Tuesday, April 30, 2013

The Budget. What if our prime minister gave a really good speech?

People would make fun of her:

Below the fold is the heart of a truely excellent speech.

Here's my take:

Gillard and Swan have tried everything else. Now they’re trying honesty.

A year ago they locked in permanent increases in payments to families and Australians on welfare worth $1 billion per year to be funded by “spreading the benefits of the boom”.

They made no mention of the possibility that the boom wouldn’t last, whereas the extra payments would continue for ever.

The legislated increase in lightly-taxed superannuation contributions starting in July will cost the government a fortune by the time it is complete at the end of the decade. It was to be funded by a mining tax, one leading economist Ross Garnaut said Monday was deeply flawed and might never raise much money.

The National Disability Insurance Scheme eventually set to cost $6 billion per year was approved with not a whisper how it would be paid for.

As revenue began to fall well short of the forecasts in October the government fudged things, producing a budget update that attempted to make up the shortfall by one-offs such as making some quarterly company tax payments monthly and hoovering up earlier money in unclaimed bank accounts.

All the while its official line was nothing much was wrong. The budget was still on track for a surplus.

Until December when Swan admitted the jig was up and told the truth about the futility of cutting for cutting’s sake, merely in order to announce a surplus (a view endorsed in the past fortnight by his shadow Joe Hockey).

Now the prime minister has laid bare the whole truth. The easy days of Mining Boom Mark I are over and will not return. Company tax reached “an astonishing 5.3 per cent of gross domestic product” in the final year of the Howard government. It is now 4.5 per cent. Capital gains tax was 1.5 per cent. It is now 0.4 per cent.

Normally low inflation might be welcome, but right now it is hurting profits, weighing on investment plans and weighing down the company tax take. Normally strong overseas confidence in Australia would be welcome, but right now it is keeping the dollar high and further denting company profits and investment plans.

The prime minister has levelled with us. She hasn’t said what she is going to do.

In today's Sydney Morning Herald and Age

Julia Gillard:

The back drop to our Budget decision making – Australia’s resilience, global weakness, a persistently high dollar – have been known for some time.

What is new is how strong the revenue pressures on the nation’s Budget are.

We must plan for these strengthening pressures – and that is a key part of preparing our Budget for this year.

The persistent high dollar, as well as squeezing exporting jobs, also squeezes the profits of exporting firms: with lower profits for these companies comes lower company tax going to Government.

We can’t assume this will change soon.

The high dollar is also placing competitive pressures on firms here, who face new pressures from cheaper imports – holding down prices across the board, with the high dollar making it hard for these firms to pass on price increases, holding down profits – and in turn holding down company tax.

Consumers do benefit, but many businesses are doing it tough.

All this means the data on our economy now reveals a significant new fact.

This is the striking and continuing divergence between what economists refer to as real GDP growth and nominal GDP growth.

My best shorthand description of those terms is this.

Real GDP growth is growth in the volume of the economy.

The actual activity in the economy, how many jobs there are, the quantity of infrastructure we build, the amount of goods and services we export – how many tonnes of coal, how many international students pay for a course here, how many houses are built.

Nominal GDP growth counts this growth in volume and it also counts growth of the prices of all these things.

Today, real GDP is growing solidly – we’re creating more jobs, exporting more goods and services and buying and selling more from each other, just as we planned.

However prices are growing at a slower rate than is usual for this stage of the economic cycle, a slower rate than was forecast – and so nominal GDP growth for this current year is significantly slower than was forecast and we expect nominal GDP growth for future years to be revised down.

The current data shows nominal GDP growth after the first half of the 2012-13 year was an annual rate of two per cent.

At Budget last year, we had forecast nominal GDP to grow at five per cent.

What’s changed?

While the prices of our exports continue to be lower than their recent peaks because of weak global demand and increasing global supply, the prices of imports are now lower than forecast because of the strength of our dollar.

The prices of goods produced at home are also lower than forecast because competition from imports is so fierce.

This is now putting so much downward pressure on prices that growth in nominal GDP is actually lower than growth in real GDP.

What’s more, this has now been true for nearly an entire financial year – since the beginning of the June quarter last year.

This has never happened for such a long period in the whole half a century and more of the National Accounts.

Not during the global financial crisis, not during the 1991 or 1982 recessions.

Not even during the Menzies “credit squeeze” of 1961, which was effectively a deliberate policy attempt to slow price growth, do we find a similar effect.

Now, that’s a long explanation of a pretty technical fact.

But for the Budget bottom line, it’s a very meaningful fact – because, naturally enough, companies don’t pay tax on volume, they pay tax on value, which is driven by price.

The Pharaoh might have kept one fifth part of the grain from the field but the Tax Commissioner collects in dollars and cents.

So even if the economy is growing as much as expected, when prices are growing much less than expected, tax grows much less too.

The “bottom line for the Budget bottom line” is this: the amount of tax revenue the Government has collected so far this financial year is already $7.5 billion less than was forecast last October.

Treasury now estimates that this reduction will increase to around $12 billion by the end of the financial year.

This unusually low revenue, which wasn’t forecast even a few months ago, creates a significant fiscal gap over the Budget period.

Put simply, spending is controlled but the amount of tax money coming to the government is growing much slower than expected.

Inevitably, confronted with the facts, the economic simpletons and sloganeers will squirm and throw in arguments to distract.

First, you will be told that revenue for the next financial year is still expected to be more than this financial year. That’s true – at the same time our population will be larger, more people will be on the age pension, health costs will continue to rise.

Indeed the growth in health and in the age pension will be far higher than the growth in tax money.

So revenue growth will be less than natural growth in key areas of expenditure and is spectacularly lower than reasonably predicted.

It is the failure of growth in tax money to match reasonable predictions that creates the Budget challenge.

Second, you will be told it isn’t about less tax money in but about spending.

However... of the advanced Western economies, only Switzerland spends a smaller share of its economy on government than does Australia.

The total size of government here is less than the US, less than the UK.

Not as measured in revenue either, measured in spending.

And let me reiterate, for the future we will continue to match new spending in the Budget with savings.

Given all this, tax money down, spending controlled, the question for Budget planners is difficult to answer, but simple to state: how, and how fast, to fill that significant fiscal gap?

Australia will not go back to the extraordinary revenue peaks of “mining boom mark I” from 2002-03 to 2007-08.

While we should expect revenue to improve as we move to the production and export phase of the current mining boom, it’s clear that the extraordinary revenue peaks of the mid-2000s won't be repeated.

The overall story: by 2005-06 the share of the economy taken in tax reached a peak of 24.2 per cent – compared to 22.4 in 1996 and 22.2 as we reported in our last update in October.

The huge profits of that time meant that company tax revenue reached an astonishing 5.3 per cent of GDP in 2006-07 compared to a share of 4.5 per cent of GDP last financial year – a fall of around $10 billion in company tax a year.

Capital gains tax was 1.5 per cent of GDP in 2006-07 – last financial year it was 0.4 per cent.

We collect less than one-third of the amount compared to seven years ago and in dollar terms the drop in tax collection is around $15 billion a year.

Quite apart from any other factor, remaining competitive in the contemporary global economy doesn’t allow us simply to turn back time on tax collection by dialling up tax revenue to these levels.

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