MYEFO – Page 2 – Digital Finance Analytics (DFA) Blog

Monday’s MYEFO will look good, but…

An appallingly perfect storm is brewing for the federal budget:

a government with much more income than expected
a federal election due within months
a government well behind in the polls

With the election all but announced for May, next Monday’s Mid Year Economic and Fiscal Outlook (MYEFO) will be the effective start of the campaign.

The latest figures put the government’s budget position about A$10 billion better than was expected when it was delivered last May.

The budget has been gifted much higher revenues from corporate income taxes, almost entirely driven by mining companies selling more than they expected (at higher prices than they expected) to China.

A stronger than expected domestic economy has also helped, producing small upside surprises in various other taxes and cutting the need for government spending.

In the past six months the stars have aligned to hand the government a virtual war chest with which to fight the election.

A full MYEFO, then an election budget

Prime Minister Scott Morrison has laid out the timetable.

MYEFO is due on Monday December 17 and an early Budget will be handed down on Tuesday April 2, days before the government is expected to call the May election.

In announcing it, he promised to deliver a budget surplus in 2019/20.

This tells us two things, firstly, that he has zero interest in bringing that surplus forecast forward to the current financial year, 2018-19; and second, that that surplus is unlikely to be materially different from what Morrison previously forecast (as treasurer) in May.

That will give him room to make some very expensive announcements.

With as much as (or more than) an extra A$10 billion per year to play with, Morrison’s ministers will be rubbing their hands together working out how to get the most electoral bang for the bucks.

Endangering the budget long term

This does not bode well for government finances beyond the next few years.

Highly targeted spending measures aimed at improving election prospects are rarely the best use of public funds.

New spending commitments in the just past few months are set to cost the budget just under A$500 million this year, rising to almost A$1.5 billion next year.

Spending all or most of the extra money that’s pouring into the Treasury coffers risks creating a budget black hole if the sources of that revenue prove to be temporary.

A slowdown in Australia or a drop in China’s demand for raw materials could take a big chunk out of the budget.

The damage to the government’s finances after the global financial crisis was only partly the result of spending aimed at averting a recession.

We now know a big part of the surge in revenues in the years before the crisis were temporary.

The increased spending and repeated lower taxes they funded were permanent, creating a structural budget deficit that has taken a decade to repair.

As mentioned, the latest upside surprises on revenue are largely due to strong commodity prices and a rising tax take from mining companies.

They might vanish as quickly as they appeared.

Commodity prices are notoriously volatile and almost entirely dependent on what is happening in China.

Problem: China

Perversely, China is buying more of our commodities because it has upped spending on infrastructure to boost a slowing economy under threat of trade war.

The boost in infrastructure spending won’t last.

Eventually we will see a shift in the drivers of Chinese growth towards domestic consumption and business investment and away from metal-intensive infrastructure spending.

It will curtail the growth of our exports and weaken our corporate income tax take.

Dark clouds are forming at home as well.

Problem: Australia

Bank profitability has stopped growing, and the indications from the Hayne Royal Commission are that bank profits will be challenged over the next few years as remediation costs rise and lending slows.

And then there is housing.

While not a direct source of revenue for the federal government, the fall in house prices could start to bite into economic activity as early as next year.

While consumers have so far looked past the lower house values, that is likely to change in 2019 if prices continue to fall.

It’d be wise to hang on to the extra billions

The best economic approach would be for this government to save money and leave it for the next government to use them prudently as needed.

It’s certainly not going to happen.

Centre right governments tend to characterise unexpected bumps in revenue as belonging to the citizenry and to be given back.

They usually do it in the form of income tax cuts. We should prepare for substantial fresh income tax cuts, from as soon as July 1, 2019.

Control of the Treasury is one of the most important weapons available to a political party contesting an election.

Having a prime minister who spent several years as treasurer only enhances the weapon.

The government’s timeline for MYEFO and the April budget suggests they fully intend to use it.

Author: Warren Hogan , Industry Professor, University of Technology Sydney

MYEFO – There’s a Consumer-Shaped Hole in Our Budget

On first blush, the revised federal budget has improved according to the MYEFO (Mid-Year Economic and Fiscal Outlook) released by the Treasurer today. But consumers are the weak link, and wage growth and consumption a problem – no wonder there is now talk of tax cuts for consumers! In addition, more savings are forecast, including an extension of the waiting period for newly arrived migrants to access welfare benefits and a freeze on higher education funding.

The budget is, they say, on track to return to balance in 2020-21, and overall debt as share of GDP is set to fall further. The latest projected surplus of $10.2 billion in 2020-21 is an improvement of $2.7 billion compared to May’s Budget estimate.

At the 2017-18 Budget, gross debt was projected to be $725 billion in 2027-28. Gross debt is now projected to reach around $684 billion by 2027-28 — a fall of around $40 billion. But absolute debt is still rising!

The improvement is driven by a rise in company profits, and company tax take. Commodity prices helped also, although they remain a key uncertainty to the outlook for the terms of trade and nominal GDP, especially in relation to the Chinese economy.

They say the fall off in mining investment is easing, while non-mining business investment is predicted to rise (a little), but we think overall business investment remains an issue.

Real GDP is forecast to grow by 2.5% in 2017-18, lower than at budget time (2.75%). Beyond that, real GDP is forecast to grow at 3% in 2018 19, per the original budget.

The 2017-18 forecast is lower driven by anemic outcomes for wage growth and domestic prices. More than 360,000 jobs at a rate of 1,000 jobs a day having been created in 2017. Yet, wages are now forecast to remain lower for longer, with index growth of 2.25% in June 2018, 0.25% lower than at budget time, and 2.75% to June 2019. They admit wages growth is lower than expected, but they still hope lifting economic momentum will lift wages, eventually – despite the very high levels of underemployment, and structural changes in working patterns. This lower forecast for wages is expected to weigh on personal income tax receipts and slow household consumption.

Finally, the assumed Treasury yields are set quite low, for modeling purposes. Rising rates in the USA and elsewhere may lift rates faster.

MYEFO – Underlying Cash Deficit of $40.4 Billion is Now Expected in 2014-15

The Government published their mid-term review today. Since May, two key factors have primarily driven the $43.7 billion deterioration in the budget over the forward estimates: the impact of the economy on tax receipts and payments; and the impact of the Senate’s decisions. Primarily as a result of the collapse in iron ore prices by over 30 per cent and weaker than expected wage growth, tax receipts have been revised down by $31.6 billion. Government payments have also been affected. Delays in passing legislation and negotiations with the Senate have cost the budget more than $10.6 billion over the forward estimates, keeping debt and interest payments higher for longer. An underlying cash deficit of $40.4 billion is now expected in 2014-15 (2.5 per cent of GDP), narrowing to a deficit of $11.5 billion (0.6 per cent of GDP) by 2017-18.

Overall, the outlook for real GDP growth is unchanged since Budget. Real GDP is forecast to grow at 2½ per cent in 2014-15, before increasing to near-trend growth of 3 per cent in 2015-16. This reflects the expectation of solid growth of real activity in the economy continuing.
However, the changes to the economic outlook since the Budget are driven by the sharper than expected fall in the terms of trade, including significant falls in prices of iron ore and coal, and weaker wage growth. While the forecasts for solid real GDP growth are unchanged, the prices we receive for our production have declined significantly. Accordingly, nominal GDP growth in 2014-15 is expected to be weaker than forecast at Budget, at 1½ per cent. This would be the weakest nominal GDP growth in a financial year in over 50 years.

Iron ore prices have unexpectedly fallen by over 30 per cent since the Budget. MYEFO assumes a free-on-board iron ore price of US$60 per tonne over the next two years, which compares with a spot price of US$95 at Budget. The fall in iron ore prices has led to company tax receipts being revised down by $2.3 billion in 2014-15 and $14.4 billion over the forward estimates. At the same time weaker wage and employment growth are expected to lower individuals’ income tax receipts by $2.3 billion in 2014-15 and $8.6 billion over the forward estimates. Weaker wage and employment growth will also increase payments for existing government programmes. Excluding policy changes, total taxation receipts have been revised down by $6.2 billion in 2014-15 and $31.6 billion over the forward estimates. This brings the total writedown in tax receipts since the Government was elected to over $70 billion. To avoid detracting from economic growth, the Government has let the impact on the budget from sharply lower iron ore prices and slower wage growth flow through to the bottom line, rather than taking decisions to cut expenditure dramatically or increase tax.

The 2013-14 MYEFO showed that, without action, the budget would not return to surplus for a decade, and debt would reach $667 billion by 2023-24 and still be rising. Despite the deterioration in the fiscal outlook over the forward estimates, the medium-term outlook for the budget is considerably better than a year ago. Debt is now projected to be nearly $170 billion lower than it would have been by 2023-24 and to be falling. The underlying cash balance is projected to reach surplus in 2019-20, with the surplus reaching 0.8 per cent of GDP by the end of the medium term, including future tax relief being incorporated from 2020-21. This remains a considerable improvement from the 2013-14 MYEFO projections.