Commentary 16th Dec 2014

Federal budget deficit climbs to $40.4bn: experts react

The federal budget deficit will blow out to A$40.4 billion in 2014-15, up from the $29.8 billion forecast in May's budget, according to the Mid-Year Economic and Fiscal Outlook (MYEFO) released today.

The government has pointed to falling commodity prices for a A$14.4 billion loss in revenue over the forward estimates, and blamed senate blockages for A$7.2 billion in foregone savings over the same period.

federal-budget-deficit-experts

"We are now witnessing the largest fall in the terms of trade since records began in 1959," Treasurer Joe Hockey said in a statement.

"This has been faster and deeper than anyone expected. Our nation's export income has not been what we expected. For example iron ore, which is one fifth of our nation's export dollars, has fallen from $120 a tonne at the beginning of this year to around $60 a tonne today."

The missed forecasts have led the government to revise its plan to bring the budget back into surplus out to 2019.

Real GDP is forecast to grow at 2.5 per cent in 2014?15, before increasing to near?trend growth of 3% in 2015?16. Hockey today said Australia needed to lift economic growth to 3 per cent and beyond to create more jobs and reduce unemployment.

Weaker wage and employment growth are expected to lower the government's income tax receipts from individuals by $2.3 billion in 2014?15 and $8.6 billion over the forward estimates, with unemployment forecast to grow to 6.5 per cent in 2014-15, falling back to 5.75 per cent in 2017-18.

An additional A$3.7 billion has been cut from foreign aid, which Hockey said was "by far the largest reduction" in the updated spending plan.

Our panel of experts respond below.

Professor Jakob Madsen, Department of Economics

The budget has been in structural deficit since the Howard government, supported by Labor, which reduced the effective tax rate by 3 percentage points in the wake of the windfall gain from the boom in commodity prices, asset prices and income in most of the first decade of this century.

The surplus enjoyed for many years was, to a large extent, temporary and we are now stuck with a structural deficit that neither Labor nor the Coalition have done much to close – in fact, the current government's abolishing of the carbon and mining taxes has worsened the structural deficit and, from an economist's perspective makes little sense.

The hope that economic growth will close the deficit in due course is wishful thinking as the economy is not showing any sign of recovery within the foreseeable future. Furthermore, the falling commodity prices have been converging towards the long-run equilibrium; not bad luck.

The government needs to make a much more credible commitment to reduce the structural budget deficit than it has done to date. If the intention is to do that through savings, then they need to go for savings on large expense items like the family tax benefits and old age pensions.

The hope that economic growth will close the deficit in due course is wishful thinking as the economy is not showing any sign of recovery within the foreseeable future.

Professor Jakob Madsen

Department of Economics

Dr John Vaz, Department of Banking and Finance

MYEFO occurs in the midst of what has been a political nightmare for the government. So much so that the Coalition's credibility in selling these numbers is as shaky as that of the Labor government; much of the criticism made by the Coalition in opposition of Labor is being used by the Coalition as an excuse for missing current forecasts. Factors, such as revenue write downs are central to both Labor and Coalition explanations for missing forecasts.

The government blames the senate and cites $36 billion in savings that are in jeopardy citing some $10.6 billion cost due to savings not achieved in relation to Education reforms and welfare payments frustrated by the senate alone. Astonishingly $7 billion of these lost savings were due to the governments eagerness to remove the Minerals and Resources Rent Tax without finding structural offsets, rather targeting education and social security payments to balance the benefits handed back to the mining sector. Thus the government doesn't appear interested long term structural issues in the revenue side of the budget preferring to pursue initiatives are on the spending side reducing benefits to those who can least afford it facing further senate problems.

The previous and current government have not demonstrated the will to tackle structural issues in revenue and this government in particular seems to think further cuts on the spending side can work; which runs the risk of further economic slow down and worsening revenue.

The government should go back to the Henry review and look at opportunities to improve its revenue position. Some examples include the loophole reopened by the government in relation to salary sacrifice for cars, which costs this budget close to $2 billion per annum, reversing a saving undertaken by the previous government. The missed opportunities (for both governments) include "subsidies" such as capital gains discounts, negative gearing, diesel subsidies for miners, concessional super tax rates for very high income earners using self managed super funds and tax minimisation trusts. This is a political decision that is very costly to long-term revenues. The current government has taken a what is seen as a manifestly unfair stance in its budget (providing the Senate cross-benchers with political oxygen) by targeting welfare payments that hurt those recipients rather than targeting embedded subsidies to those who don't need them.

This article is part of longer piece on The Conversation.

  • jakob-madsen-pr

    Professor Jakob Madsen

    Professor, Department of Economics Monash Business School

    Read more
  • john-vaz

    Dr John Vaz

    Department of Banking and Finance Monash Business School

    Read more