Deloitte Access Economics Budget Monitor

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25 November 2024:  Over the past few years, the themes underlying Deloitte Access Economics’ Budget Monitor commentary have carried a consistent message: relying on ‘unforeseen’ revenue upgrades is not a sustainable fiscal strategy. That axiom has rarely been more relevant than it is right now.

Releasing the November 2024 edition of the Budget Monitor publication ahead of the 2024-25 Mid-Year Economic and Fiscal Outlook (MYEFO), Deloitte Access Economics Partner and report co-author, Cathryn Lee, said: “Adopting conservative commodity price assumptions has regularly delivered substantial revenue upgrades to the federal budget for much of the last decade. During the term of the current government, for example, each of the four budget updates that have been published to date have revealed $80 billion in revenue upgrades, on average.

“Those upgrades have been the driving force behind the recent, extraordinary short-term swing from pandemic-induced deficits to the first consecutive underlying cash surpluses in almost two decades.

“The government still deserves credit. Most of the ‘unexpected’ revenue which has flowed into federal coffers over the past two years has been saved rather than spent. That has required discipline, particularly given the calls for more cost-of-living support that have reverberated throughout the community during that time.

“More generally, however, over the last two decades both major political parties have fallen short of the standard of fiscal rectitude necessary to ensure the long-term health of the federal budget. The structural budget position – that is, what the budget balance looks like after correcting for the swings and roundabouts of the economic cycle – is in deep deficit, meaning that without cyclically serendipitous commodity price booms, a surplus is out of reach.

“This is exactly what is playing out in 2024-25. While Australia appears to have achieved the much-vaunted soft economic landing that policymakers had been seeking, the federal fiscal position is returning to Earth with a thud.”

Deloitte Access Economics Partner and report co-author, Stephen Smith, said: “It has already been revealed that the 2024-25 MYEFO will see Treasury downgrade expectations for company tax relative to the forecasts set out in the 2024-25 Budget released in May. Deloitte Access Economics’ forecasts in this edition of Budget Monitor go further, predicting a worsening of the underlying cash deficit forecast for 2024-25. A deficit of $33.5 billion is anticipated, compared to the official forecast of $28.3 billion.

“If realised, that would represent a deterioration in the budget bottom line of more than $49.3 billion following the $15.8 billion surplus inked in 2023-24. That stunning turnaround in Australia’s fiscal fortunes would be the largest nominal contraction in the underlying cash balance on record, excluding the pandemic-hit budget of 2019-20.

“Worryingly, there is little to suggest that the situation will right itself in the years to come.

“The longer-term pressures facing the Commonwealth’s fiscal position have been well documented by the Parliamentary Budget Office and in the projections published one Intergenerational Report (IGR) after another. The latest IGR, published in 2023, noted the federal budget’s underlying cash balance is expected to deteriorate by almost 3% as a share of the economy over the next four decades.”

Stephen Smith said: “In the United States, Donald Trump’s emphatic victory is impossible to either ignore or deny. Exactly how that mandate is deployed is still a matter of considerable uncertainty. Should substantial tariffs be slapped on imports into the United States, including at rates of up to 60% of goods from China, Australia’s federal budget will not be immune. The Chinese economy is already reeling from a dislocation of the property market, high debt levels and worsening structural challenges such as a declining population. An enormous glut of tens of millions of unsold residential properties is weighing on prices and undermining housing construction and steel demand. In turn, Chinese demand for Australian iron ore is flagging.”

Given its reliance on commodity prices via company tax receipts, the federal budget may well be relatively more exposed to these issues than the Australian economy more generally. The Department of Industry, Science and Resources currently expects iron ore prices to fall by 12% over the next two years.

Lee added: “The composition of the Australian economy means it will always be more exposed to global commodity prices than most other developed economies. Even so, building a more resilient federal budget with a firmer structural balance and with better safeguards against commodity price exposure is possible, but it requires change. Chalk that up as another reason why productivity-boosting economic reform and substantive changes to the tax system are desperately needed.

“There have been steps in the right direction. Recently announced aged care reforms and the new $900 million National Productivity Fund both represent good policy, alongside the energy transition reforms that are underway. It’s also been great to hear the Treasurer talk more about Australia’s productivity challenge and the need for reform in recent speeches.

“However, more generally, there has been a lack of substantive economic reform in Australia over a period stretching more than two decades. That has resulted in a coddled and cosseted economy bereft of competitiveness and dynamism. Economic and productivity growth are moribund and real incomes are declining, while income, wealth and intergenerational inequality has morphed into a broader schism through Australian society.

“The time will come for changes to tax. It must. Economists know that proper tax reform, done correctly, can be good for the economy, good for the prosperity of Australians, and good for the budget. But if triggering tax reform requires a crisis of the scale which besets Australia’s housing sector, for example, it may be too little too late. In the meantime, governments hoping to continue to unveil ‘surprise’ revenue upgrades year after year will be disappointed. Australia needs a more sustainable fiscal strategy.”

The more the Future Fund changes, the more it stays the same

Establishing the Future Fund as Australia’s sovereign wealth fund was one of the better decisions of government in the last two decades. Since its inception in 2006, the Future Fund has generated an average annual return of 7.7%, adding more than $165 billion in value. It is well run, well regarded, well established and highly performing.

Stephen Smith said: “Australia’s economic institutions like the Future Fund should not remain static. Indeed, as the Federal Treasurer likes to note, they should be regularly ‘renewed’, ‘revamped’, ‘reformed’ and ‘refocused’. But any changes need to be justified and made for a specific reason. And where an institution is, like the Future Fund, performing well, the bar for making changes should be set very high.

“It is not obvious that the Federal Government’s new Investment Mandate and Statement of Expectations for the Future Fund meets that threshold. In fact, the changes raise more questions than they answer.

“The updated Investment Mandate retains the existing benchmark rate of return of at least the consumer price index (CPI) plus 4-5% per annum over the long term. It also retains the same expectation that the Future Fund determines an ‘acceptable but not excessive’ level of risk.”

Smith added: “Unlike previously, however, the new Investment Mandate requires that the Future Fund has regard to national priorities including supporting an energy transition, increasing the supply of residential housing, and delivering improved infrastructure.

“Until now, the Future Fund Board of Guardians has had sole responsibility for determining the investment strategy, as well as the asset and geographic allocation of the portfolio. That is now changing, and the Future Fund is becoming less independent as a result. That is true even though the wording of the new Investment Mandate makes clear that having regard to these national priorities does not require the Future Fund to deviate from its obligations to maximise returns over the long term.

“But if having regard to these national priorities can be consistent with maximising returns, why has the Future Fund not invested more in these areas in the past?

“Equally, if the new Investment Mandate doesn’t change the benchmark risk or return, and doesn’t strictly require investment in a specific area – in other words, if it changes nothing – then why was it published?

The Future Fund is large and impressive. But it is dwarfed by the size of Australia’s superannuation sector, and global capital markets more broadly. The superannuation sector manages several trillion dollars of assets and has a penchant for investing in long-lived alternatives with stable returns of the sort broadly consistent with the national priorities listed in the new Investment Mandate.”

As such, Deloitte Access Economics would argue that there is already sufficient capital available for investments in the national priorities, without requiring the Future Fund to tip in extra. Further, in the case of residential property, additional capital is unlikely to do much to lift the number of new dwellings in the short term given that the constraints which are holding back additional development rest largely on the supply side, with high materials costs, a lack of workers, and poor construction sector productivity.

Like anyone balancing both risk and return, the Future Fund invests in a portfolio of assets. Not all these investments will earn the requisite return – some will earn more, and some will earn less. The expected return is the average. Does the new Investment Mandate encourage the Future Fund to adjust its portfolio to incorporate lower-return investments in national priorities, while taking on higher-return (and therefore higher risk) investments elsewhere such that the overall return is maintained?

These questions highlight that, while keeping economic institutions relevant is a wise and worthy ambition, the specific rationale for the Federal Government’s new Investment Mandate and Statement of Expectations for the Future Fund appears elusive.

Stephen Smith said: “Reform should seek to bring change. But the explanations of these reforms – from both the Federal Government and the Future Fund – have restated that, ultimately, the risk, return, independence, strategy, portfolio and role of the Future Fund will stay the same. That inherent inconsistency is hard to reconcile. Indeed, a better explanation of why the Future Fund requires ‘refreshing and renewing’ would go a long way to building broader consensus for the changes put in place by the Federal Government.”

An election looms. Will spending surge?

When it comes to putting together a budget, politics matters. Indeed, elections are often a time for popular spending policies aimed at maximising votes. That may be particularly true ahead of a federal election that looks like it will run much closer than many had expected not long ago.

So, will a government that has shown respectable spending restraint over the course of its first term remain disciplined as the political blowtorch is applied? There are reasons to be optimistic, including because there are economic limitations to the amount of spending that can be rushed out the door over coming months.

Cathryn Lee said: “As several recent elections around the world have shown – from the United States, the United Kingdom, France, Japan and India, among others – the politics of inflation is diabolical for incumbents. As such, the balance between spending and inflation will be front of mind heading into an election in the first half of 2025.

“Governments have limited options for dealing with elevated price growth. While big spending can help to ease the pain for households, it also fuels the very problem it is trying to fight. At the same time, severely cutting spending can help to take the pressure off inflation, but risks alienating voters who are struggling with cost-of-living pressures.”

At a minimum, Deloitte Access Economics expects a range of cost-of-living relief to be renewed for the 2025-26 financial year. And there will be pressure on both the government and the opposition to promise more to support households in what is likely to be a fiercely competitive campaign.

Lee added: “With speculation that the next federal budget will be handed down after the election rather than before, the figures in the 2024-25 MYEFO will take on added meaning for the campaign ahead. The challenges, however, will come once the election is over, with the difficult task of removing household support (and increasing measured inflation in the process), dealing with emerging deficits, and tackling the longer-term structural issues that remain a challenge for the budget. The possibility of a swelling cross bench and minority government might make those tough decisions even harder.”