There's no getting around it: Labor has delivered yet another budget deficit this year. After all the revenue write-downs of recent months, the final figure for 2012-13 came in at -$19.4 billion, and this year the figure is forecast to be -$18 billion. Of course, this time last year, Wayne Swan promised a surplus.
The revenue slump
Why is the budget in deficit? The Treasury says it's mainly because revenue has taken a hit. Labor has held spending increases below 2 per cent. But the shortfall in tax revenues has kept the bottom line in the red.
More broadly, the reason for the decline in revenue is the now-familiar story of falling commodity prices and a high Aussie dollar. This means that nominal GDP is actually less than real GDP — a “highly unusual combination” that has crimped company profits and hurt tax revenues. The budget papers argue that “had tax receipts stayed at the share of 2007-08, the Budget would have been in surplus from 2012-13”.
So what's driving the ongoing weakness in many parts of the economy? The dollar. It's no secret that the persistently high Australian dollar is hurting exporters, as well as those businesses that compete with imports, particularly in the manufacturing, education and tourism sectors.
The Budget papers include a special break-out box on the topic, which bluntly states that “the persistently high dollar is creating acute and enduring challenges in many sectors and is weighing heavily on profitability and prices across the economy”. One of the most “acute” of these “challenges” is profitability. Non-mining profits essentially flatlined in 2012, punching a huge hole in federal company tax revenue. And that's a big reason why nominal GDP is so anaemic. Profits represent around 40 per cent of nominal GDP, so with profits way down, nominal GDP is too. Budget Paper 1 tells us that “through-the-year nominal GDP growth was below real GDP growth for the third consecutive quarter in December — its longest period of relative weakness on record.”
The economy: from “patch-work” to “transition”
According to the Budget papers, the economy is in good health. GDP growth is forecast to be 2.75 per cent in 2013-14 and 3 per cent in 2014-15, while unemployment is forecast at 5.75 per cent. Inflation will remain moderate, giving the Reserve Bank more space to cut interest rates if necessary; the Consumer Price Index is forecast to remain firmly in the RBA's target band at 2.25 per cent.
Last year's Budget was big on explaining Australia's so-called “patch-work economy”. This year, the Treasury says the Australian economy is undergoing two large-scale “transitions”. One is the transition from the investment and construction phase of the resources boom, into the production phase. Huge mines and natural gas plants are just starting to come on line and start exporting their lucrative raw materials. The Budget papers forecast a 30 per cent increase in non-rural commodity exports over the next three years, and that's even before the LNG starts to flow.
The second transition is to “non-resource drivers of growth”. As the mining investment boom slacks off, other sectors are expected to help out. Policy-makers have long hoped that the housing sector will be a key player. The Budget papers say that "after a decade of lacklustre growth in housing construction, conditions are favourable for a sustained recovery". Treasury points to a range of factors that could spur the sector, including demographics, low vacancy rates, high rental yields and low interest rates. However, in a reference to the difficulties of export sectors struggling with the high Aussie dollar, Treasury says that “the transition underway in the economy may not be seamless”.
Where are the pre-election handouts?
There aren't any. Labor has largely avoided a traditional pre-election spendathon on marginal seats and swinging voters, instead placing its emphasis on long-term social welfare reforms in schools and disability care. As a result, there are few of the usual sweeteners, cash handouts or tax cuts voters have come to expect in an election-year budget.
Gonski, Disability and the path to surplus
Rather than focus on the immediate spending plans of 2013-14, Labor has framed this Budget for the longer term. Many measures are presented over multiple years, and there is provision for the implementation of the national disability insurance scheme that won't properly begin until 2019. There's also billions of dollars promised in future years for the Gonski schools funding reforms.
In funding these commitments, Wayne Swan has made significant savings. The government says that both the disability insurance scheme and Gonski are fully funded. This has been done beyond the forward estimates, in some cases out to 2023. Big savings include various revenue increases (like the rise in the Medicare Levy) and spending cuts (such as abolishing the Baby Bonus).
Hence, despite the extra spending, Labor says it has a “sensible pathway to surplus” which will see a $10.9 billion deficit next year and a small surplus in 2015-16.
Why were the budget forecasts so wrong?
You're probably wondering why Treasury gets its forecasts so wrong, so consistently. Wayne Swan certainly must be: the unexpected cratering of tax revenues is the main reason he has deficit egg on his face tonight. Treasury Secretary Martin Parkinson has also apparently been looking into the matter. He's commissioned an internal review into the way the department makes its forecasts.
The results of that review are provided in a special appendix to Budget Paper 1. It's a mea culpa, of sorts. “Macroeconomic forecasts are always subject to a margin of error,” it admits. The average error in Treasury growth forecasts going back to 1990 has been 0.9 per cent. Given that growth in an average year is 3 per cent, that's quite a lot. An extra per cent of growth this year would go a long way to alleviating Swan's deficit problem. One per cent less growth would have seen unemployment starting to rise.
On the other hand, Treasury does get it right, most of the time. It was Treasury, remember, that came up with the advice for a big stimulus program in 2009, at a time when many right-wing economists argued that fiscal stimulus couldn't work. To give the boffins their due, their forecasts generally get the direction of a given trend right, but fail to pin down an exact number. Nor can Treasury foresee “black swan” events like the Japanese tsunami, or a US debt default brought on by a bickering Congress.
In the end, forecasting something as complex and unpredictable as the Australian economy is pretty difficult. Treasury says it does about as well (or as badly) as other forecasters overseas.
The government says it will implement $43 billion in savings including the $16.4 billion announced in the 2012 mid-year economic and fiscal outlook. These can be split into revenue increases, and spending cuts.
All these figures are “over the forward estimates”, in other words, out to 2016-17.
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