategies actually are. In addition, the balance of risks is that the economic and fiscal outlook will in fact turn out to be worse than projected. Clearly, on the Government’s own figuring, the nation cannot afford income tax cuts in the foreseeable future, unless it is prepared to embark on expenditure cuts never before contemplated, or increase other taxes substantially.
Michael Keating, AC, is a former Secretary of the Departments of Employment and Industrial Relations, Finance, and Prime Minister & Cabinet.
Michael Keating is a former Secretary of the Departments of Prime Minister and Cabinet, Finance and Employment, and Industrial Relations. He is presently a visiting fellow at the Australian National University.
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