Economic Insider: Federal Budget Review with Alan Langford
18 May 2015
Austerity from last year gives way to efforts to underpin growth in the small business “engine room” of the economy.
- Small business the big winners from the budget (those with turnover less than $2 million).
- They get immediate depreciation write-off of multiple assets worth up to $20,000 each for the next two years.
- And a reduction in their corporate tax, from 30% to 28.5% if incorporated.
- Or a 5% discount on their tax bill if unincorporated.
- Budget generally much less austere than last year’s.
- So deficit declines much less slowly.
- Still plenty of work to do with fiscal consolidation (meaning budget repair), which will be taken up in the white papers on the tax system and the federation.
- Budget assumes a further significant fall in the terms of trade in 2015-16, but then a levelling out in 2016-17, which is heavily dependent on commodity prices bottoming as well.
- The budget assumes a 77 cent exchange rate throughout its four year forecasting/projection horizon. If it is closer to 70 cents, at least in 2015-16, the tourism, rural and education sectors should fill much of the void left by the end of the construction phase of the resources boom.
Stung by the fallout from last year’s austere budget, including the failure to get so many of its measures through a hostile Senate, the federal government has elected to slow the pace of fiscal consolidation markedly. So rather than return the budget to surplus sooner rather than later, this year’s budget reduces the deficit from a peak of 4.2 per cent of GDP in 2009-10 (when it was ravaged by the GFC), to 2.1 per cent in 2015-16, then further to 0.4 per cent in the final of the budget’s “out years” (2018-19).
Apart from the political reality of the difficulty the government had in getting much of last year’s budget through a hostile Senate, the softly softly approach this time reflects the significant decline in key commodity prices since the coalition’s first budget was delivered in May 2014. This in turn triggered a steep fall in the terms of trade - which is the ratio of export to import prices (Figure 1). Had Canberra elected to deliver a scorched earth budget for a second year in a row in the face of a far worse external backdrop, the risk of it tipping the economy into recession would have been enormous.
The exceptionally high peak in Australia’s terms of trade in 2011-12 were predominately driven by sky-high commodity prices, which have subsequently fallen sharply since they peaked in the middle of the 2011 calendar year. While the budget is based on realistic assumptions of commodity prices in 2015-16, they are then bottoming out in 2016-17. But if they don’t, the budget’s real economic growth assumptions (Figure 2) will fall short, in which case budget repair will be that much harder, because the trajectory of economic growth is a bigger driver of the budget’s bottom line than revenue and expenditure measures.
Faced with a disappointing transition from heavy reliance on the construction phase of the resources boom, Canberra needs the rest of the economy to ramp up its investment. So the budget unashamedly taps small business on the shoulder as the “engine room” of growth in the economy.
Businesses with annual turnover of less than $2 million get a cut in their tax rate from 30 per cent to 28.5 per cent if they are incorporated, and a 5 per cent discount on their tax bill if they are not. Moreover, the same turnover threshold is applied to the eligibility for immediate, rather than phased depreciation of purchases, of multiple assets values up to $20,000 each.
Businesses with turnover above $2 million miss out, as does the big end of town. Nevertheless, a less austere budget should give households the confidence to spend more freely than they have since the GFC. And if they do, their demand for goods and services will rise accordingly.
The downside of slower fiscal consolidation is that ‘bigger deficits for longer’ keep pushing Canberra’s net debt even higher. It is projected to rise to $285 billion (17.3 per cent of GDP) in 2015-16, and to a peak as a share of GDP in 2016-17, at 18.0 per cent, before easing back to 16.8 per cent of GDP in 2018-19.
As massive as that sounds, particularly compared to net debt of -$44 billion (-3.8 per cent of GDP) in 2007-08, the net general government debt of all levels of government in Australia is low compared to other advanced economies, including Germany (Figure 3).
Australia’s low level of net debt compared to most other advanced economies in part reflects the lagged effect of very high commodity prices until recently, but what was good for Australia in the boom times leaves its fiscal position vulnerable to a steeper fall in commodity prices in future years. So the imperative to take out a bit of insurance against a very steep fall in commodity prices clearly supports the case for further fiscal consolidation.
This budget goes only part of the way there, and relies on personal tax bracket creep to achieve quite a bit of what consolidation it does incorporate. So the big ticket items in addressing long-term fiscal challenges are outside the budget process itself, and rather, are embedded in the government’s response to white papers on the tax system and the federation.
This year’s budget said nothing that suggests that Canberra had backed away from the announcement in last year’s budget that it intends to strip $80 billion out of assistance to the states for schools and hospitals between 2018 and 2025. So the issue is sure to dominate the federation white paper, but it will cut across the tax white paper as well, given the GST is a tax collected nationally, but carved up among the states. Canberra is clearly hoping that one or more of the states will break ranks and suggest the rate and/or scope of the GST needs to be expanded, but none has taken the bait yet.
Fiscal consolidation would be greatly assisted if the Australian dollar resumes its decline soon. And better yet falls to a 2015-16 average - closer to 70 cents than the 85 cents it has averaged so far this financial year. That would probably be the best-case, rather than realistic base-case scenario, however the dollar is more likely to fall than rise back up as and when the US Federal Reserve raises its equivalent of the RBA’s cash rate target.
It is possible that the first move by the US Federal Reserve could yet be delayed until 2016, but we are still quietly confident that it will occur this year. And if it does, we are equally confident that the Australian dollar will ‘do the right thing’ by falling further, and just as importantly stay at the lower level for more than just a few months. In which case much of the impact of lower commodity prices will be offset by a more competitive currency. That won’t necessarily please importers, but as a big exporting nation, Australia almost by definition does better when its currency is cheap, as it allows exporters to land their wares on world markets at prices attractive to the overseas purchaser.
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Chief Economist, Bankwest