With all the data in the government’s Mid Year Economic and Fiscal Outlook (MYEFO) for 2016-17 we’re breaking it down for you in seven charts.
The A$0.6 billion drop in the 2016-17 deficit in MYEFO compared with the budget figure from earlier in the year is flattering for the government. It actually misses the big story which is the impact of the unexpectedly lower GDP growth in the September quarter of this year, which fell by 0.5%.
This will put a large hole in tax revenue to the tune of A$5.3 billion, reflected in the fiscal balance but not the cash balance in this financial year. These are the two measures of the budget deficit.
The underlying cash balance, which is the measure in this chart, is a cash measure that records revenue that’s received and expenses paid. The fiscal balance (not shown here) is an aggregated measure that instead records revenue when it’s earned and expenses when they are incurred.
The difference between the two measures is essentially due to timing. This is very important this year given the sudden sharp drop in tax revenue earned by the government in this year, but most of which will not be received until next year.
MYEFO estimates that the fiscal balance worsens by A$4.4 billion this financial year even though the cash balance improves by A$0.6 billion. At least three quarters of the drop in tax revenue is income tax, the remainder being GST and other taxes on goods such as excise and customs duties.
The significantly worsening cash balance in future years, from 2017 to 2020, compared with the corresponding projections in the 2016-17 Budget, reflects the deteriorating economic outlook. The drop in GDP in the September quarter this year was not an aberration. It was due to unexpectedly lower private sector investment, reflected in a drop in business confidence.
This has led to downward revisions to GDP growth over the next few years. MYEFO forecasts GDP growth of 2.75% in 2017-18 compared with a 3% forecast in the 2016-17 Budget. Accompanying weaker GDP growth is slower wages growth and prices for goods and services (see the chart below), which lowers revenue from income tax and indirect taxes (mainly the GST).
On the positive side however, prices of iron ore and coal have been growing much more strongly since the 2016-17 Budget and the subsequent 2016 Pre-Election Fiscal Outlook (PEFO). In the battle between slower GDP growth and rising commodity prices, the former is projected to win, with projected total tax receipts lower by a very large A$30.7 billion over the four years to 2019-20. This consists of about A$20 billion in lower income tax from individuals, A$6 billion from lower company tax revenue and A$5 billion from lower taxes on goods and services.
Slower government spending growth is also playing its part. Over the next four years it is projected to grow slower than GDP. The upshot of the revenue and expenditure revisions is that the projected return to surplus in 2020-21, reflected in the 2016 PEFO, is maintained. This represents an average annual pace of deficit reduction of 0.5% of GDP.
However this crucially depends on the government legislating its very substantial agenda of spending cuts and revenue increases that remain baked into the fiscal projections.
The big ticket items here are the A$2.4 billion of university funding cuts, the A$2.1 billion of cuts to pensions from lifting the pension age to 70, although this would not come into effect fully until 2026, A$1 billion of saving paid parental leave, and against these savings is the child care package that would cost the government A$3.2 billion.
The worst case for the budget bottom line would be to lose the battle on the savings and be obliged to follow through with the child care package, a net effect of at least A$10 billion. This would be the final straw for the increasingly tetchy credit rating agencies, and the end of our AAA credit rating.
The net effect of new budget measures since the 2016 PEFO is to worsen the deficit by more than A$2 billion in total this year and next, and to improve the deficit by about A$1.3 billion in the following two years, hence a net worsening of the accumulated deficits over these four years to the tune of about A$0.7 billion. On the positive side of the ledger is more than A$1 billion in interest payments on the 19 billion of loans from the government to NBN Co for the national broadband network rollout over the four year period.
Similarly the reductions in Family Tax Benefits A and B will save the budget A$1 billion over the four years. Offsetting these measures are additional expenses associated with the Australian Renewable Energy Agency of A$0.6 billion, and spending on infrastructure and regional development of A$0.7 billion, and a host of smaller ticket items.
The unexpected rise this year of 62% in the iron ore price and 100% in the thermal coal price has partially cushioned the effect on tax revenue of the slowdown in GDP. Commodity prices are notoriously volatile and hard to forecast and have large effects on the budget bottom line.
According to MYEFO, a 10% fall in non rural commodity prices could reduce nominal GDP by 1% which in turn would reduce the underlying cash balance by around A$4.6 billion in 2017-18. Changes in commodity prices of 10% are quite common over a 12-month period, or even less, as shown in the chart.
Consequently, Treasury has just announced a change in the way it forecasts commodity prices. Instead of using recent average prices it now assumes a graduate phased return to a long run average which would imply lower price forecasts in over the budget projection period and therefore lower revenue projections.
Wage growth and company profits are important drivers of tax revenue. Wage growth has been moderate and company profits volatile. Both indicators tend to be underlying drivers of GDP growth, so the weaker GDP outcome in the September quarter may well flag more weakness in wages and company profits to come which would in-turn put further pressure on tax revenue.