Treasurer Jim Chalmers has been bitten by the giveaway bug. This budget contains not only the well-foreshadowed tax cuts for all taxpayers, but a range of new spending measures in health, education, infrastructure, aged care and more. There are few savings measures.
There are no new taxes, only the promise of stronger tax compliance from the Australian tax office in receipts. On the spending side the largest saving comes from reduced spending on consultants and contractors to government.
This is bad news for any consultants who evade tax, but good news for almost everyone else.
Chalmers delivered a A$22 billion surplus in 2022-23. Barring some extraordinary disaster, he will deliver another, predicted at $9.3 billion, in the current year.
But it stops there. From the next financial year onwards, the budget year, and the three forward estimates years, it’s all deficits.
In isolation, whether a government has a surplus or deficit is not significant. It is largely a consequence of what are called “automatic stabilisers”. When the economy is doing well, unemployment and its associated benefit payments fall, income and company taxes rise. The reverse happens in a downturn.
For the past two years, the government has reaped the benefits of high employment and a booming iron ore price. To its credit, it has chosen to bank most of that windfall. It could keep doing that – but at a high political cost.
A key factor has been that notorious villain, bracket creep. As people’s incomes rise, they move into higher tax brackets and pay more income tax.
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Eventually taxpayer patience is tested, and governments feel obliged to deliver back some or all the creep in the form of tax cuts. That inspired the previous government’s Stage 3 tax cuts, which have found their way, following much modification, into the latest budget.
This, together with Treasury’s forecast on iron ore prices, are the main reasons why there is less of a windfall for the treasurer to bank in 2024-25. He is faced with new spending programs to deal with cost of living, energy transition and housing pressures.
On top of that, the budget reveals traditional Labor priorities in terms of spending on health, infrastructure and education, and some bipartisan ones like defence. It is little wonder the deficit has grown to $28 billion in the budget year, $42.6 billion in 2025-26.
The budget laid bare
The story is laid bare by the wonderful reconciliation table in Budget Statement 3.
This table sets out what changes to the budget numbers come from government policy decisions, and what arises from factors outside the government’s control (for example, the outcomes of wage cases, changes in numbers of participants in the NDIS, or natural disasters).
In 2023-24 the factors outside government control added to the budget bottom line by far more than government spending decisions reduced it. In the budget year, 2024-25, this no longer happens.
The net impact of factors beyond the government’s control is only $51 million, hardly more than a rounding error in the budget totals. Government policy decisions reduce the budget balance – that is, they amount to net spending– by $9.5 billion. It is a similar pattern in each of the forward years. That is why we have deficits in those years.
Nevertheless, they are only modest deficits, 1% or less of Australia’s economic output (GDP) in all years but 2025-26 (still only 1.5% of GDP).
If, as the government predicts, inflation drops below 3% in each of the budget and forward years, there is little in the fiscal policy settings to prompt the Reserve Bank to raise interest rates. The far more important drivers of inflation are overseas and domestic business conditions.
Inherently a modest deficit like this is sustainable. If all the forecasts pan out, the government is on track to gradually reduce debt over time. This is important for intergenerational equity, not burdening future generations with the national credit card bill.
In fact, there is potential for unexpected surpluses in future years if the iron ore price defies Treasury predictions and remain high. For years now, Treasury has been predicting iron ore prices will return to trend levels. Eventually they must be right. In any one year though, it’s hard to pick.
What drives this is not Australian domestic demand but China’s.
That is very hard to predict. It does appear China’s economy has been slowing in recent years, due to changes in domestic priorities.
This could drive down Chinese demand for Australian iron ore and thus prices. But again, it might not. Forecasting China is notoriously difficult. Still, mostly our surprises on this front have been positive – and that might happen again.
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