MYEFO optimistic but Australia needs to stay the course on fiscal discipline

The overall MYEFO figures are strong and welcome. But it is crucial that the government should maintain a fiscal discipline and use the improving budget position to pay down its borrowings as fast as prudently possible. That way our nation’s balance sheet will be in a better position to deal with any future negative shock. The government’s overall economic projections present an optimistic picture of the coming next few years – but there are a number of risks and challenges to this outlook which means Australia needs to stay the course on fiscal consolidation.

Wages/consumption

Real wages are projected to grow by over 3 percent per annum in the next 4 years, which we think looks a little on the optimistic side. Moreover, MYEFO assumes that consumer spending will be strong, revising down the 2018-19 figure by only 0.25 percent and maintaining the Budget-time number for 2019-20. The latest national accounts show weak consumer spending and a savings ratio falling to a 10-year low. Since consumption is about 56 percent of GDP, this assumption is crucial to the Budget numbers and the macroeconomic outlook. Falling house prices are likely to be a further drag on consumer spending through the wealth effect. So the assumptions for consumer spending may be too rosy.

Deficit/Tax cuts

MYEFO predicts an underlying cash deficit of $5.2 billion for 2018-19, which is significantly lower than the deficit of $14.5 billion predicted in the 2018-19 Budget in May this year. The biggest factor in this turnaround is the additional $7.5 billion that the government expects to collect in company and individual income tax. Further, MYEFO anticipates the underlying cash balance to be in surplus for every year from 2019-20 through to 2028-29.

While the improving figures are clearly welcome, as a country we still need to generate enough revenue to pay back the government debt built up during the period of deficits. So even though wage growth is still low and personal tax cuts would be welcomed by many, we would warn against giving large tax cuts ahead of going into surplus, which will make it harder to pay back the debt. If the government is now receiving a cyclical gain in tax receipts then history repeatedly tells us it should be banked rather than being used to bake in permanent tax reductions. Tax cuts should be embraced only to the extent that the personal tax system gives rise to bracket creep. If a surplus actually materialised, it would only start the process of paying down government debt. The priority must be to build up surpluses so as to pay down debt more quickly.”

The MYEFO forward estimates to 2021-22 include around $9 billion in revenue reductions arising from measures that the government has decided on, but not yet announced. Once again we caution the need to stay fiscally disciplined.

Spending

From a spending perspective, the most expensive policy decisions taken since the May Budget include the retention of the energy supplement for certain income support recipients, some reductions in waiting periods for new migrants to receive income support payments and the establishment of the Community Health and Hospitals program.

The government has noted real growth in payments of 1.9 percent per annum over the five years from 2017-18. But with annual population growth as a whole expected to be 1.7 percent over that period, real improvements in the service standards would be negligible. When you look at our older population (i.e. 65 years +), that cohort in society is expected to grow by 3.0 percent per annum over the next five years. It is well known that the cost per person to government skyrockets once someone hits their mid-60’s, with high health care, aged care and aged pension costs. So to only be increasing public expenditure by less than 2 percent each year means that service standards for the elderly population are likely to be eroded; unless savings from other parts of the budget can be found to top up those costs.

Tax measures

Of the few (announced) tax-related policy decisions taken since the 2018-19 Budget, a noteworthy item is the expected $3.4 billion in additional revenue that the government expects to collect over the forward estimates period from the extension of the goods and services tax (GST) compliance program.

The acceleration of tax cuts for smaller businesses, and withdrawal of proposed tax cuts for larger businesses, will cost the government a net $1.1 billion over the period to 2021-22, compared to the position anticipated in the May Budget.

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