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Federal budget deficit climbs to $40.4bn: experts react

Treasurer Joe Hockey and Finance Minister Mathias Cormann say the government’s mid year outlook sets the path to budget recovery. AAP/Lukas Coch

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.

“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% 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% 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% in 2014-15, falling back to 5.75% 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.

Richard Holden, Professor of Economics at UNSW Australia Business School

The key message from today’s MYEFO is not that the budget outlook is materially worse than predicted. And it’s not just that iron ore and wheat prices have fallen a lot in recent times.

In the wake of this, tax receipts are forecast to fall by $6.2 billion this year and $32 billion over the next four years. This is because a shockingly large proportion of Australian government tax revenues come from company and personal income tax. This is out of whack with other OECD nations, distorting and inefficient, and exposes us to the whim of commodity prices.

The main takeaway is that to avoid volatility and inefficiency of tax receipts we need to shift our tax mix from income taxes to consumption taxes, with appropriate compensation for less well off individuals.

Jakob Madsen, Xiaokai Yang Professor of Business and Economics at Monash University

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.

Margaret Mckenzie, Lecturer, School of Accounting, Economics and Finance at Deakin University

The budget deficit “blowout” is worth less than 1% of GDP. In principle it could be due to chance, but the government placed so much emphasis on the budget that it has been obliged to highlight it. The MYEFO points to slower than expected growth in nominal GDP (current dollars) of 1.5% compared with on track and “solid” growth in real GDP (adjusted for price changes) of 2.5%. The slower growth in nominal GDP is attributed to a higher than expected fall in the terms of trade, including “significant falls in prices of iron ore and coal, and weaker wage growth”. This implies a lower rate of inflation. Normally a government would find this attractive in the context of Australia’s good real GDP growth. But instead the statement has a flavour of desperation of about it. The subtext is that the government may be relying on bracket creep whereby inflation raises marginal tax rates.

What the MYEFO also reveals is the fragility of prediction. Commodity prices are always volatile. Australia’s dependency on commodities and the continuing absence of a strategy for reducing this is shown up. The corporate tax fall attributed to commodity price falls is estimated at $2.3 billion in 2014-15. This is not nearly so large as the tax foregone by repealing the carbon tax which earned $6.6 billion for 2012-13 alone. Ironically a fall in demand for coal is partly attributable to other countries including China seeking cleaner energy.

Again weaker wage growth could be met with approval by this government. But together with weaker employment growth, income tax receipts are lowered by $2.3 billion and “increase payments for existing government programmes”. The actual estimate for the increase in social security and welfare is not given in the overview, and is apparently buried in Table 3.22 as $4.3 billion. None of these items is large in the context of a total tax take estimate of around $386 billion and expenditure of $423 billion in 2014-15.

*Ben Phillips, Principal Research Fellow, National Centre for Social and Economic Modelling (NATSEM) at University of Canberra *

As was expected the budget deficit for 2014-15 has increased substantially and the return to surplus has been pushed out beyond the forward estimates. The reasons are largely due to changes in the all-important economic parameters. Lower terms of trade, wages growth, national income more broadly and higher unemployment are all powerful drivers of the deficit. These are the same culprits that have led to continual revenue write-downs since the global financial crisis in 2008.

The difficulties in the senate are also causing significant problems for the government with substantial dollars unable to be booked as savings in the budget update. The Treasurer does get around this in part for some measures such as the freeze to family payments and eligibility thresholds for various government allowances and payments by shifting the freeze by one year into the forward estimates. This means that while savings won’t be banked for 2014-15 these savings will effectively be made up for by extending the freeze for 2017-18.

The major driver of Australia’s budget challenge is the economy post the global financial crisis and the heavy reliance on income taxation. While incomes in Australia grew by 23% in real per capita terms in the 6 years prior to the GFC we’ve had zero growth since. Since the GFC, government revenue has followed the income stream but government expenditure has followed the pre-GFC expenditure stream.

Given the superior borrowing and repayment capacity of government relative to households and business it makes sense for government expenditure to help smooth out economic fluctuations. That said, deficits are now becoming a more substantial issue and on current policy settings the risk is that debt will continue strongly at the same time as we face the fiscal headwinds of an ageing population and no obvious replacement for the mining boom.

While spending restraint is important, consideration must be given to the revenue side. Revenue as a share of GDP is below long term averages while expenditure is moderately above average. The revenue base was fine under the easy economy of last decade but is unlikely to be sustainable into the future. The Tax White Paper will hopefully be the starting point for a national conversation on the need for taxation reform in Australia that will lead Australia to a more sustainable and fairer base. In the absence of serious tax reform future budgets will inevitably cut into services and the income safety net for those in most need.

*Lawrence Abeln, Dean of the Business School at University of Adelaide *

The government has blamed the declining terms of trade for a large part of the problem, but of course these are always cyclical so there is a bigger underlying issue.

There are three main factors that have caused the increase in the deficit:

1) Weaker corporate earnings and therefore less business taxes mostly due to a 30% decline in iron ore and other commodity prices.

2) Weaker growth in wages and pressures on employment. Wages have only grown 2.5% and employment will be constrained with weak commodity prices. I expect our unemployment rate will be in the range of 6.5% next year.

3) Reduced capital investments which limit new projects, cause hiring freezes in commodity firms and other companies dependent on those on firms for their growth.

The figures confirm we are too dependent on natural commodities as an engine of our economy and we need to diversify to focus on the export of services, technology, education and other goods that reflect the advantages of the Australian economy.

Our over emphasis on government regulation and labour markets are affecting our competitiveness. We are a very high wage economy and have not seen the translation of higher wages into productivity gains. And in fact a World Economic Forum report indicated that our labour markets were too rigid. We ranked 136th for the rigidity of its hiring and firing practices and 132nd for the rigidity of its wage setting. Our overall global competitiveness fell to 22 in 2014 according to the World Economic Forum.

Australia ranks low in patents and service related trademark applications, and so we could do more to encourage innovation and the creation of new goods and services.

We should use our borrowing capacity in the world markets to make important strategic national investments to foster future growth, increase employment as well as to expand our exports. In particular we need to invest in ways to transform our economy to be less commodity dependent and instead to give us a comparative advantage to export more in technology, education, and other services.

*John Vaz, Course Director Master of Applied Finance at Monash University *

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 $36B in savings that are in jeopardy citing some $10.6B cost due to savings not achieved in relation to Education reforms and welfare payments frustrated by the senate alone. Astonishly $7B 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.

Ross Guest, Professor of Economics and National Senior Teaching Fellow at Griffith University

The MYEFO only confirmed that the Treasury and government accept what we’d already been told by independent experts: the Federal Government budget is shot. There is no prospect with the current level of taxes and array of spending programs of getting spending and revenue back into line within a decade and probably longer.

The government has been hopeless at explaining what this means. Talk of “deficits” and “debt” is a waste of time - they might as well be talking Spanish. Voters think: that’s your problem not mine. The government needs to make it clear that it is our problem. It means we will face higher taxes and/or weaker government services in future. And the longer we leave it the worse it will get due to compound interest on the debt.

The next, much bigger, task facing the government is to condition people to the reality that we need a major new source of tax revenue and higher levels of existing taxes. Spending cuts will not do the job alone. This is a political marketing task that is utterly beyond the skill set of this government. We need a combination of higher GST and an inheritance tax. Taken together this would be equitable with relatively (compared to other taxes) little damage to incentives to work, save and invest.

Susan Harris Rimmer, ARC Future Fellow, Asia Pacific College of Diplomacy at Australian National University

The impact of the savage aid cuts will be overshadowed by the Martin Place siege. But the $3.7 billion cuts, the largest multi-year aid cuts ever, coming after the equally savage cuts in May are also a tragedy for thousands of people Australians will never see, never know, never feel empathy for.

Australian aid helps extremely poor people in our neighbouring region. It can always do better, but we have learnt lessons over the past 40 years and Australian aid does good things. We do save lives in emergencies, get kids immunised and off to school, help pregnant women to safe births, show solidarity with our neighbours in their development journey. Cutting our aid budget by one third will hurt poor people.

The government is not cutting aid because of anything to do with the quality of the aid program or the Australians who deliver it, or the actions of host governments. They are cutting it because it is easier to cut than other savings. No dealing with the Senate or big business. No affected poor people to write angry emails or protest outside Hockey’s office. It is a gutless act.

Australia is the 4th largest OECD economy, who just hosted the G20. No one is going to believe we can’t deliver a decent aid budget, because it simply isn’t true. This is a political choice and it is the choice our region will not forgive. And shouldn’t.

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