Saturday, May 04, 2013

Why it'll be a near $10 billion deficit, with lots of small cuts

Not as dramatic as you've be led to believe

A mere ten days away, Wayne Swan’s sixth budget is nowhere near complete.

Last minute decisions and rapid responses to deteriorating conditions have become a hallmark of what he and his department have put themselves through each May.

Two weeks ago Europe’s carbon price collapsed, robbing the budget of $5 billion per year after Australia links to the European carbon price in 2015.

While not quite working around the clock (as did happen during the global financial crisis) staff in the Treasury building are working until midnight and sometimes beyond in a last-minute scramble to find money and politically acceptable savings, arriving back hours later wrung out.

Until January Jim Chalmers was Wayne Swan’s chief of staff. He says while no six consecutive Australian budgets have been framed in more challenging circumstances, this one is especially difficult.

“It’s the dramatically lower expected tax take,” he says. “If this one makes the necessary room for the schools plan and disability care despite falling company revenues it will be more difficult to land than the others but will arguably have bigger socio-economic dividends.”

His bugbear is forecasting. “It’s like throwing darts at a moving dartboard in a stiff wind,” he says.

The Treasury is being blamed for the revenue forecast spectacularly wrong. As recently as October it was forecasting revenue down only $2 billion on what it expected last May. It is now likely to be down an extra $12 billion, an extraordinary deterioration for an economy not actually in an economic downturn.

The events since October couldn’t have been foreseen and weren’t, despite of queue of critics lining up to say they always thought the revenue forecasts were fanciful.

“The critics were right for all the wrong reasons,” says former Treasury official Stephen Koukoulas, who also briefly worked as an economic advisor to prime minister Gillard.

“Well good on them. They said the budget wouldn’t get back into surplus this financial year and it won’t. They deserve to go to the top of the class for their forecasting ability. Except that their reasons were wrong. They thought the economy would be a lot weaker than the Treasury thought. It isn’t. Treasury got economic growth pretty much right"...

What Treasury didn’t get right, what no mainstream forecaster foresaw, was that the Australian dollar would stay high as the prices for Australian exports fell.

“It hasn’t happened before. The terms of trade and the dollar typically move together. If you had been within Treasury arguing that the terms of trade were going to fall 13 odd per cent but that the dollar was going to remain high at about 103 US cents no-one would have believed you. You would have been laughed out of the room. It made no sense.”

The high dollar removed the cushion Australia had previously enjoyed whenever export prices fell. The full force of the collapse in late 2012 flowed straight through into Australian dollar income. Company profits shrank. Budget revenue slipped behind target.

That the high dollar is an vote of confidence by international money markets is cold comfort.

So too is the continuing boom in mining investment notwithstanding some high-profile cancellations.

The more that resource companies spend building new plants the more they more they cut their taxable income. That their taxable income is already being hit by an unprecedented combination of lower prices and a high dollar makes the hit to Wayne Swan’s budget all the more painful.

A weaker outlook for resource prices would normally be expected to curb mining investment, but the big projects already underway can’t easily be stopped. In time the canceled projects will benefit immediate tax revenue, just as the completed projects will boost long term revenue. But that’s in the future. Right now Swan’s budget is wearing the pain of an investment boom without reaping the benefit.

And the mining tax itself has raised nothing like what was expected, in part because the government didn’t fully understand what it had signed up to when it sat down around the Cabinet table with the chiefs of BHP Billiton, Rio Tinto and Xstrata. A second tax measure, introduced at the same time, is doing better. The government extended the existing offshore petroleum tax to the North West Shelf and to onshore petroleum. It’s doing so well that the Coalition plans to keep it should it win office, while axing its better-known cousin.

The financial task facing the government isn’t as big as it would have you believe.

It has promised not to make up the $12 billion the budget has fallen short, suggesting it’ll forecast a deficit for this financial year and for the next of around $10 billion to $12 billion. Compared to previous years it’ll be a good outcome. The deficit for 2011-12 was $43.7 billion.

To get there all it has to do is to pay for its new measures with cuts or extra taxes. The big new measures are the National Disability Insurance Scheme and the Gonksi education reforms to the states. The 0.5 per cent extension to the Medicare levy announced this week gets it much of the way.

“It isn’t financially difficult, it’s politically difficult,” says koukoulas. “They only need a few billion, but finding that without annoying people - in an election year - will be awfully hard.”

“I have seen the Treasurer and Finance Minister put up good ideas and have minister after minister knock them down. The process is exhausting. What starts out as a big measure ends up small.”

The cuts to superannuation tax breaks announced early ahead of the budget are a case in point. After considering measures that would have raised it between between $500 million and $1 billion per year, the government settled on a package that made $900 million over four years. Tellingly it received few complaints from the superannuation industry.

“They ended up with a few crumbs off the table,” Koukoulas says. “If they had gone in hard they could have easily got another billion or two and hurt very few people. We would have forgotten about it by now and they would have got a big chunk of cash.”

Koukoulas thinks the government’s reluctance to offend means the big budget decisions are already known. What’s left will be a multitude of small measures, each offending someone, but most of them not too much.

Reports on Friday suggested the government was unlikely to go after the massive $3 billion paid to the mining industry in diesel fuel rebates. The rumours themselves were enough to spark a advertising campaign hammering the message that taking money from mining is “a really dumb idea”.

It’ll go after easier targets, some of whom fear even worse under the Coalition. The public service will get another so-called “efficiency dividend”.

What it won’t be able to do is to lie. Even a minor fudge would be found out. On Monday August 12 the Governor General will issue writs for the election. Ten days later the heads of treasury and finance have to release what’s known as PEFO - the pre-election economic & fiscal outlook. A creation of the former treasurer Peter Costello as part of the Charter of Budget Honesty PEFO has to represent their own views, free from the dictates of political masters. With a change of government likely they will have every reason to call it exactly as they see it. Fiddles will be exposed, which is why there almost certainly won’t be any.

The heads of departments might even go further, offering their own views as to whether finances are sustainable beyond the standard four years of “forward estimates” included in the budget. Such an assessment would be appropriate given that many of the budget measures will have a life of well beyond four years, including the National Disability Insurance Scheme.

And if the heads don’t do it, the Parliamentary Budget Officer will. The new post, set up as part of the agreement with the independents gives former finance department deputy secretary Phil Bowen the right to report on whatever he chooses. Within weeks of the budget he will deliver his assessment of whether it is in sustainable balance, and for good measure he will look back ten years to examine whether previous budgets were.

Calculations released by the Australia Institute on Saturday show the six successive years of personal income tax cuts kicked off by the Howard government in 2003 are costing revenue $38.9 billion per year. The cost over and above the price of merely indexing the tax scales so people weren’t pushed into higher brackets is $25 billion per year.

Swan has a week and a bit to get the pieces to fit. The document needn’t be printed until Sunday. The final piece of the forecasting puzzle - the exchange rate assumption - won’t be settled until Thursday or Friday. He will rise to his feet on Tuesday.

In today's Sydney Morning Herald

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