theguardian.com, Friday 7 November 2014
The economy is not strong enough to withstand the spending cuts and tax hikes to secure the treasurer’s promised surplus
Joe Hockey may have some bad budgetary news coming up for the prime minister, Tony Abbott. Photograph: Lukas Coch/AAP
Joe Hockey’s commitment at the National Press Club in 2012 that “we will achieve a surplus in our first year in office and we will achieve a surplus for every year of our first term” is long gone.
It is a distant memory with the outlook for the budget deficit this year, and in the next two years, much wider under the stewardship of the treasurer than the one he inherited from the Labor government in September 2013. What’s more, the path to budget surplus is at least two years behind what Labor was budgeting for when it framed its policy outlook ahead of the 2013 election.
As 2014 draws to a close, there is one significant economic policy statement to come before year-end. Treasury is working on its economic forecasts and budget matters which will be released in the mid-year economic and fiscal outlook. Hockey has indicated that the MYEFO will be released around mid- December, after the release of the September quarter national accounts. This will allow the economic forecasts underpinning government revenue and expenditure estimates to be recast to reflect the most up-to-date readings on where the economy has been and where it and the budget measures are forecast to go.
On the basis of existing policy settings, the MYEFO is likely to show a deterioration in the budget bottom line, that is, the budget deficit estimates are likely to be larger than assumed at budget time in May and the move to surplus will be push back a year or two.
These wider budget deficits will be due to a mix of the economic parameters being weaker than assumed when the budget was framed in May, but also due to policy decisions taken by the Abbott government which have undermined the revenue base and boosted government expenditure.
Importantly, the economy is skating along at a sub-trend growth pace. The budget was forecasting real GDP growth of 2.5% for 2014-15, but with household consumption and business investment growth faltering, this looks a best case. Critical for government revenue is income tax and recent trends in the labour market are well short of the estimates at budget time. In particular, the budget forecasts of 1.5% jobs growth in the year to June 2015 with an associated 3% rise in wages, is now out of reach.
More likely is employment growth around 0.75% and wages growth is set slide to a fresh all time low near 2%, particularly when the public sector wage increases under 1.5% over the next three years filter through the economy. This will leave the number of people employed and actually paying income tax short of the budget forecasts, while low wage increases for the 11.5 million people in paid work will mean tax will be lower than the budget was assuming.
The risks are growing that the budget could weaken even further as the economy is impacted by the free-fall in commodity prices and persistently gloomy consumers.
The budget revenue and spending forecasts were based on assumption of iron ore prices remaining above US$100 a tonne and world oil prices (Malaysian Tapis) remaining around US$113 a barrel. Prices of these two commodities have, in recent days, been around US$77 a tonne and US$89 a barrel, respectively. This would not be a problem for the budget if the Australian dollar had fallen by a similar amount to cushion the effect of this decline in prices for some key commodities. Quite remarkably, the Australian dollar has remained firm notwithstanding the recent dip. The budget assumed that the trade weighted index for the dollar would be around 71 index points and it is only a few per cent below this level even though commodity prices are 20 or 30% lower.
For government revenue, this is a problem and it could get worse.
The problems extend to the unemployment rate which has hit its highest level in over a decade and there are no signs of a turnaround with job vacancies remaining weak. An even higher unemployment rate in the months ahead, which seems likely, may force a further rethink from the government about its budget priorities. Rather than pitching for smaller deficits and an early return to surplus, the prudent policy advice to Hockey and the government might be to allow the budget deficit to run its course. The economy is just not strong enough to withstand a further dose of fiscal austerity via a mix of spending cuts and tax hikes.
The economy appears to be set for a further year or two of sub-trend, low inflationary growth prone to rising unemployment. If so, Hockey may have to acknowledge the reality, so evident in the past 5 or 6 years, that a budget surplus relies on strong economy, and he is not presiding over one at the moment and that the budget will and should remain in deficit for every year of his first term.
Stephen Koukoulas is a research fellow at Per Capita, a progressive think tank.
