One sure thing for Tuesday’s budget: the forecasts will probably be wrong

Politicians may place a lot of weight on budget forecasts, but they’re often based on incorrect assumptions. Lukas Coch/AAP

This year’s federal budget will again illustrate the difficulty for governments in making forward estimates in uncertain economic times.

Forecasting is even more challenging when the federal budget is consistently framed in terms of a “return to surplus”. If we go back to the federal budget of May 2011, a return to surplus (of A$3.5 billion) was expected for the year ending June 30, 2013. The eventual outcome for that budget year was a deficit amounting to $18.8 billion, and the further surpluses forecast for future years in that earlier budget also failed to eventuate.

The deficit for the 2015-16 year, to be released in this week’s budget, is expected by commentators to be between something like $40 billion and $46 billion. Given the confusion caused by so many budget forecasts being made at so many different times, it’s worth revisiting the various estimates made in the original budget papers, and the Mid-Year Economic and Fiscal Outlook (MYEFO), to view the reliability of the forward estimates. Federal budgets include estimates for the ensuing budget year and forward estimates for a further three years.

The estimates of the expected budget outcome for each of the 2015-16 and 2016-17 budget years, as released at various times in the budget papers, are shown below.

The top tab shows the expected budget outcome for the 2015-16 year. While a surplus of $7.5 billion for 2015-16 was forecast in the May 2012 budget, this declined to a narrow $0.8 billion surplus by the time of the May 2013 budget. Twelve months later, the May 2014 budget revealed that the 2015-16 budget bottom line had turned into an expected deficit of $17.1 billion. This was then increased, only seven months later in the December 2014 MYEFO statement, to a deficit of $31.2 billion.

The same declining budgetary trend can be seen in the forward estimates for the 2016-17 budget year (the second tab). While a $6.6 billion surplus for the 2016-17 budget year was forecast in the May 2013 budget, this deteriorated to an expected deficit of $10.6 billion by the May 2014 budget. The estimate of the deficit then almost doubled to $20.8 billion only seven months later in the December 2014 MYEFO statement.

Surplus forecasts are no better

While the above figures focus on budget deficits, it’s easy to forget the relatively recent past when healthy economic conditions resulted in the underestimation of budget surpluses. With each federal budget being released in May for the ensuing financial year, the final outcome becomes known approximately 16 months later. The table below shows the difference between the originally budgeted bottom line and the actual final outcome for the 2005-06 to 2007-08 budget years.

The data shows forecasting budget results over only a one year period has been problematic.

The forecast errors are not confined only to the federal arena — they also apply in state and territory budgets. Take Victoria as an example. In its May 2014 budget, the Victorian government provided a forward estimate of a $3 billion operating surplus (net result from transactions) for the 2015-16 year. But in last week’s budget, that estimate was reduced by a sizeable 60% to an expected surplus of $1.2 billion.

In uncertain economic times, it’s clear forward estimates, certainly for anything beyond a one or two year period, can be unreliable. Forward estimates are simply that — estimates based on certain assumptions when there is considerable uncertainty as to whether those assumptions will ultimately hold.