MYEFO Confirms Hockey Is Lost As The Economic Fog Sets In

Although it has been over-shadowed by the dramatic events in central Sydney, yesterday's release of the Mid-Year Economic and Fiscal Outlook is important news in its own right.

The MYEFO, as everyone abbreviates it, is the half-yearly scorecard that lets Australian citizens know how the government's budgetary policy is progressing. It sets out the state of the nation's finances, allowing us to assess how Treasurer Joe Hockey has been performing.

How has Hockey been performing? On yesterday's figures, poorly.

The government has been giving broad hints in recent weeks that the budget's bottom line has deteriorated markedly. Falling revenues linked to collapsing commodity prices have hit the budget hard.

The headline figure sees the budget deficit balloon to $40.4 billion in underlying cash terms. That's 2.5 per cent of GDP. The deficit is $10.6 billion worse than the $29.8 billion forecast in Hockey's May budget.

The rivers of red ink flow on and on. The MYEFO updates the fiscal outlook to project budget deficits all the way through the forward estimates. To add to the $10 billion this fiscal year, the deficit also blows out by an extra $13.5 billion, $10.2 billion and $8.7 billion in 2015-16, 2016-17 and 2017-18. The budget has been written down a cumulative $43 billion over the forward estimates.

By 2018, the budget deficit will still be around $11 billion. It seems unlikely Australia will return to the black until the first year of the government elected in 2019. Joe Hockey's pre-election bluster about the Coalition's superior fiscal management skills is looking decidedly short-sighted.

The reason for the deficit is plain enough: the Australian government spends more money than it raises in tax revenue. Receipts this fiscal year are estimated to be $379 billion. But payments are $417 billion. With spending at 25.9 per cent of GDP, the Abbott government is indeed spending more than Julia Gillard's government – more, in fact, than every year of the Rudd-Gillard era, except the stimulus year of 2009-10.

These figures show two things.

Firstly, the Abbott government is not truly pursuing austerity. It has not cut spending in any appreciable terms. Spending is up in both real and nominal terms. Since taking office, the government has increased outlays across several different measures, such as fighting another foreign war and giving the Reserve Bank an unnecessary $8.8 billion. Back in 2013, Wayne Swan's final budget forecast government payments this year to be around 24.4 per cent of GDP. Instead, they will be 25.9 per cent.

That's not to say the government hasn't made cuts, of course.

Overseas aid has yet again been slashed – to its lowest level on record. More cuts have been made to health and education. Meanwhile wealthy superannuants, carbon polluters and big mining companies have been rewarded.

The truth of the Abbott government's fiscal policies is not so much a cut in spending, as a redistribution of it – away from the world’s poor and from low- and middle-income families, and towards big business, big polluters and the top end of town.

Secondly, the cause of this fiscal woe is weak revenue. As happened to Wayne Swan, Joe Hockey has found that the revenue arriving in ATO coffers has been much less than forecast. Thus there have been revenue downgrades worth tens of billions of dolars.

The MYEFO papers say that the two main reasons for the revenue shortfall are falling commodity prices and the government’s inability to pass savings measures in the Senate.

Iron ore is a chief culprit. The May budget factored in iron ore prices at $90 a tonne. They're now well south of that, wiping billions from company tax receipts. According to the Treasury, falling iron ore prices will cost $14.4 billion over the forward estimates. The Treasury is now setting its iron ore benchmark at $60, suggesting just how weak it thinks global iron ore demand will remain.

The fall in global commodity prices and the tail-off of Australia's mining boom are impacting the budget in other ways. Family Tax Benefit payments are up, in large part because wages across the economy are down.

“Family Tax Benefits are expected to increase by $3.2 billion over the forward estimates, largely reflecting the impact of lower than expected wage growth which is driving up average payment rates and recipient numbers,” the MYEFO confirms.

All up, the MYEFO is more evidence of the “income recession” that economists like Ross Garnaut have been warning about. As Australia's terms of trade fall, the weakness in our exports is flowing through to slow wages growth and lower company profits. With iron ore, coal and gas prices all falling, the MYEFO states bluntly that the coming fall in our terms of trade will be “the largest fall in the terms of trade in a financial year since the Australian Bureau of Statistic's Annual National Accounts started in 1959-60.” Ouch.

What can Joe Hockey do? In the short-term, not much.

The economy is too weak to sustain a major cut in government spending, as even Hockey himself has acknowledged. Raising taxes would also hurt growth. The other levers that could really help, such as interest rates and the exchange rate of the dollar, are out of the Treasurer's hands.

Even if economic growth were to improve, Australia still has a structural budget deficit.

While neoliberal radicals still argue for a sustained drop in government spending, in the long-term, we will need to raise more taxes if we are to live within our means. Tax reform could help, of course, by broadening the tax base and eliminating costly tax concessions and perks. But tax reform is difficult, as the government found when it made a minor adjustment to fuel excise. 

As a result, the Abbott government finds itself in a difficult political position.

After campaigning so strongly on economic management in 2012 and 2013, the Coalition is discovering that a change of government in Canberra can't magically improve the global factors that increasingly determine Australia's economic wellbeing.

Many will wonder if the MYEFO is being rather optimistic when it forecasts economic growth of 2.5 per cent next year. It could easily be lower than that. If so, unemployment could rise above 7 per cent. And all of this is assuming we don't see any “black swan” events, like a European financial meltdown or political turmoil in China.

At the end of a bruising political year in which the Coalition has spent nearly all of its political capital on a deeply unpopular budget, the government can't claim much in the way of economic success. The economic outlook is flat, or even negative, while the budget itself is even worse than when Joe Hockey took office. 

A weak economy means weak revenues, and that's a political as well as an economic problem for Tony Abbott's government. The Coalition will not have the money to fund extravagant election promises in 2016, and it won't be credibly able to claim it can deliver a surplus either.

And that's the real message of yesterday's report. As in so many other policy spaces, the MYEFO shows that the Coalition's economic policy is hopelessly confused.