On 13 May 2014, the Treasurer, the Hon Joe Hockey MP delivered the Coalition’s first Budget. The Deloitte view and analysis on the Budget announcements and the implications for business will be published in the 2014-15 Deloitte Budget Brief on 14 May 2014.
Welcome to the politics of Budget repair. Australia has just seen the toughest Federal Budget since 1997, with spending cut and taxes raised to generate policy savings on a scale not seen for the better part of two decades. As expected, from a business taxation perspective, the Treasurer has continued to reposition existing tax policies with no major surprises or changes. The more important focus for business will be the White Paper on the Reform of Australia's Tax System, which will provide a longer term considered approach to tax reform and which is due prior to the next election.
The 2014-15 Deloitte Budget webinar will be held at 9am on 14 May 2014. Register for the Deloitte Federal Budget webinar.
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Welcome to the politics of Budget repair. Australia has just seen the toughest Federal Budget since 1997, with spending cut and taxes raised to generate policy savings on a scale not seen for the better part of two decades.
The headlines will be full of the complaints of those affected.
Those complaints will reverberate all the harder because of the uncomfortable political backdrop created by a dangerous divergence: the news on the economy is reasonable, but the news on the Budget is not.
That performance gap creates problems for the Government because the electorate doesn’t understand the need for Budget repair – they see an economy that is OK and wonder why the Budget isn’t.
Yet a tougher Budget has been a long time coming.
For many years a long-running resources boom poured money into Canberra’s coffers, leaving surpluses despite big spending decisions and a series of tax cuts.
However, the impact of the resources boom on the tax take eventually evaporated, whereas the cost of past policies have lingered. Over the past decade both sides of politics made permanent promises off the back of a temporary boom.
2013 was no different. In fact just as Treasury was accelerating the pace of its revenue writedowns, the politicians were accelerating the pace of their bipartisan promises, dominated by disability insurance and school funding.
The end result was deficits as far as the eye can see.
Australia doesn’t need to be back in surplus tomorrow. But we do need a clear path to fiscal sustainability, with the National Commission of Audit pointing out which areas of spending are ripe for cutting, and the Government in this Budget laying out which reforms that political constraints allow it to tackle.
However, for all the heat they are generating, the size of the decisions made by the Government in this Budget are relatively small. In net terms, policy decisions announced in the Budget will drain $36 billion out of Australia’s economy over the four years to 2017-18. Although that sounds big, it is worth placing it in context – it represents just 2.1% of the $1.7 trillion of Budget spending over the next four years, or 0.5% of the $7.2 trillion in national income that Australia will generate across that period.
Or, in other words, the scale of the political reaction to the Budget says more about the good times we’ve had for more than a decade than it does about the actual severity of these Budget cutbacks.
The key to the Budget outlook is nominal GDP. That is because we tax income much more than we tax production (real GDP, the measure that economists usually concentrate on). The big revenue writedowns of recent years came in large part as the nominal economy – which is sensitive to coal and iron ore prices – kept growing slower than Treasury expected.
The Budget update released in late 2013 saw another notable drop in expectations on that score.
The good news is that the economy has since steadied with this year’s Budget featuring relatively small revisions to economic growth forecasts. Six months ago, Treasury forecast gains in nominal GDP of 3.5 per cent this financial year and next. The forecasts in the Budget suggest the ‘size of the pie’ is now slightly stronger than previously expected in 2013-14, with a rise of 4 per cent, but slightly weaker than previously expected in 2014-15, with a rise of 3 per cent.
Indeed, the economy is better than most people realise. Sustained low interest rates are lifting the willingness of families to spend, boosting retail to its best results in years. And the recovery in home building may not accelerate at the ‘pocket rocket’ pace of times past, but it too is set to soar. At the same time that the export phase of the construction boom is accelerating, the national appetite for imports is dimming.
That is a lot of good news. Yet, offsetting that good news, the Budget papers note the fall-off in resource-related construction is gathering pace. So while the good news is that Budget growth forecasts for this financial year have edged up of late amid the strengthening response of retail spending and home building to record low interest rates, the bad news is that – at a real GDP growth rate of 2.5 per cent in 2014-15 – the Budget still sees growth in Australia’s economy stuck a tad below average.
The weakness in the economy left the Budget in deficit in 2013-14, with Treasury estimating the cash underlying deficit at $49.9 billion. With some better economic news recently – for example, company profits have started to get some momentum, partly thanks to low interest rates and, more importantly still, thanks to a lower $A – and the help of the policy measures announced in this year’s Budget, the gap closes next year. That sees Treasury estimating a deficit of $29.8 billion in 2014-15.
Thereafter, the gap closes further, with a projected deficit of $17.1 billion in 2015-16, and projected deficits of $10.6 billion in 2016-17 and $2.8 billion in 2017-18.
Some of that improvement in fiscal fortunes is due to Treasury’s view that the current weakness in ‘profit related’ taxes such as company tax will improve over time. But most of the improvement is due to policy. This includes tightened tests for a range of benefits, the introduction of new co-payments in the health sector, the reintroduction of indexation of fuel excise rates and a temporary high-income levy.
Beyond the usual four-year forward estimates, the Government has also flagged $80 billion coming out of hospital and school funding by 2024-25. That pushes a major part of continuing budget repair onto the states – which in turn may move the GST back onto centre stage of national political debate ahead of the White Paper on Tax Reform.
The path back to surplus is still fraught with risks. One is that the electorate will still need convincing that the measures announced in this Budget should not be overturned by a fractured Senate. Another is that the Budget still remains heavily exposed to the risk of a more significant China slowdown and lower commodity prices.
The politics of Budget repair starts now.