Why a cost-cutting Government still has a budget problem

by John Daley

Published by The Australian Financial Review, Monday 6 October

Five months after Treasurer Joe Hockey delivered the 2014-15 budget, it’s time to take stock. Are the books going to balance – or at least show less red? And if they don’t, what are the options?

The 2017-18 budget outcome will be better than this year’s, but it will not more or less balance as the Treasurer projected on budget night. At the current rate, the 2017-18 deficit may well be more like $12 billion.

A deficit of $12 billion is still a lot better than the $49 billion deficit for 2013-14. Most of our political debate is about the explicit proposals the government made in the 2014-15 budget. These would improve the 2017-18 budget position by $17 billion.

But the budget balance will improve mostly because of decisions the government has not made. The Commonwealth will collect about 1.5 per cent of gross domestic product more in personal income tax in 2017-18 than 2013-14. That difference is worth about $29 billion in 2017-18 – almost double the value of the explicit budget measures. Capital gains tax receipts are expected to increase as taxpayers run out of losses accrued during the global financial crisis. Bracket creep will do a lot of work.

Thus, most of the improvement in budget balance over the next four years is a result of doing nothing. However, political events do account for the difference between the more or less balanced budget planned for 2017-18, and the looming deficit in reality.

Almost half (by value) of the measures announced on budget night have not passed. Despite agreement last week on a number of welfare changes, measures worth $7.5 billion in 2017-18 seem unlikely to pass.

The largest items are changes to the family tax benefit ($2.8 billion), medical co-payments ($1.7 billion), changes to the student loans scheme ($1.7 billion) and indexation of petrol excise ($1 billion).

By contrast, things don’t change much as a result of the debate over the minerals resource rent tax. The final legislation slowed the transition, but by 2017-18 policies associated with the tax will have been abolished, including small business tax concessions, the schoolkids’ bonus and low income super contributions. Because these policies cost more than the mining tax raised, the 2017-18 budget will be $2.8 billion better off.


The 2017-18 budget will also be dragged backwards because the starting position has deteriorated. The ALP has not yet passed measures that it proposed when in government, worth about $2 billion in 2017-18, including deferred tax cuts, reductions in research and development tax incentives, and converting student start-up scholarships to loans.

Mining prices have also declined faster than forecast. Although it is hard to reconcile Treasury forecasts directly to spot iron ore prices, current prices seem to be about 15 per cent lower than Treasury forecast for December 2014, and 5 per cent lower than the forecast for June 2016. If these trends continue, tax receipts will be about $3 billion per year lower than forecast.

So the budget has a substantial problem. The combined effect of unpassed measures from the 2014-15 budget, unpassed measures from ALP budgets, and lower minerals prices could well deliver a budget deficit of $12 billion in 2017-18.

The problems could get bigger in future years. Even before it has written its white paper, the government has committed to spending 2 per cent of GDP on defence. Budgeted defence spending for 2017-18 is only 1.4 per cent of GDP – so making up the difference would cost $12 billion in 2017-18.

The NDIS will cost an extra $8 billion per year by 2020, although it is not yet clear how much of this the Commonwealth will pay.

What can the Commonwealth government do?

It could change some of the policies that are dragging on the budget. For example, it could abandon proposals for paid parental leave. Imposing the large company levy that is part of the proposed scheme, but not introducing paid parental leave, would improve the bottom line by about $3 billion a year. It’s somewhat unlikely, but the Commonwealth could re-impose a carbon price, which would have collected about $6 billion in 2016-17.

Grattan Institute’s report, Balancing Budgets, outlined other options for budget repair. It identified measures that would make a material difference while dragging less on other things we care about, such as economic growth, the welfare of those in the bottom 20 per cent, and home ownership. Over a decade, the large opportunities include tightening the Age Pension assets test, increasing the age at which people can access old age pensions and superannuation, and reducing tax concessions for super, capital gains and negative gearing. Collectively these could add around $34 billion per year in today’s terms. Individually, none of them will be popular.

The government indicated last week that despite the compromise on welfare reform, it will not back away from its commitment to balance the books. A stocktake of the current situation shows that this is not going to be easy. The gap is larger than planned, there will be additional pressures in future, and the available options are all politically difficult.