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Monday, December 14, 2015

MYEFO. The truth will be ugly, but it's what we need

Expect the unvarnished truth on Tuesday, because there will be little point in lying.

Usually the budget and the mid-year budget update are designed to make things look good. That's why this year's budget included largely fictional savings of $67 billion over 10 years held over from the previous budget on the ground that the Senate might one day pass them. 

It's why at a time when the economy was growing by 2.5 per cent, the May budget forecast a jump to 2.75 per cent and then a leap to 3.25 per cent. It's why it assumed a dramatic leap to 3.5 per cent after that, and then assumed growth would stay that high each year and every year right through to 2020-21, even though it hadn't come within cooee of 3.5 per cent in every year but one since the financial crisis.

It'll end on Tuesday. If Malcolm Turnbull and Scott Morrison are wise they'll stop building unlikely Senate decisions into their forecasts and they will be honest about what is happening to revenue.

The May budget assumed an iron ore price of $US48 a tonne for the entire year. It's now $US38 and heading south. And that so-called spot price is calculated on a different basis to the price used in the budget. Comparing like with like, the iron ore price is close to $US35 and heading south, compared to the $US48 factored into the budget. Every $US10 fall in the price is said to rip $2.5 billion per year out of the budget as mining companies deliver lower than expected profits and pay less tax.

The LNG boom was supposed to start paying tax big-time when the big projects started moving gas. But the price of gas is tied to the price of oil. Since the budget it has collapsed from $US64 per barrel to $US35.

And wage growth has sunk to its lowest on record. If it stays near 2.3 per cent instead of climbing to 2.75 per cent as expected in the budget it won't be delivering the extra tax that was expected as more and more of us got pushed into higher tax brackets.

As well, Treasury is going to be more realistic about the future.

Until now, the "secret sauce" in every budget has been the projections...

The first two years of each budget's forecasts are what they seem to be: genuine forecasts. But the numbers following them are often dramatically better. That's because they are "projections", which means are not meant to be taken literally.

Here's how it works. Treasury forecasts economic growth of 2.75 per cent this financial year, climbing to 3.25 per cent next year. That's what it actually expected, and it will replace it with lower figures on Tuesday. Growth isn't yet above 2.5 per cent. But for the following five years it picked an outsized 3.5 per cent, which wasn't a forecast at all.

All of the projections for increased revenue and a steadily shrinking budget deficit from 2017-18 flowed from it. It's the main reason the budget deficit was projected to shrink to zero by the end of the decade. But it's an assumption rather than a forecast.

From two years out Treasury assumes unemployment will fall to 5 per cent over the course of the following five years, because that's the rate it believes unemployment would settle at if everything was working properly. In other words it assumes that things will come right.

For that to happen the economy needs to grow faster than normal for five years. Faster than normal was thought to be 3.5 per cent. It was anything but a forecast, and it's now out of date. So slowly has the economy been growing, partly because of a slowdown in population growth, that Treasury said in November it would revise down the figure to nearer 3 per cent.

The combined effect will be bigger deficits stretching out further than we have previously been told.

Tony Abbott and Joe Hockey would have found it difficult to handle. Only six months ago they were telling us the big budget challenges were behind us. Turnbull and Morrison will embrace it. Like anyone new taking over a job done less than competently, they'll want us to see the full horror of what they inherited.

And they'll want to use it in a way Abbott and Hockey never did to prepare us for tough medicine. Persuading high income earners to part with billions of dollars in unjustified tax concessions would be difficult if everything was rosy. Persuading the states to tax the land on which family homes sit would be difficult if the Commonwealth's finances were on a sure footing.

The mid-year update has come exactly the right time for a government attempting to convince us that things are going to have to change. We need to see a problem before we'll accept a solution. Tuesday's statement will outline the problem. The tax package the government will take to the election will be part of the solution.

In The Age and Sydney Morning Herald