What should we be looking for in #Budget2017?

1 May

Jeremy Thorpe - Economics and Policy Partner

It is easy to get caught up in the cut and thrust of the plethora of budget initiatives, the endless debate about the Budget surplus/deficit, and then the inevitable distillation of the budget commentary down to the ‘who wins/loses’ headline.

Instead, when thinking about the Budget this year, we suggest that there are 4 somewhat interrelated questions that we should be asking about the Budget and the initiatives that it contains.

1. Has it rebuilt trust in the budget process?

Recent years have seen increasing distrust in government and the consequent move to the protest oriented political movements.1

It would not be unreasonable to view the Budget as one of the prime examples where the public may feel let down.

There is, quite rightly, a natural scepticism of the Budget when the claimed budget position by both Labor and Coalition Governments has been so consistently wrong, and so consistently wrong on the downside. As the figure below shows, in recent years, the Budget forecast and the claimed return towards a Budget surplus has been consistently overstated.2 That is, the past seven Budgets have all been overly optimistic about the fiscal position of the Commonwealth.

Source: Treasury

This is not to say that the expectation should be that every forecast, or even any forecast, is perfect. The reality is that forecasts will differ from the resultant reality given that:

● the Budget is a political document which needs Parliamentary support for its implementation, and this may not be forthcoming

● macroeconomic forces shift and hence the assumptions upon which the Budget is constructed may not eventuate as expected.

Given these challenges, two specific questions are worth addressing in any assessment of the 2017 Budget:

● Are we confident that the ‘zombie measures’ have finally been killed off? Zombie measures are those claimed savings that need Parliamentary support to crystalise, but where there is no obvious case that there will be support coming from the Senate’s opposition parties. As shown in the following figure, the Government’s continuing reliance on such zombie/unlegislated measures from two Budgets ago reinforces the message that the Budget headline is being massaged for a positive headline rather than painting a true sense of the national government’s fiscal position.

● Are we confident in the assumptions underlying the Budget’s macroeconomic projections? Forecasting is not a perfect science, and errors are always to be expected. However, when underlying assumptions are well out of alignment with market expectations, with a consistent bias to suggesting an improved Budget position, it is reasonable to demonstrate a little less faith in the Budget process.

 

Source: Parliamentary Budget Office

2. Is there an embedded bias towards growth?

Lower growth is the new global norm. Indeed, PwC’s The World in 2050 report notes that:

The world economy will slow down over time, with a marked moderation in growth rates after 2020.

We project annual global economic growth to average around 3.5% over the next 4 years to 2020, slowing down to 2.7% for 2021-2030, 2.5% for the decade after that, and 2.4% for 2041-2050. This will occur as many advanced economies experience a marked decline in their working-age populations. At the same time, emerging market growth rates will moderate as these economies mature, which is consistent with academic research on the tendency for growth rates to ‘regress to the mean’ in the long-run.3

Australia’s growth too will be lower in coming years than we have seen over past decades, even though it will be propped up by population growth.

Why is low growth an issue?

For one thing, it means that Australian companies will have fewer opportunities to grow domestically, driving their focus overseas to growth markets. While this could be seen as a positive outcome, the increasing irrelevance of the domestic market, with increasingly uncompetitive tax system, means that we are at risk of losing companies to overseas (i.e. moving manufacturing/production and management overseas). Think the South Australian experience of a hollowed-out economy (now with only one ASX100 company), transposed onto the whole of Australia).

When companies face weaker growth they:

● slow wages growth, which we are seeing currently

● do less hiring, which means unemployment is higher, or there is a preference for casual rather than permanent employees. The slow pace of hiring is especially hard on young people trying to enter the workforce.

These impacts have second round consequences for consumer spending, further lowering economic growth.

Slow growth also makes it much harder for governments to repair their finances or sustain them during economic shocks. That is, in a lower growth environment not only does the cost of welfare programs stay high, but tax revenues stay low.

Hence, in aggregate, long periods of lower economic growth implies a radically slower improvement in living standards. Indeed, it may be that, on a per capita basis, we will see declines in living standards.

This risk is shown in the following figure. Historically, two measures of the community’s real standard of living (i.e. gross national expenditure and gross national income) tracked in line with gross domestic product (GDP). The resources boom provided a boost to real incomes and hence we saw a divergence of these measures from GDP, indicating a higher practical standard of living. However, the cessation of the resources boom has seen a correction, and on a per capita basis we are seeing a decline in our standard of living. While this decline is real, since we were above trend, the public is not yet really feeling the consequences of this correction. The risk is that the correction continues past the trend and the public starts to feel a real decline in their standard of living.

Source: RBA

In this environment, the Budget should at every conceivable point have a bias to supporting economic growth. This does not mean ‘spending for spending’s sake’ (see the following two challenges) but instead means that each policy option should not be an undue impediment to growth (e.g. has the most efficient policy instrument been employed? is innovation supported? are the deadweight costs of regulation minimised? etc).

3. Does it encourage productive investment?

Attracting new investment and maximising the returns from such investment should be a national priority.

Australia is endowed with a number of advantages as a destination for investors (rule of law, stable and growing economy) and we have industries that are globally attractive (e.g. mining, agriculture).

We need to be careful not to rest on our laurels.

Global tax competition is a fundamental challenge to Australia’s ability to attract international investment.

It would be too much to hope for substantive tax reform (which has been put into the ‘too hard’ basket), but we need to be vigilant to ensure that any changes to taxation arrangements do not stifle investment attraction, and indeed should be focused on making Australia a more attractive place in which to invest.

From the government perspective, we need to ensure that investment is productive.

Spending on infrastructure is too often seen as a virtue in and of itself. How many times have we seen politicians in hard hats and fluro vests standing with a shovel in hand and proclaiming that the construction of [insert road/bridge/playground/etc] will generate so many jobs.

Are the Government’s expenditures on the ‘right’ things? That is, is the investment supporting the most productive economic outcomes (i.e. rather than the most productive political outcomes), and not crowding out private sector investment?

4. Is the fiscal position sustainable?

Treasury’s Corporate Plan states that ‘Fiscal sustainability will be achieved by identifying effective and efficient government spending arrangements and reducing pressure on the Government's revenue base by improving the structure and integrity of the tax system.’

While the political emphasis tends to be on ‘when we will be back in surplus?’ The manner in which we get there is possibly more important than a definitive timeframe around a return to surplus:

● Again, barring substantive tax reform to make our tax base more sustainable (i.e. switching taxation to more efficient tax methods) we need to be wary if the path to surplus is underpinned or accelerated by temporary stimuli (e.g. potentially unsustainable increases in our terms of trade).

● On the spending side:

○ does each part of the community ‘chip in’ in some way, or does one sector/demographic make all the sacrifices? Unbalanced sharing of the ‘pain’ of reduced spending is unlikely to be sustainable.
○ do government departments and agencies have the right incentives to reduce their own operating costs and find new more efficient ways of delivering services to the public?

 

Footnotes:

1. See Steven Spurr 2017, “Trust Free-Falls in the Land Down Under” at http://www.edelman.com/post/trust-free-falls-in-the-land-down-under/

2. Due to the more precise nature of forecasting one year in advance, the nearest forward estimate for each year has been removed to reduce the noise in the chart

3. https://www.pwc.com/gx/en/issues/economy/the-world-in-2050.html
 

 

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