The Government’s Mid-Year Economic and Fiscal Outlook (MYEFO) released yesterday contains few changes and no surprises. The critical question is whether the path back to surplus is actually credible, especially given the many failed promises in the past. This post examines the government’s economic forecasts that underpin the budget numbers and whether the government’s approach to Budget repair is really viable.
True to form, the Government’s Mid-Year Economic and Fiscal Outlook (MYEFO) released yesterday contains no surprises. The budget projections and economic forecasts are not materially different from the May Budget and the numbers released in the Pre-Election Economic and Fiscal Outlook.
The Government claims that it has been able to fund all its election campaign promises by realising savings of $22 bn over four years, mostly in employment and training, and welfare programs. As a result, since the previous budget update, there has been an underlying improvement in the budget balance of $2.5 bn over the next four years. And of course, as the Government has trumpeted, according to these projections the Budget will return to surplus by 2020-21.
But the critical question is can these budget plans be believed? After all four different Treasurers have made this promise of a budget surplus in the foreseeable future, and the first three Treasurers all failed to deliver.
Fundamentally there are two main areas where the credibility of this budget update must be questioned:
- The economic assumptions underpinning the budget numbers are critical, and in that context so is the Government’s so-called Plan for Jobs and Growth
- The Government’s approach to achieving policy savings, and whether that can be expected to deliver the budget savings promised.
The Economic Outlook
The economic forecasts and projections in this MYEFO are for the most part conservative. Indeed, the Government is to be congratulated for incorporating lower commodity prices into its forecasts than those currently prevailing.
Nevertheless, what has been holding this economy back has been the slow rise in consumer demand, mainly because of slow wage growth. In its forecast, however, the Government shows consumer demand increasing by as much as 3 per cent in the next financial year, while at the same time real wages are only forecast to increase by 2 per cent. This seems an inherently unlikely combination, and it matters a lot because consumer demand accounts for more than half of total demand.
The other key elements of the Government’s Plan for Jobs and Growth that are meant to drive the economy are:
- A company tax cut costing $50 bn
- New infrastructure projects – again costing $billions
Labor supports the company tax cut for small companies and that may make a marginal difference to their investment in the next few years. But most of the cost will not occur for a few more years when it is proposed to extend the lower rates to larger companies, and this measure is being opposed by Labor and possibly by other parties.
Frankly it is hard to think of reasons why this extension of the company tax cut would represent value for money, as it is unlikely to make much difference to investment nor growth. Indeed, company tax has been cut by a lot over the last few decades in a lot of countries, but in no country was there a significant impact on investment, output or employment. Second, the Government’s own modelling shows that this company tax cut would only increase GDP by 1% after as many as 20 years – which is an infinitesimal impact in the foreseeable future.
Third, the Government claims that this tax cut is needed so as Australia can remain competitive with the company tax regimes of other nations. However, this argument fails to recognise that Australia is almost alone in offering dividend imputation which means it is impossible to directly compare the impact of company tax in Australia with that of the rates in other countries. For example, because of dividend imputation, Australian companies effectively do not pay any company tax in respect of the dividends that accrue to their Australian resident shareholders. Instead this company tax is effectively a form of withholding tax which is credited to the shareholders as franking credits. Thus, Australian company tax mainly affects foreign companies and foreign shareholders, but many foreign companies pay no tax in Australia, and equally there is no evidence that Australia has difficulty attracting foreign capital – indeed, on occasions it is arguable that we get too much.
Fourth, non-mining business investment is not low at present relative to aggregate demand, and if allowance is made for the present level of capacity utilisation. There is therefore no particular reason for seeking to encourage more investment by tax breaks, and especially not by poorly targeted and very expensive tax breaks. What is needed instead are policies to increase aggregate demand, and as both the IMF and OECD have argued that involves policies for inclusive growth that seek to tackle the increasing inequality that has been shown by these international agencies to be bad for growth.
Turning to the Government’s proposed infrastructure projects that it now proposes to fund, of the 21 transport projects, each over $100 million, announced in the election, only 5 had been placed on the Infrastructure Australia approval list. The rest have not therefore been subject to proper evaluation or have failed that evaluation. This represents a further extension of a long tradition of National Party pork-barrelling that will actually lower national productivity. These dodgy projects should be scrapped as part of genuine budget repair.
Finally, while it is good to see the Turnbull Government supporting innovation, so far that support has been nothing more than rhetorical. Nothing has been done to restore the funding for innovation programs that the Abbott Government cut, and in addition there have been further cuts to education and training programs that are vital for encouraging the adoption and adaptation to new innovations.
True Budget Repair
The MYEFO includes $13.2 bn over the next four years of so-called ‘zombie’ measures that were mostly introduced in the 2014 Budget, but which have failed to gain parliamentary approval ever since. That is a further reason for doubting the Government’s prediction of a return to surplus in 2020-21.
More importantly, the Government’s insistence on continuing to press for these zombie measures is an example of why getting the Budget back into shape is so difficult. Almost everyone recognises, that achievement of budget savings is difficult and is unlikely without compromise. So long as the Government continues to push these measures that have been so widely condemned, then compromise will be difficult. In addition, as so many other commentators have recognised, Budget repair requires action on both the revenue as well as the expenditure side of the Budget. In particular, the Government should recognise that tax expenditures are no different in purpose to Budget outlays, and the Government should be prepared to examine these various tax expenditures in the same way as outlays are examined.
Finally, so long as the Government focuses its budget cutting on welfare, health and education programs, while spending the proceeds on wasteful programs, such as many of the infrastructure projects and company tax cuts, then it is difficult to see how compromise around sensible budget savings will ever be achieved. That is not to say that sensible savings cannot be found in education and health – indeed they may well be necessary – but those savings are unlikely to be found the way this government approaches the savings task. Too often this government approaches the savings task in terms of who is deserving, whereas it would be more productive to focus on how cost-effective is each program.
Some might wonder whether after so many years of budget deficits, why do we need to return to surplus. After all we seem to be doing better than most other countries, just muddling along, and our public debt levels are still low relative to other countries. So why put ourselves through all the pain to achieve an outcome when the means to achieve that outcome remain in dispute?
Certainly the answer to this question does not lie in the ‘bogey man’ of a down-grade by the ratings agencies, which is so frequently cited by business and the media. Loss of Australia’s triple AAA credit rating is much more of a political test than an economic test.
The ratings agencies should have been totally discredited, following their performance in assessing credit worthiness in the lead-up to the GFC. Furthermore, and contrary to popular opinion in Australia, when countries have lost their triple AAA credit rating in the past (Japan,2002 and the US, 2011) it had no detectable impact on financial prices (see posting by Stephen Grenville, former Deputy Governor of the RBA, 18 December). As Grenville argues, ‘Financial markets make their own judgements about risk, without the help of ratings agencies, .. so it’s time to stop genuflecting at the ratings altar’.
Equally over time Australia does need to live within its means. Now after more than eight years since the Australian budget went into deficit, and with uninterrupted economic growth since, it is disappointing that the Australian budget has still not returned to surplus. The Government’s aim of a budget surplus equivalent to around 1 per cent of GDP over the medium term is prudent and should be supported. Australia does need this fiscal capacity to respond to future economic shocks, which will undoubtedly occur again as they have in the past. Furthermore, the time table outlined by the Government in the MYEFO seems about right with the annual pace of fiscal consolidation averaging 0.5 per cent of GDP. This should be consistent with maintaining a reasonable rate of economic growth and employment.
Michael Keating AC was formerly Secretary, Department of Finance and Secretary, Department of Prime Minister and Cabinet.