Budget improving now, but tough decisions still to come

The recovery in the Australian economy over 2022 has somewhat repaired the budget, as high energy prices, rising inflation and Australia’s robust labour market combine to boost tax revenue. 

However, the Budget has also been delivered in the context of rapidly escalating economic risks, and inflation remains front of mind. Today’s Consumer Price Index (CPI) release for the September 2022 quarter showed inflation at new heights, with the CPI increasing by 1.8% in the quarter, and by 7.3% through the year. 

 Relative to the official forecasts released in March 2022, the stronger-than-predicted economic backdrop has tipped an additional $164.1 billion of revenue into the Federal Government’s pockets over the next four years.

Some of that windfall has been spent, with spending expected to be $126.1 billion higher over the next four years. That’s partly due to an increase in the cost of governing – via higher inflation, wages and interest rates – as well as additional spending across various areas of social policy.

The increases in revenue outweigh the increases in spending in the near term. As a result, underlying cash deficits are expected to be smaller in 2022-23 and 2023-24 by $41.1 billion and $12.5 billion respectively. This improvement in the budget bottom line is welcome news. 

However, those gains are temporary. Higher spending and an assumed decline in commodity prices mean the underlying cash deficit is now expected to be $10.7 billion worse over 2024-25 and 2025-26. A significant, structural deficit will persist for the remainder of the next decade and beyond.

Wider risks to the outlook are rising, as the global economy faces a serious and significant downturn. 

The United Kingdom and Europe are likely already in recession, while a recession in the United States now looks very difficult to avoid and growth in China is slowing. Budget decisions today should be made with the dangers of higher inflation, rising interest rates and a potential global recession front of mind. The budget handed down yesterday broadly passes that test by not adding significantly to spending in the short term (a neutral fiscal policy pairing with a tightening of monetary policy). 

Pessimistic commodity price assumptions baked into the budget – including an 86% reduction in thermal coal prices over the next six months – mean that additional write ups in company tax may be announced in future Budgets. Even so, achieving repair over the coming Budgets will be tough.

The budget papers show an embedded deficit equivalent to around 2% of GDP stretching over the next decade. If Australians want the Government to continue to fund existing programs and meet the cost of a long list of important spending priorities – from aged care and childcare, to disability care and defence – we must be prepared to either pay higher taxes over time or find equivalent savings in other areas to maintain fiscal sustainability.

The Federal Budget October 2022 included a modest set of savings, but it also in large part kicked the can down the road, laying the groundwork for a much tougher set of decisions to be made in the next Budget in just seven months’ time. The May 2023 Budget may be more difficult for the Treasurer to navigate.

Click here to see our detailed Budget analysis.