Last Friday afternoon I gave a presentation on the 2015-16 Budget at a private function I organised at the Tattersall’s Club in Brisbane. My slides are available for download (Budget briefing 15 May 15).
Good afternoon. Today I’d like to share my views on the Federal Budget 2015-16, and particularly what it means for us in Queensland. The main conclusions I’ve reached so far are:
- While there were a number of good savings measures, such as lower threshold of assets outside the family home in the pension assets test, the budget has deferred the hard decisions that are ultimately necessary—it has kicked the can down the road—particularly further tightening of the age pension and tax reform involving a broader GST, possibly with a higher rate; and
- while there is much concern that the Budget isn’t supporting the economy at a time it needs fiscal stimulus—a view expressed by the Opposition leader last night—as Peter Switzer put it at the PwC Budget Breakfast Wednesday morning, this can be seen as a “Viagra budget”, with a well-targeted incentive to boost investment.
The Government’s has been smart to rely on accelerated depreciation, a remarkably effective policy, and not instead on infrastructure spending, for example, to provide a boost to the economy. I’ll explain later why I don’t think a big fiscal stimulus is sensible at this time.
Reviewing the forecasts
So let’s begin with the Budget forecasts. We’ve all heard about how reductions in commodity prices and particularly the iron ore price has driven the deterioration in our budget outlook and that is largely true. The Government has also suffered from not being able to get some of its controversial measures such as the GP co-payment and higher education deregulation through the Senate. The combination of these factors means the fiscal outlook has deteriorated relative to last Budget and Mid-Year Economic and Fiscal Outlook (MYEFO). [SLIDE 2] [SLIDE 3]
There is no surplus in the forward estimates, the four years which comprise the official Budget estimates period. These are the years for which the comprehensive Budget analysis is done—i.e. the Government is using detailed program spending and revenue information from Finance and Treasury. But even within the forward estimates years, the final two years are labelled by Treasury as projections rather than forecasts. Treasury basically admits it can’t generate a decent forecast of economic performance in these years so simply assumes that key Budget drivers such as GDP grow at a trend rate, more-or-less consistent with long-run averages [SLIDE 4].
This automatically should lead to some skepticism of the numbers in the projections period. So what about the trajectory to surplus that the Government is talking about? [SLIDE 5] The first sliver of surplus occurs in 2019-20, after the official forward estimates. The medium-term projections are even less solid than the ones at the end of the forward estimates period. They rely upon a bare-bones budget model that was a by-product of the intergenerational report model.
So I don’t really think it’s worth paying much attention to the medium-term forecasts and the Government’s failure to target a surplus in the forward estimates is very disappointing. It’s barely doing much to cut our relatively high level of expenditure to GDP (compared with pre-financial crisis levels) and is relying a lot on revenue increases—largely bracket creep—to reduce the size of the deficit. [SLIDE 6]
I’d note that there is a significant risk that future expenditures could blow out, particularly in social security and welfare, and particularly on the NDIS, which has a major impact on total Commonwealth spending [SLIDE 7]
Bracket creep can certainly fix the deficit but it’s a rather sneaky way to do it, involving effective tax hikes as people move into higher tax brackets solely due to inflation. It’s clear from independent estimates that the Government’s Budget is in structural deficit—but bracket creep will help fix this over time. Also, the new Netflix and Google taxes will help, but bracket creep appears to be the main game.
The Government really should do more than rely on bracket creep, however. We really need to start running big surpluses to pay down the ever-increasing debt. Also, if there is a downturn before the end of the decade, the expected transition to surpluses may not eventuate. Note that the Government’s projected surplus in 2019-20 essentially requires that Australia will have gone 28 years without a recession—a remarkable achievement.
Paying down the debt is very important, even though the debt isn’t that extraordinary in historical comparison [SLIDE 8] and appears relatively benign in international comparison.
But we need to pay down the debt to reduce the interest bill [SLIDE 9], much of which goes in payments to foreign bondholders [SLIDE 10]. Interest on Government bonds, Commonwealth Government Securities, has grown to over $10 billion and will continue to be borne by taxpayers in the future, requiring a higher level of taxation than otherwise to fund.
Also, although the debt is benign in international comparison, ratings agencies have signalled that they are worried about the combination of our growing total public debt [SLIDE 11] and high private foreign debt. I’d rate the risk of losing our AAA rating as low, but it’s something we need to be vigilant about, so it’s best we start the Budget repair as soon as possible.
What did the Budget get right?
It’s been widely acknowledge that the Budget is very good for small business and in my view the small business package has been a well-targeted stimulus package. As has been well known since the work of US economists Dale Jorgenson and Robert Hall in the 1960s, accelerated depreciation is a highly effective means of inducing and bringing forward investment spending. Some back-of-the-envelope calculations I made suggest that the immediate write off of capital equipment, rather than depreciating it over a number of years, could result in an effective price reduction for small businesses of capital goods such as cars, business equipment, et cetera of over 10 per cent. [SLIDE 12] This will no doubt translate into significant additional sales at electronic and car retailers in particular.
The Government was right not to invest huge amounts of money into infrastructure, where it would take a long time to impact the economy and would blow out the deficit. I agree largely with Tony Makin that fiscal policy shouldn’t be used to help boost the economy at the present time, but rather that monetary policy should do the work. In a small open economy with a floating exchange rate, monetary policy is much more potent than fiscal policy. Hence the Government should focus on getting the budget sustainable, rather than using it as a macro-stabilisation tool.
So overall the budget is good for small business, although the small business company tax cut appears poorly designed. As my ESA Committee colleague John Humphreys has pointed out, there is a very high effective marginal tax rate on additional taxable income for small businesses near the $2 million threshold, which could, although likely in only rare circumstances in my view, act as a disincentive to expand [SLIDE 13]. Also, it adds to the complexity of the tax system, for only small benefits.
What are the impacts on Qld?
Let’s turn to the impacts on Queensland. There was some good news in the Budget for Queensland regarding our improved share of GST revenue, from 21.8% in 2014-15 to 22.8% in 2015-16.
This provides some welcome relief, but the Queensland Budget will still be under pressure from possible future write downs in royalties—on which we’re now highly dependent [SLIDE 14]—and declines in specific purpose payments already flagged, as existing agreements come to an end, and, in the future, as new less-generous indexation arrangements apply to health and education funding [SLIDE 15].
With total Commonwealth payments to Queensland to increase only 0.7% in 2018‑19, this will no doubt represent a real decline in Commonwealth funding to Queensland, given inflation in the cost of government services.
With much lower Commonwealth payments in health and education than expected from around the end of the decade, the Queensland Government may have to divert funding from other areas. It will have to run lean and mean outside its core business areas—i.e. possibly not much left over for areas such as state development, tourism or the arts—because there doesn’t seem to be room to divert money from infrastructure which is already low in the forward estimates [SLIDE 16]. This is because the previous Government was expecting $8 billion or so from leased out assets to spend on infrastructure in coming years.
The Commonwealth hasn’t done any favours for Queensland regarding infrastructure, except for the Northern Australia Infrastructure Facility, which in my view is bad policy. The facility will provide concessional loans to nation building projects, but seems to me to be a case of putting the cart before the horse. Is the Government sure that $5 billion of viable projects worthy of public subsidies are out there for Northern Australia right now? I’m doubtful there will be many projects with good business cases, and which would be likely to obtain the necessary environmental approvals, that the Facility could fund. The establishment of the Facility suggests the Government would expect to lend $5 billion, but to do so it might end up funding some dubious projects that turn out to be white elephants.
I expect the Queensland Government will be reluctant to use the concessional loans from the new Northern Australia Infrastructure Facility. It would mean taking on more debt, although possibly it could be taken on by a new government-owned corporation set up for a particular project and would hence not be counted in the Government’s preferred debt measure for the public sector (general government debt), which comes in at under $50 billion compared with the total Government debt figure the previous Government used.
In summary, while the boost in GST revenue is welcome and a great help, Queensland still faces large budgetary challenges and particularly in 2018-19 on current forecasts when Commonwealth payments are likely to decline in real terms. This is also the year the State Government is supposed to be paying down over $1½ billion in debt. Unless we have an economic boom at the end of the decade, I doubt this is achievable on current trends. This is because of the problem with Commonwealth funding and my expectation the State Government will need to spend more on infrastructure than is allocated in the current forward estimates.
For this reason I think it would be sensible for the Queensland Government to support GST reform, which from what I can tell the Queensland Treasurer hasn’t ruled out, and it may be this is what the Federal Government had in mind when it changed indexation arrangements—i.e. forcing the State Governments to support GST reform.
What would I do instead?
So let’s chat about what I would do to fix the Commonwealth and Queensland’s budget problems? Clearly I support GST reform, given it is a very efficient tax [SLIDE 17] Obviously, the family home should be included in the assets test for the pension for both efficiency and equity reasons [SLIDE 18]. Also negative gearing and capital gains tax should be investigated. And super tax concessions could be reduced.
Unfortunately all of these policies would be highly controversial and unlikely to be implemented, although I think changes to negative gearing are more likely than others.
These would be good policies but I don’t think Australia will be ruined if we don’t adopt them. I’ve always believed we need to fix the budget but never though it was an emergency—although creating the sense of urgency can be a good strategy for actually getting something done. I expect we’ll muddle through, in a state of almost permanent deficit but at relatively low levels, on average, hopefully. We won’t do much to pay down our debt, a large part of which is owed to foreigners, and hence future generations will suffer the burden of servicing the debt. This is costly to the economy, given the marginal cost of public funds is much higher than one, but we might put up with it. Given our general level of material comfort, and our new complacency, we’ll think she’ll be right.