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Deloitte Access Economics Budget Monitor

A forecast miss becomes a fiscal plan…

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29 November 2023:  In the lead up to the release of the 2023-24 Mid-Year Economic and Fiscal Outlook (MYEFO), the Australian economy is in a precarious position. The economy continues to grow, but that is largely due to population growth. Economic activity per capita is in retreat, and there is a growing sense that Australians are no longer ‘getting ahead’ – a function of many years of reform neglect.

In contrast to that gloomy economic backdrop, the Federal Budget is in its strongest position since the Howard-Costello years. Federal taxes are mostly levied on nominal income and spending. While a high inflation environment has put the pressure on household budgets, it has delivered strong growth in the government’s tax base and significant upward revisions to revenue.  

Economic conditions are only one component of the improvement in the budget bottom line. The other component is the Government’s approach to banking, rather than spending, upside surpises in revenue. This approach helped secure a larger-than-expected surplus in 2022-23, and – should the Government be able to keep spending in check – it looks likely to deliver another surplus in 2023-24. Choosing not to spend these upward revenue revisions is starting to look like a fiscal strategy. 

Releasing the November 2023 edition of the Budget Monitor publication, Deloitte Access Economics Partner and report lead author, Stephen Smith, said: “At its simplest, the Government’s fiscal strategy appears to be to project spending in line with relatively conservative revenue projections, and then stick to those spending projections when revenue outperforms.

“In the mining boom in the early 2000s, Treasury consistently underestimated revenue and the resulting upside surprises were spent on everything from personal income tax cuts to baby bonuses. Post‑financial crisis, revenue was consistently overestimated and budgets were burned by downside surprises. Since then, there has been a concerted effort to ensure revenue assumptions are conservative and governments can celebrate revenue windfalls. The difference now, thankfully, is that those windfalls are being banked, rather than spent.

“It’s a recipe for budget repair that’s better at dealing with debt in the short term than with structural deficits in the long term. It might suit an election cycle, but it is not sufficient as a strategy to firm up the foundations of the long term budget position. But an improving bottom line and a propensity to bank revenue windfalls rather than just spending them creates an opportunity to do so much more.

“Successive governments have failed to make the longer term structural reforms on tax and spending that will be needed to shore up Australia’s fiscal health for the long term. If economists and commentators sound like a broken record on this point, that’s only because of the silence emanating from Canberra.”

Deloitte Access Economics Partner and report co-author, Cathryn Lee, said: “As a result of cyclical economic tailwinds, Deloitte Access Economics expects the 2023-24 MYEFO to reveal over $70 billion worth of additional revenue over the next four years, compared to the budget forecasts released in May.

“Treasury’s commodity price assumptions are likely to be conservative, leading to upward revisions in company taxes. High inflation, a strong labour market, and a surging population are likely to grow the personal income tax base beyond expectations.”

Based on policy announcements to date, spending is expected to be modestly higher over the next two years and – should it stay that way – Deloitte Access Economics anticipates an underlying cash surplus of $2.4 billion in 2023‑24, compared to the $13.9 billion deficit that was forecast in the 2023-24 budget. The budget position is expected to return to deficit in 2024-25, but those deficits will be smaller than previously anticipated. In the three years from 2024-25 to 2026-27, cumulative underlying cash deficits are estimated to be $51.4 billion smaller than the official forecasts from May. That is expected to reduce net debt to an average of 20% of GDP over the next four years, rather than the 23% forecast in the Budget.

The problem with a fiscal plan that relies on forecast misses

“Fiscal timebombs are ticking away in plain sight,” Smith said. “It’s no secret that spending pressures will accelerate markedly over coming decades, with the ‘fast five’ categories of costs expected to grow particularly quickly: health, aged care, the National Disability Insurance Scheme (NDIS), defence and interest costs.

“The 2023 Intergenerational Report spelled out the issue clearly. The cost of the ‘fast five’ is expected to increase by 5.6 percentage points of GDP over the next 40 years. But government revenue is expected to increase by just 1.0 percentage point of GDP in that period. That leaves Australia with two reform challenges. First, lifting the revenue base and identifying areas of government spending that can be curtailed to accommodate other priorities, and second, smoothing the transition away from slow growing sectors toward those growing more rapidly.

“A fiscal strategy that simply relies on a fast-growing nominal economy and a disciplined approach to banking the revenue surprises is not an adequate fiscal strategy for the long run.

An opportunity to do so much more

The November edition of Budget Monitor also includes analysis of a number of alternative tax policy settings that were first put forward by Deloitte Access Economics in May 2023: a simpler and lower personal income tax, a broader and higher GST (with compensation for welfare recipients), and a reduction in the capital gains tax discount.

“These policies do not represent an exhaustive set of reform options. They are examples of balanced, meaningful and achievable reforms that would place the budget on a firmer structural footing while contributing to a more equitable and efficient tax system,” said Smith.

Deloitte Access Economics estimates that the three reforms would add $377 billion in revenue over ten years and shift the budget into surplus through 2029-30.

“Critically, the reforms would do more than just alleviate the structural budget deficit,” said Smith. “They would simplify the tax system, lessen the burden of our tax system on productivity, and help solve some of the equity issues and intergenerational concerns stemming from our current tax system.

“Reform is always easiest from a position of fiscal strength. The current three-year election cycle may ultimately be seen as a ‘sliding doors’ moment for Australia.”

The future of fiscal federalism

The Australian Government is not the only one facing long term fiscal pressures. In general, state and territory budgets were hammered by the pandemic, although some fared better than others. Victoria, which endured the longest lockdowns and biggest health costs, saw the most significant budget blowout.

The structure of the federation means the states and territories are responsible for most government service delivery, while the Commonwealth has the capacity to raise the most revenue. The GST was introduced partly to address that imbalance. But the GST rate is controlled at the federal level and 20 years after its introduction, the states and territories once again have limited options to raise revenue.

“With states and territories backed into a corner, there is a growing reliance on the Commonwealth to come to the rescue,” Lee said. “That was true of health costs in the pandemic and performance-based funding to boost housing supply is another example. The fiscal position of states and territories increasingly represents a risk for the Federal Budget.”

“The mismatch between service responsibility and revenue raising capacity is an important and worsening worry, but is also a notoriously difficult area for reform.

A better alignment of spending and revenue raising responsibilities would be helpful. But, sadly, the more likely outcome will be continued ad hoc grants and policy band aids, with some political expediency thrown in for good measure, rather than wholesale reform.