Sunday, February 24, 2008

The surplus that isn't

Access Economics and the Business Council of Australia have warned the Treasurer Wayne Swan that the previous government left the nation's finances in much worse shape than had been believed.

Calculations prepared by Access for the Business Council's pre-budget submission show that the Coalition left Australia with an “underlying” or “structural” budget deficit of $11 billion, rather than the surplus it had claimed.

The Treasury calculates but does not publish its estimate of the structural deficit, which indicates where the budget would be had Australia’s terms of trade been growing at their long trend rather than jumping as a result of the minerals boom.

The Treasury was projecting a $14.4 billion budget surplus for 2008-09 in the last months of Coalition rule, but Access says that once “$26 billion in boom effects” is stripped away the Australian budget is heading for a structural deficit of $11 billion...

Around $7 billion of that deficit will result from the $7 billion in tax cuts promised by the Coalition during the election and due to be delivered by Labor in July.

“The previous Government’s fiscal policy so far through this amazing cycle could be summarised as ‘spend the lot’,” Access says in this morning’s report.

“As fast as the boom in profits has generated a tax windfall, the previous Government parceled it back out again as tax cuts and increased spending, notably the ‘barbeque stopper’ increases in family benefit payments and baby bonuses.”

“The resultant recent mix has seen lax fiscal policies as federal and state governments have spent their share of the commodity and housing booms together with tight monetary policies as the Reserve Bank attempts to reduce capacity pressure in the economy.”

“That combination – with one policy accelerating and the other braking – is almost the exact opposite of what is required in an economy with stretched housing prices and a large current account deficit amid a commodity boom.”

Access says that if commodity prices stumble, “it will be evident that the huge policy spend of recent years has been made on the back of a temporary surge in revenues.”

If commodity prices return to their long-term trend government revenues will fall $24.7 billion and expenses will climb $1.5 billion.

While demand for Australian commodities is likely to remain strong in the period ahead - perhaps permanently – the report says “that won’t save today’s commodity prices”.

“For most commodities, supply is still barely bigger than it was a handful of years ago. Yet that is increasingly changing. And when supply does start to catch demand, then commodity prices could fall – perhaps substantially so”.

The Access Economics report says that while the Australian Treasury has assumed in its pre-election forecasts that coal and iron ore prices will fall, it has also bravely assumed that company tax collections will remain high.

“The Treasury is assuming profit tax collections will permanently rise faster than profits themselves,” it says.

“Booms are often assumed to last forever. The official fiscal forecasts emanating from the US at the height of the boom proved to be wildly optimistic. So too did those in Japan at the height of its late 1980s property boom.”

“The policy response of recent years has been to spend this windfall. And the windfall is still getting larger rather than smaller.”

“But economics – the iron triangle of demand, supply and price – suggests that this windfall will ultimately prove to be temporary.”

In its pre-budget submission the Business Council calls on the government to freeze spending for the next three years in real terms in order to deliver cumulative savings of $32 billion.