Path to budget surplus built on shifting foundations

Tuesday, May 12, 2015, 10:08 AM | Source: The Conversation

Warwick Smith

In the lead up to tonight’s federal budget treasurer Joe Hockey and prime minister Tony Abbott backed away from the strong rhetoric of deficit and debt emergencies that accompanied last year’s budget. However, they have still promised “a credible path to surplus” because the government “must live within its means”.

Modest budget deficits can be run sustainably forever and the government’s stated goal of getting to surplus and staying there is a path to economic ruin. But Joe Hockey did promise in 2013 that the Coalition government would achieve and maintain surpluses in its first term, and he’s been held to that ever since.

The budget outlines major new initiatives that will cost a total of $14.6 billion over the forward estimates, tax changes that will cost the budget $1.5 billion and savings measures totalling $11 billion. The net impact on the budget position will be about $5 billion in the red (although they are counting on measures from the last budget that remain stalled in the Senate to fill that gap).

Infographic: 2015 federal budget at a glance

The result of combining the budget measures with Treasury’s economic forecasts gives us a budget deficit of $35.1 billion in 2015-16, $25.8 billion in 2016-17, $14.4 billion in 2017-18 and $6.9 billion in 2018-19 for a total of $82.3 billion over the forward estimates. The budget is projected to be in surplus in 2019-20, a point well beyond the confidence of even the most foolhardy of economic forecasters. The surplus will be primarily achieved by allowing bracket creep to increase the tax-to-GDP ratio every year across the forward estimates from 23.9% of GDP in 2014-15 to 25.9% by 2018-19.

Margin for error

Economic forecasting is similar to weather forecasting. The system is complex and the links between the things we can measure now and future outcomes get weaker and weaker the further out the forecast or projection. We can tell with a pretty high degree of confidence what tomorrow’s economic conditions will be like, but once you start talking about next year we might as well be playing pin the tail on the donkey. No serious economic forecaster would tell you otherwise.

Importantly, the scale of the impact of the announced measures pales in comparison to the potential impact of external factors on the budget bottom line. Statement 7 of the budget, a section that few bother to read, reveals that the 90% confidence interval for the estimate of the 2015-16 budget balance is 3.5% of GDP (or $60 billion). That’s next year. Once we get out to 2016-17 that confidence interval doubles to 7% of GDP (more than $120 billion). In other words, Treasury is 90% sure that the 2016-17 budget balance will be somewhere between a $45 billion surplus and a $75 billion deficit.

As an illustration, in the five months since the government’s Mid-Year Economic and Fiscal Outlook (MYEFO), revenue estimates have fallen by $20.1 billion over the forward estimates. That forecast deterioration occurred in less than six months and is larger in scale than the total savings outlined in the budget across the forward estimates.

Does the budget represent a credible path to surplus? I think credible implies a lot more confidence than actually exists. Plausible might be a better word. Ultimately though it’s the wrong question to ask. We don’t actually need a credible path to surplus; we need a strong and robust economy. It is possible that we will be in surplus by 2019-20 as the budget suggests but previous budget outcomes tell us that the projection for 2019-20 has about as much chance of being accurate as I do of being struck by lightning on my way home tonight.

Rather than focus on budget balances in particular years, we should adopt measures that make our economy more robust. Modelling can help us with that. A robust economy can be supported by measures that keep the economy diverse and nimble, improve productivity, encourage sustainable and productive economic activity and create jobs. A few of the government’s measures tick some of those boxes but most are just a mix of housekeeping and window dressing.

As John Maynard Keynes said, “look after the unemployment and the budget will look after itself”. If you listen to the rhetoric, the government seems to agree. The word “jobs” is everywhere in the budget. However, actual measures that will result in greater employment are thin on the ground.

Confidence challenge

The flagship childcare package announced on Sunday aims to increase labour supply by nudging more parents into the workforce. However, in the absence of job creation, this is a pointless exercise because job seekers currently far outnumber available jobs. The same goes for the measures that tighten compliance conditions and increase penalties for job seekers.

The infrastructure programs, the tax cut for small businesses and the friendlier arrangements for start-ups will contribute somewhat towards the goal of job creation but will hardly be transformative. The changes to wage subsidies will have some impact on employment at the margins but are mostly just re-bundling and reorganising of existing measures with no new net expenditure. Business confidence is very low which means tax cuts and other benefits provided to small business are likely to be saved by many.

Nothing in this budget is likely to significantly improve business confidence, which is driven by weak demand. Clearly the budget modellers agree, as there appears to be negligible impact on jobs growth or the unemployment rate in the forward estimates despite the big headlines about “Growing Jobs”.

Similarly, the budget summary document highlights the importance of productivity growth for our future prosperity but the entire 152-page budget measures document mentions productivity improvements only twice and one of those is in relation to the now defunct East-West link road project in Melbourne.

The government’s recently published Intergenerational Report painted a grim picture of our future public finances but, as the Australia Institute’s executive director Richard Denniss pointed out, this grim scenario is constructed by assuming that the government will cut taxes every year from 2020 onwards. If they didn’t cut taxes they’d be flooded with revenue from bracket creep. In other words, the budget is in serious trouble - unless we increase revenue a little bit – in which case it will be fine. There is no economic problem here, there are only political problems.

Shh… don’t tell anyone, just keep talking about the deficit.

The Conversation

Warwick Smith does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.

University of Melbourne Researchers