MICHAEL KEATING The Fiscal Outlook: Is the projected Budget surplus sustainable and should it be? Part 2Oct 8, 2019
With a stagnant economy, there are strong arguments for a fiscal stimulus package that would almost certainly postpone the return to Budget surplus for a couple of years. But what of the longer term? This article uses the Medium Term Fiscal Projections recently released by the Parliamentary Budget Office to query the longer-term fiscal outlook, and whether Budget surpluses are in fact sustainable without policy changes.
Two weeks ago, the Treasurer used the release of the final figures for the 2018-19 Budget to issue a triumphant press release headlined: “Budget back to balance for the first time since 2007-08”. That of course, begs the question of whether in fact we should be aiming for a Budget surplus, in present circumstances. As I discussed in my article, “Economic Update”, posted yesterday, the Australian economy is stagnating. Like many others, including the Governor of the Reserve Bank, I argued, that a fiscal stimulus package is needed.
Even a modest fiscal package, equivalent to say half a per cent of GDP over the next eighteen months, would be sufficient to wipe out the projected surplus for this and the next financial year. Furthermore, the Treasurer’s predicted Budget surplus for this year and next relies heavily on the economy growing much more strongly than it has recently. Indeed, if the economy continues to stagnate, the Treasurer may well find that his promised Budget surplus in fact fails to eventuate (see more below). So the Treasurer needs to stop treating a Budget surplus as some sort of holy grail, and recognise that fiscal policy is a means to support the real end of achieving full employment and economic growth.
But beyond the next year or so, there is another important question about the sustainability of a fiscal surplus over the next decade or more, and this issue will also be examined further in this article below.
Looking to the future: can a budget surplus be sustained
Last week the Parliamentary Budget Office (the PBO) released its latest Medium Term Fiscal Projections. These projections are based on projections for the economy that are provided by the Government, and then reflect the implications of continuing present Government policies. No allowance is made for any changes in policy, including any changes that the Government might find that it is forced to make in order to achieve its objectives.
The PBO’s projections suggest that with ongoing government expenditure restraint, combined with lower public debt interest payments, the underlying cash balance is expected to improve over the next decade to a surplus of 1.6 per cent of GDP by 2029-30. However, this apparently favourable outcome is critically dependent on:
- The Government’s economic projections proving to be realistic, and
- The Government being able to maintain its present policies without change over a period as long as the whole of the next decade.
Both these assumptions will now be examined in more detail.
The Government’s medium term economic projections
As the PBO put it:
economic activity has been operating below its sustainable level for the past decade, with inflation below its target range.
Nevertheless, the Government’s economic projections basically assume a rapid recovery from the present very low rate of economic growth and wage growth. During a five-year period of catchup annual economic growth is expected to average 3 per cent, after which the economy grows in line with its assumed potential growth rate of 2¾ per cent. Inflation is also expected to pickup consistent with the Reserve Bank achieving its target rate of inflation averaging between 2 and 3 per cent.
In yesterday’s article, Economic Update (Pearls & Irritations, 7 October 2019) I argued that present policies were most unlikely to achieve these projected outcomes. For this reason alone we might query the sustainability of the projected fiscal surplus. For example, I have calculated that, if over the next decade the average rate of increase in nominal GDP was only half a percentage point lower than the Government is projecting, then the loss of revenue alone would be sufficient to almost remove the predicted Budget surpluses for 2019-20, 2020-21 and 2021-22. Furthermore, if the slightly slower rate of increase in nominal GDP continued, then on my estimates the Budget would register a small deficit in each of the remaining years of the next decade, assuming there were no change in policy.
Will present policies be maintained
The PBO has stated that:
The spending restraint seen over the past few years may be difficult to maintain over the coming years given the length of time over which restraint has been applied, the pressures emerging in some spending areas, and the potential need for fiscal stimulus, noting that the improvement in the budget balance is mildly contractionary.
I very much agree. In particular I would note that:
- Much of the expenditure restraint has been accompanied by “meanness”, and there is a powerful case for increasing payments that the poorest households rely on, such as Newstart and rental assistance.
- The cuts to all forms of education spending are counter-productive. Instead Australia needs to spend more on education and training across the board if it is ever going to tackle the rise in inequality and low wages that are the main cause of the economic stagnation that we have been experiencing.
- Given the deterioration in the international relations in our region, it will be foolish not to increase spending on both defence and our diplomatic effort, including foreign aid.
Equally there are questions about the sustainability of present tax policies over the medium term. The PBO finds that:
Personal income tax receipts are also projected to contribute to an improving fiscal position, driven by bracket creep.
Even with the tax cuts, average tax rates are projected to continue to increase with the growth in incomes, particularly for low- to middle-income groups.
More specifically, the PBO finds that on present policies, by 2028-29 the average tax rates for the second and third quintiles in the income distribution will have increased by 4 percentage points compared to their average rates in 2017-18, while the average rates for the top quintile will not have increased at all. Again this emphasises the inequity of the later stages of the Government’s tax package: in effect tax cuts for the top incomes are being paid for by low and middle income earners. This is not only a matter of inequity; it is precisely the opposite of what the Australian economy needs. Hopefully, these later tax cuts will be reversed.
The pursuit of the Budget surplus is the pursuit of a mirage. It is unlikely that present policies are compatible with achieving a sustainable Budget surplus. It would be better to make a virtue of necessity and spend more on those priorities that are being neglected. If necessary extra revenue should be raised later on to finance this additional expenditure, starting with a withdrawal of the later stages of the legislated tax cuts. A policy package along these lines would improve both equity and economic growth. It thus offers the best chance of realising a sustainable Budget surplus over the medium term.
Michael Keating is a former Head of the Departments of Prime Minister & Cabinet, Finance, and Employment & Industrial Relations. He is presently a Visiting Fellow at the Australian National University.