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Federal Budget 2016–17: big ideas, small canvas?

Posted By on May 3, 2016 @ 06:00

Malcolm Turnbull’s aim for an ideas boom looks set to take some flesh in tonight’s Federal Budget, showing up in everything from cities and infrastructure initiatives through to a re-focusing of tax policy.

Yet although many of these potential initiatives may sound big when they are announced, they have to be shoehorned into a Federal Budget which is still feeling the after effects of a tumultuous decade.

It was a decade in which a booming China led to a Budget bubble, as the company tax take in particular, soared. In turn, that rush of incoming revenue got rapidly parcelled back out into a range of permanent promises—everything from eight personal income tax cuts in a row through to family benefits, baby bonuses and, more recently, worthy initiatives such as the National Disability Insurance Scheme.

Yet slower growth in China in recent years means that the combination of a temporary boom with permanent promises has subsequently led to lingering Budget deficits.

The first question that tonight’s Budget has to answer is whether China’s slowdown is still wreaking havoc for both the Australian economy and the Federal Budget, or whether recent better news from China and in the realm of iron ore prices means that the Budget bust of recent years has finally bottomed.

Chances are that there will be relatively good news from Treasury on both fronts, though it remains likely that the economic outlook will be brighter than the Budget outlook. Real growth in the Australian economy has been relatively modest since the initial bounceback that followed the global financial crisis. In fact there’s been only one year of above trend growth in the last eight.

The good news is that Treasury is likely to forecast continuing solid growth; the bad news is that growth isn’t likely to be at rates above 3%--a rough benchmark of trend—in either the financial year just finishing or that soon to start.

Yet while the news on Australia’s economy may be ok, that on the Budget may be more challenging—several factors in play are more important for the Budget than they are for the economy. For example, the continuing pressure on corporate profits is an issue for the Australian economy, but not a big one. However, it looms large for the Budget. Indeed, the Budget forecasts are likely to indicate the company tax take in 2015–16 will be below the collections achieved in 2007–08, before the global financial crisis hit.

Even more so, the weakness in wage growth is a double-edged sword for the economy. Wages are a cost to business and an income to families, meaning that weak wage growth is improving Australian business competitiveness at the same time that it is weighing on family finances. On balance, that’s probably a small net positive for the economy.

But it isn’t a positive for the Budget. There's three times as much tax collected through personal tax than is raised via company tax. And wage growth traditionally comes with an ‘accelerator effect’, pushing people into higher tax brackets. The absence of wage momentum therefore hangs relatively heavily on the Budget outlook.

That said, the Budget outlook—as usual—can be expected to forecast a return to sunnier conditions, with steadily falling deficits. But, as always, those official forecasts will be worth a closer look.

For example, even the official forecasts of the debt trajectory are likely to be enough to see debt-to-income ratios temporarily move above rates that have previously seen the Australian government lose its AAA credit rating. And while the importance of an AAA credit rating is much exaggerated, it will still be worth monitoring what the ratings agencies have to say in the wake of this Budget. After all, the AAA rating doesn’t only cut credit costs to the Feds—it does the same for State governments, and arguably also cuts funding costs for business and home mortgage borrowing as well.

In addition, there’s a chance that the official forecasts prove too optimistic. That is, after all, the consistent story since China’s economy peaked back in 2011.

So there will be three caveats to the official figures—China, the Senate and the States.

China’s economic transition may yet throw more spanners into the works for Australia’s economy and (even more so) its Budget. Although Chinese growth just took a turn for the better, it’s very much the result of a huge rise in borrowings and debt. In fact the latest surge in Chinese credit aggregates is even bigger than what happened there in response to the global financial crisis. That suggests continuing Chinese strength in the short term may come at the cost of great risks in 2017 and beyond.

Second, don’t forget that some of the improving Budget trajectory in the official figures will rely on the Senate finally agreeing to a bunch of savings measures that it has blocked for several years now. The passage of those bills seems optimistic, particularly in an election year.

Third, the largest savings in the Federal Budget in recent years involve pushing a bunch of costs on to the States. However, although the States could do better on both taxing and spending than they do, they only have a handful of taxes at their disposal, and the States are in the front line of big cost pressures in health and education.

That’s why it was no surprise that the Federal Government just blinked, handing back extra money for hospitals when those earlier cuts were about to bite. In turn, if the official deficit forecasts are therefore optimistic, the same will be true of the debt forecasts.

Finally, it’s worth noting that the above commentary still comes down to my favourite summary of how Australia’s Federal Budget got into this mess in the first place: a temporary boom was spent on permanent promises.

Although Australia’s economy is doing refreshingly well in the circumstances, those words look set to haunt the Federal Budget for some time yet.

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