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Deloitte Access Economics Budget Monitor

A second surplus – once more with feeling

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30 APRIL 2024:  The context for the 2024-25 Budget is complex. Much of the global economy has the wobbles. Domestic inflation is in retreat, but is still not quite where it needs to be. The Australian economy is in a precarious position, with household spending and dwelling investment both in the doldrums, and the relief of tax cuts and stronger real wage growth still not realised. On top of that, a federal election is due in the next 12 months or so, meaning this could be the last budget before the writs are issued. 

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 May 2024 edition of the Budget Monitor publication, Deloitte Access Economics Partner and report lead author, Stephen Smith, said: “The highwire balancing act of supporting growth but not reigniting inflation is the stuff of budget nightmares. The Treasurer is therefore right when he talks about a greater ‘degree of difficulty’ in achieving a surplus for a second time, even if at least part of that messaging is surely intended to enable a greater level of crowing when that surplus is announced.

“The underlying cash surplus in 2022-23 – ultimately inked at $22.1 billion – came with a sense of the unexpected. It was the surprise surplus, underpinned by cyclically serendipitous commodity prices and labour market outcomes as Australia emerged from the pandemic.

“Rather than a surprise, a second consecutive surplus would come with a greater degree of ownership and authority. An opportunity, perhaps, for a government to talk up its economic credentials. Indeed, announcing another year with the budget in the black will no doubt be a proud moment for the Federal Government – consecutive budget surpluses for the first time in almost 20 years.

“Although the government should take credit for producing the surpluses, its fiscal plan ultimately relies on banking upside revenue surprises. It’s a short term approach that does little to firm the foundations of the long term budget position.”

Deloitte Access Economics Partner and report co-author, Cathryn Lee, said: “The current string of surpluses is very likely to stop at two. With revenue projected to go backwards in 2024-25 as the redesigned Stage 3 income tax cuts come into effect and cyclical headwinds hit company taxes, the budget will be back in the red next year even if spending holds steady as a share of GDP.”

Smith said: “The fiscal position looks increasingly dire the further out one looks. With a set of known spending challenges looming on the horizon – and the likelihood of plenty of currently unknown spending challenges, too –  the budget needs reform on both the tax and spending side to shore up Australia’s fiscal health for the long term.

“There is still no credible action plan, for example, to suture the extraordinary growth in the cost of the National Disability Insurance Scheme, while the budget allocation earmarked for defence has swollen remarkably. At the same time, the tax system is not fit for purpose – particularly, but certainly not solely, because of its heavy reliance on personal and company income tax.

“Australians will need to pay more tax in the years ahead in order for governments to afford the raft of long term spending promises made by both major political parties. How that tax is raised matters enormously for Australia’s prosperity.”

Lee said: “A second surplus still isn’t a fait accompli, but Deloitte Access Economics is expecting that it will come to fruition. Based on updated economic parameters and policy announcements to 18 April 2024, Deloitte Access Economics forecasts an underlying cash surplus of $13.4 billion for 2023-24 compared to the -$1.1 billion deficit forecast in the 2023-24 MYEFO.

“That surplus will be a product of both further write-ups in company and personal income tax revenue, and spending restraint.

“Company taxes are delivering windfalls because Treasury’s commodity price assumptions are once again proving too conservative. After Treasury added $9.2 billion to this year’s company tax forecast in the 2023-24 MYEFO, Deloitte Access Economics now estimates that stash will be a further $14.5 billion larger.

“The resilience of the labour market means taxes on individuals have also outperformed forecasts. Treasury added $10.7 billion to this year’s individual tax revenue forecast in the 2023-24 MYEFO. Deloitte Access Economics expects a further $5.6 billion to be added to that haul.

“These windfall gains are offsetting write downs elsewhere, with taxes on superannuation funds and the petroleum resource rent tax underperforming. 

“The overall outperformance of the nominal economy compared to the forecasts in the 2023-24 MYEFO is set to deliver the government some $14.8 billion in additional revenue in 2023-24.”

Costs associated with the new policy measures shown in Budget Monitor (only those that have been announced between the 2023-24 MYEFO and 18 April 2024) are expected to add an estimated $6.1 billion to net spending over the forward estimates, including just over $200 million in 2023-24.

Taken together, parameter variations and announced policy decisions (plus an adjustment for the expected change in the distribution of the GST to the states and territories) are expected to increase spending over the four years to 2026‑27 by $0.4 billion relative to forecasts in the 2023-24 MYEFO.

“That result broadly reflects decreases in spending due to parameter variations offset by increases from announced policy decisions and GST outlays,” Lee said.

“There is a list of reasons why government spending needs to be restrained in the short term, from inflation and capacity constraints to the fact that revenue is projected to go backwards in 2024-25 as the redesigned Stage 3 income tax cuts come into effect and cyclical headwinds hit company taxes. Even if spending holds steady as a share of GDP, the budget will be back in the red in 2024-25.” 

An estimated cumulative improvement in the underlying cash balance of $48.2 billion over the four years to 2026-27 will mean another downward revision in the forecast for net debt. Net debt is expected to average 18.4% as a share of GDP over the four years to 2026-27, compared to the 19.8% of GDP forecast in the 2023-24 MYEFO.

The Future Made in Australia policy

Australia’s deep, long term fiscal deficit threatens to be eroded further if new industry policy is poorly designed or poorly implemented.

The Prime Minister’s speech on the Future Made in Australia policy in April shocked many. The reaction from the country’s economists has been swift and loud.

“This is an important debate because the global context is defined by fragmentation, a retreat from globalisation, a narrow nationalism across democratic and non-democratic states, and a new triangulation of economic growth, technology, and national security.  In a world with these dynamics, policy objectives have become more complex,” Smith said.

“Value for taxpayers and return on investment for the economy over the medium to long run is paramount. A policy that violates the largely bipartisan economic orthodoxy requires careful explanation. Indeed, any argument for the Future Made in Australia policy must surely be heavy with nuance, emphasising the complexity of balancing the aims of the policy with its obvious costs.

“But nuance has been sorely missing from the explanation and communication coming from the Federal Government. The justification for the policy is that ‘the world has changed’, that ‘others are doing it, therefore so should we’ and that ‘protectionism is the new competition’. Meanwhile, critics have variously been labelled flat-earthers, out of touch with reality, or simply out of their depth.

“That is not nearly good enough. The Future Made in Australia policy is unlikely to stack up when considered using orthodox economic models because it will impose economic costs that outweigh the economic benefits.

“Solar panels built in Australia, for example, will be more expensive than those that can be purchased from China. There will only be a market for Australian-made panels if the price of Chinese-made panels is artificially raised by tariffs, quotas or other distortions in the market.

“Why would the Federal Government seek to implement a policy which will impose higher prices on Australian consumers and greater costs on the Australian economy? The only conclusion is that Future Made in Australia is not an economic policy. That is, those advocating for the policy must be taking a broader view of the costs and benefits than orthodox economic models would imply. The costs of the policy are clear. But what are the benefits?

“If, for example, there was a risk that Australia would not be able to obtain solar panels from China in the future because of a bifurcation of global trade, the implications would be significant. This is a lesson from the pandemic that must loom large in the minds of policymakers.

“A proper debate on the Future Made in Australia policy must focus on the costs and benefits of both doing nothing – if the world has changed – alongside the costs and benefits to taxpayers and consumers from intervention.

“To date, the case for the Future Made in Australia policy has not been made, and the debate has been too narrowly focused. A wider and more detailed explanation of the policy merits by those arguing the case is sorely needed.”

What (and what not) to do on housing

Budget Monitor also includes some analysis to assist in ‘debunking’ two tax reform ideas that are at the forefront of the current policy debate on Australia’s housing challenges. Those policies are lowering the capital gains tax discount from 50% to 33.33%, and abolishing the ability to negatively gear residential rental income.

Deloitte Access Economics has analysed these two policies in terms of their effect on both the housing market and the budget (assuming that the policies would be phased in gradually over five years). These reforms would have a small, positive fiscal impact – jointly raising some $12.1 billion over the next three years, and in the order of $13.5 billion per year a decade after the change.

“These reforms would modestly reduce house prices, although they are hardly game changers for housing affordability,” Smith said. “But while the economic arguments for a lower CGT discount are robust, abolishing negative gearing is a red herring in the housing debate.

“Modest improvement in housing affordability could be worth pursuing if the reform made broader economic sense, as is the case with the CGT discount. But it’s not worth pursuing at the cost of additional distortions in the tax system, as is the case with restricting negative gearing for certain investments.

“Negative gearing is largely only a housing problem through its interaction with an overly generous CGT discount. The incentive to hold a loss making investment property only exists because of the ability to earn an undertaxed capital gain. If capital gains were taxed at a fairer rate, the incentive to make annual losses on an investment property would diminish significantly.

“Finally, it’s not clear that there are equity concerns around existing negative gearing arrangements. Just under 50% of taxpayers with gross rental income in 2020-21 recorded a net rental loss. This ratio was only slightly higher for taxpayers in the top tax bracket, at 53%. That suggests high income earners are not overrepresented in taking advantage of negative gearing.”